United States: Activist Investors' Group Issues Guide To Investors On Engagement With Electric Utility Sector Boards And Management Regarding Climate Change Risk

On April 29, 2016, the Institutional Investors Group on Climate Change ("IIGCC") released the latest publication in a series of guides aimed at increasing investor activism at the corporate board and senior management levels regarding potential risks associated with climate change. The report, titled Investor Expectations of Electric Utilities Companies: Looking down the line at carbon asset risk, targets the electric utility industry, with the purpose of setting out "guidance for constructive engagement by investors with the boards and management of electric utilities." Report at 2.

IIGCC prepared the report in coordination with the Investor Network on Climate Risk (a project of Ceres), the Investor Group on Climate Change, and the Asia Investor Group on Climate Change. Each of these organizations represents investors, asset managers, and financial institutions in voicing their positions on public policies, investment strategies, and corporate best practices related to the "risks and opportunities" associated with climate change.

IIGCC Goals for the Report. In the report, the IIGCC suggests that a lack of transparency exists in the electric utility sector with respect to climate risk disclosure, and it concludes that this lack of transparency affects the investment community's ability "to calculate their portfolio's carbon intensity, assess carbon asset risk and evaluate dependence upon 'reliable' water resources." Report at 4. The report further cites to recent actions by the G20 Finance Ministers asking the G20's Financial Stability Board to convene dialogues with public- and private-sector participants regarding opportunities to improve climate risk disclosures. The IIGCC report focuses on the energy sector, and the recommendations are intended to operate in coordination with the IIGCC's 2012 report titled Institutional Investors' Expectations of Corporate Climate Risk Management.

In support of its conclusions that the energy sector would benefit from increased investor dialogue, the report concludes that changing business models in the electric utility sector as well as the expanding nature of the regulatory framework for this sector drive the need for increased discussion and reporting. Specifically, the regulatory drivers cited are emission reduction targets, incentives for renewable energy, carbon pricing, and water resource management policies and rules. Report at 5-7. Demand dynamics involved in the changing business models include shifts in growth markets, corporate demand for renewable energy and renewable sources, and legacy assets associated with high-carbon power plants. Report at 9.

IIGCC's Guide to Investors in the Electric Utility Sector. Based on these underlying premises, IIGCC presents a guide for expectations and key questions that they believe the boards and senior management of electric utilities should be considering. Referred to as "investor expectations," the report describes six key categories of factors related to climate change on which corporate boards should focus, as follows:

  1. Governance. The report encourages utility boards to establish procedures for climate risk accountability, including management responsibilities, capabilities, and processes. Investors are directed to ask of utility boards: "Who is responsible for managing climate risk?"
  2. Carbon Stress Testing. This category involves a review of the target utility's plan to move to a lower-carbon business model, recognizing that traditional power generation will take time to transition. The report presents a series of detailed questions that IIGCC believes investors should pose to utilities regarding long-term planning for a "2 degree scenario stress test" and other technology and regulatory-based changes in business models. Report at 11.
  3. Consumer-Facing Strategy. With a focus on "business model innovation," the report asks investors to query how the company will develop its consumer-facing services. The report cites examples of Smart Meter marketing, energy efficiency, and energy services as areas of potential growth.
  4. Operational Efficiency/Resource Management. The report presents questions for investors to pose regarding the operational goals for electric utilities with respect to efficient use of existing assets and natural resources, such as water resources. It also focuses on the extent of water scarcity risks.
  5. Public Policy. Consistent with recent public efforts of similar groups, the IIGCC report asks electric utilities to make public their positions regarding environmental legislation, such as climate-related initiatives, and their lobbying efforts related to these measures. Investors are asked to avoid investment in companies that lobby against these types of measures, either directly or indirectly via associations with which they are a member.
  6. Transparency and Disclosure. This component focuses on the IIGCC's primary conclusion: that electric utilities should disclose in annual reports or through other corporate venues, such as their website or CDP (formerly the Carbon Disclosure Project), their views of and response to carbon asset risks.

The report encourages investors to use data generated by CDP in developing questions and expectations for target utilities. The CDP data is correlated to the IIGCC findings and recommendations in a report published in conjunction with CDP.

Importance for Utility Sector Boards and Management. Many electric utilities already keep information relevant to these categories as part of their routine management business operations. What is different about the six categories is that much of this routine business information is not currently disclosed, and the report and the recommendations suggest that some investors may now want to have it. A close understanding of IIGCC's conclusions and the guidance it is giving investors will allow utilities to better respond promptly and robustly to investor inquiries. It also may be appropriate to review existing disclosures with a view to their responsiveness to the issues identified in the six categories. Finally, the electric utility sector is encouraged to continue tracking similar studies and reports, including the recent release by the Task Force on climate-related Financial Disclosure's Phase I report, dated March 31, 2016, to the Financial Stability Board as described above.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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