Neil Mitchell examines the structures behind the governance of the climate commons through a social network analysis
In her classic 1990 book Governing the Commons, Nobel Prize-winning economist Elinor Ostrom provided an optimistic antidote to the gloomy predictions of Garrett Hardin’s 1968 essay ‘The Tragedy of the Commons’. Citing real-life examples of fishing rights, cattle grazing and irrigation spanning thousands of years, it transpires that, despite the selfishness of individuals and the temptation to free-ride, mankind can solve environmental problems. Moreover, we can do this by voluntarily building collaborative institutions, without relying on the state or the market. How are these institutions evolving in the battle against climate change? Where did they come from? Who writes the rules?
During the past few years, the UN has logged 151 co-operative initiatives, involving more than 28,000 ‘actors’ (climateaction.unfccc.int). Much of this development is taking place in finance and institutional investment. More than 8,000 separate entities have made one or more commitments or pledges to initiatives with a finance theme (see Table 1). Through social network analysis (SNA) – a diagrammatic representation of links – we can examine who they are.
The UN PRI and investor networks
One way to commit is to make a pledge. The UN Environment Programme Finance Initiative (UNEPFI) backs the Principles for Responsible Investment (PRI). Around 4,700 asset owners, asset managers and service providers use the PRI badge in exchange for pledging to behave consistently with its principles – incorporating, promoting, implementing, disclosing and reporting on environmental, social and governance issues. The Principles for Sustainable Insurance and Principles for Responsible Banking contain similar commitments.
Another way is to join a network. The Glasgow Financial Alliance for Net Zero (GFANZ) is a collection of networks that originated with the Net Zero Asset Owners Alliance (NZAOA) and was expanded at COP26 to include investment managers, insurers, banks, service providers and investment consultants. Members pay a fee and commit to meeting net-zero targets for the approximately US$130trn of assets under management. More than 600 investors have also joined one of the four regional networks responsible for the Investor Agenda and the Paris Aligned Investment Initiative (PAII), all of which aim to accelerate investor action, align portfolios and promote policy advocacy. Similarly, the Global Sustainable Investment Alliance is a network of regional forums, such as the UK Sustainable Investment Forum, promoting the wider sustainable investment agenda beyond climate change to include the UN’s Sustainable Development Goals.
“More than 8,000 separate entities have made one or more commitments or pledges to initiatives with a finance theme”
These initiatives shape the climate agenda by carrying out research, producing reports, providing training, technical support and investment tools, and lobbying for policy change. Many employ small teams of experts but are governed by boards, committees and steering groups made up of representatives from the finance and investment industry. More than 500 institutions are represented.
This governance is dominated by a handful of large multiple financial service groups. Pension schemes are under-represented, despite holding around two-thirds of the US$100trn of institutional money globally – their voice is only heard indirectly through their asset managers and advisers.
Activism – engage versus exit
In terms of shareholder activism, there are two options: engage or exit. Engagement can only succeed through collective action, and several prominent initiatives are active here. Climate Action 100+ (an initiative of the PRI and Investor Networks) has identified 167 of the world’s most carbon intensive companies and galvanised around 700 investors to use their collective voting power to actively engage with them. The Investor Decarbonisation Initiative (IDI), a Share Action initiative supported by 135 investors, has a similar engagement agenda.
Some campaign groups argue for a more direct approach based on excluding fossil fuel companies from investment, instead investing in renewables. DivestInvest has more than twice as many signatories as Climate Action 100+, but the majority come from faith-based organisations and philanthropic endowments, and many do not take part in other initiatives (see Figure 2). Only a handful of multiple financial services groups opt for ‘exit’, with most asset managers and pension schemes choosing ‘engage’. Those that do choose ‘exit’ tend to be more active in other initiatives.
Disclosure – risk versus impact
‘You can only manage what you can measure’ is a common investor mantra. The Task Force on Climate-Related Financial Disclosures (TCFD) framework has been widely adopted, making exposure to climate risks more transparent. However, viewing climate through a risk lens is just one approach, and investors are also under pressure to recognise the impact they have on the environment – so-called ‘double materiality’.
The dominant accounting standard for risk disclosures is the Sustainability Accounting Standards Board (SASB), now subsumed into the International Sustainability Standards Board. Initiatives such as the UK’s longstanding Carbon Disclosure Project (CDP), Dutch bank-initiated Partnership for Carbon Accounting Financials (PCAF) and the Prince of Wales Trust’s Accounting For Sustainability are also widely supported in the investor community. The Global Sustainability Standards Board (GSSB), part of the Global Reporting Initiative (GRI), has a more impact focus, as do several networks, thinktanks and campaign groups such as the Global Impact Investing Network (GIIN), France’s private equity-focused Initiative Climat International (iCI) and the UK’s Impact Investing Institute (III) and Pensions For Purpose (P4P).
“Acting through alliances and networks, institutional investors can go beyond simply altering the allocation of capital among publicly listed companies”
Figure 3 uses SNA to separate the initiatives into those with a ‘risk’ focus and those with an ‘impact’ focus, showing which organisations support each. Once again, the multiple financial service companies feature heavily, signing up to both risk and impact initiatives. Pension schemes are largely absent from ‘impact’, probably reflecting difficulties with fiduciary duties – the prospect of sacrificed returns potentially conflicting with responsibilities to their members.
The power of investors
Large privately-owned financial services companies are at the core of this framework. Is their agenda to change the world, or are they in it for private gain? Ostrom cited several design criteria that are necessary for collaborative institutions to be successful in collective action problems: clear boundaries and membership, congruent rules and collective choice arenas, robust monitoring, sanctions, and conflict resolution mechanisms. Without them, institutional frameworks develop with varying degrees of success – sometimes going through decades of experimentation, and often failing. There is no room for self-interest. Spanning nations, the climate change ‘commons’ does not have the luxury of localised structures and common legal frameworks. Would these evolving initiatives pass robustness tests? Without policy change, probably not.
Despite carbon commitments from national governments and the gradual mandating of TCFD disclosures, policy frameworks are weak and most initiatives are voluntary, with minimal formal monitoring or sanctions. Effective collective action means more than just setting expectations about behaviour, disclosure and engagement; it extends to wider policy advocacy and the management of systemic risk.
There are signs that the finance industry is starting to recognise this. In the recent NZAOA report The Future of Investor Engagement, leading asset owners stressed the need for asset owners and managers to recognise the limitations of single-company corporate engagement and be willing to use their collective might to engage with wider sectors, value chains and policymakers. This includes acting against obstructionist lobbying activities, and influencing managers to move away from the ‘alpha’ culture of the investment industry. Acting through alliances and networks, institutional investors can go beyond simply altering the allocation of capital among publicly listed companies, instead shaping policy on matters such as carbon pricing and other incentives. Statements to governments by the Investor Agenda and GFANZ are important examples.
Asset owners, their advisers and managers sit at the table of the rules-setting bodies; they must treat management of systemic risk as a natural extension of fiduciary duty, taking a universal ownership approach where possible. By setting clear expectations of their expanding memberships, collaborative networks and alliances can start to influence investment decisions.
Neil Mitchell is a sustainable development finance researcher at the University of Manchester and a member of the IFoA’s Sustainability Board
Image credit | Ikon-Patrick George