London - Fund Managers and Climate Change, Carbon Trading

On Tuesday and Wednesday, we met with the responsible investing managers for F&C Investments, which manages funds totalling about £100 billion, and Insight Investment, which manages about £150 billion. They were slightly different perspectives, but both gave me a good idea of how traditional money managers think about climate change. Clearly they see it as a business risk - particularly in certain carbon intensive industries like electricity production, cement production, aluminium production, oil and gas production, etc, and industries who are at risk for climate change impacts - like insurance and reinsurance.

F&C told us they use their clout to push that top management and board members explain how they plan to address carbon risks and encourage them to pursue energy efficiency and other carbon-friendly (and bottom line friendly) practices. They also try to play a fairly vocal role in the carbon policy debates - encouraging policymakers to quickly set stable, strong, long-term greenhouse gas reduction policies.

We had an informative and frank discussion with Insight Investments - about the role investors can play in addressing climate change by pushing companies to address risk, but also the limitations of investor actions. Investors care about the bottom line - so they see climate change through the lens of risks and opportunities. While carbon is an issue for many companies, for a lot of companies whose energy costs only make up a small percentage of their operating expenses, fund managers don't currently see climate change as a business risk. Whether this is true is another question (I think there are a lot of product-related climate risks as well), but it is the reality currently. And investors are generally skeptical that governments will take bold action on climate change, until the regulations are in place - the regulatory risks will probably continue to be discounted fairly greatly.

We also had a great discussion of some of the shortfalls of carbon reporting practices currently. Most carbon reporting is backward-looking currently, and investors have a strong preference for forward-looking projections, but companies are very reluctant to go there. What's more, carbon disclosures are rarely audited and often are presented in inconsistent and hard-to-compare formats.

Finally, we had a very interesting discussion about the outlook of pension funds - who theoretically should be very long-term investors, but who in practice often take short-term outlooks and demand quarterly returns on 2 or 3 year contracts. This a very serious problem for addressing climate change through investor influence. If investors started thinking a little longer term about climate risks, their investment strategies might change and they and their fund managers might exert leverage on companies in different ways.

On Thursday, we visited with the Carbon Disclosure Project, a non-profit that has gotten large investors like Insight, F&C, and many others to sign a letter asking companies to answer a questionnaire about their carbon emissions and carbon risk management. They've been very successful to date, getting the majority of the world's large companies to begin reporting.

We also met with Patrick Birley, the CEO of the European Climate Exchange, the electronic trading platform that handles the vast majority of the carbon trades for the EU ETS. The ECX is a subsidiary group of the same company that owns the Chicago Climate Exchange. They set up their exchange by contracting with Intercontinental Exchange, which already trades most European energy commodities. ECX only has 5 staff, which surprised me.

Patrick's a real market capitalist, having spent 14 years setting up the South African derivatives trading market after the fall of apartheid. We had a great discussion about some of the nitty gritties of carbon trading strategies and the process and risks of setting up an exchange. While a lot of CDM trades initially started out as bilateral contracts, many are now moving toward exchanges, because the counterparty risk (risk that your contracting party defaults) is reduced. In an exchange trade, that risk is assumed by a clearinghouse. Particularly these days, with some carbon developers risking default because of quickly falling carbon prices, exchange trades are safer. They can also provide some anonymimity to traders who like to keep a low profile.

The ECX only currently trades futures contracts, but will soon open a spot market, after seeing the success of a French spot market exchange called BlueNext.

All in all, learned a lot.



Group shot with Patrick Birley, CEO of ECX, outside their office.