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Climate disasters creating risks in investing | COMMENTARY

In this Sunday, Sept. 27, 2020, file photo, Flames from the Glass Fire consume the Black Rock Inn in St. Helena, California. Deadly wildfires in the state have burned more than 4 million acres (6,250 square miles) this year, a new record for the most acres burned in a single year.
In this Sunday, Sept. 27, 2020, file photo, Flames from the Glass Fire consume the Black Rock Inn in St. Helena, California. Deadly wildfires in the state have burned more than 4 million acres (6,250 square miles) this year, a new record for the most acres burned in a single year. (Noah Berger/AP)

Investors around the world have recognized in recent years the need to take stock of increasing risk related to the climate crisis, as industries are forced to absorb losses from extreme weather events. The number of impacted industries continues to expand, pushing past well-known energy, agricultural and infrastructure concerns into real estate, insurance and beyond.

This increasing risk should not come as a surprise. The U.S. has sustained more than 265 climate-related extreme weather events since 1980, with losses exceeding $1 billion and resulting in accumulated costs of more than $1.78 trillion, according to the National Centers for Environmental Information. This summer’s deadly Hurricane Laura and the destructive wildfires in California add to a string of extreme weather events in the past five years that had already caused losses in the U.S. totaling more than $500 billion.

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And, as some companies transition away from carbon-based energy sources or water-intensive manufacturing processes in response to global warming and water scarcity, investors have found opportunities among companies innovating solutions. The potential for both risk reduction and increased investment returns in assessing these trends are real and significant.

Despite the clear climate crisis, with its dangers and opportunities, the U.S. Department of Labor (DOL) Employee Benefits Security Administration has proposed a rule that would make it more difficult for pension fund managers to adequately consider environmental, social and governance (ESG) risks and opportunities in their investment decisions. In its proposed Financial Factors in Selecting Plan Investments, the department would change standards allowed for considering these kinds of risks, differentiating them from other financial information covered by the Employee Retirement Income Security Act (ERISA).

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As treasurer of Maryland, charged with stewarding the investments of the state and protecting pensions of hundreds of thousands of Maryland state workers, teachers and retirees, I believe it would be a breach of my fiduciary duties not to adequately analyze and integrate these risks and opportunities in critical investment decisions. The Department of Labor’s proposal is misguided. It will make it more difficult to incorporate these essential investment factors, ignoring both current economic and market trends.

Evidently, my assessment is shared by thousands of investors. According to an analysis of the 8,700 comments received by the DOL in this proceeding, 95% of those who commented opposed the department’s proposed rule. Opposition was particularly strong among institutional investors — asset managers, financial advisers, financial service providers, asset owners, pension plans and investment organizations — either unanimously or all but unanimously opposed to the proposal. The analysis, carried out by seven large investment and research organizations including Morningstar, Ceres and US SIF, found that comments in opposition commonly cited that the DOL proposal “includes no evidence that fiduciaries choose investments that are likely to have lower returns in exchange for ESG criteria being considered.” Moreover, they said “the proposed rule largely dismisses the financial materiality of ESG issues and ignores research regarding the materiality of ESG in financial decision-making.”

Across the global economy, the potential financial risks of ESG issues are clearly recognized. Central Banks in many countries have already taken steps to prepare their financial systems for climate and related risks and try to mitigate them. The Sustainability Accounting Standards Board recently found that material ESG risks exist in most every industry and region of the world’s economy.

Indeed, at the same time the Department of Labor is placing barriers to discourage retirement plans covered by ERISA from including these types of funds in their portfolios, recent studies by Standard & Poor’s, Morningstar and others have found that ESG funds are outperforming more broad-based index funds in 2020, while in 2019 such funds performed at par or better than the broader market. And investors and retirement plan beneficiaries want them. Sustainable investing assets in the U.S. reached $12 trillion in 2018, up 38% from 2016, according to a recent US SIF Foundation’s Trends report.

As a member of the Ceres Investor Network on Climate Risk and Sustainability, I concur with Ceres' letter to the DOL in this proceeding and with other investors who believe the DOL should withdraw or significantly modify its proposal. The rule should acknowledge that ESG issues may pose short, medium and long term financial risks, and that when they do, ERISA compels fund managers to treat these issues as economic considerations.

Nancy K. Kopp (nkopp@treasurer.state.md.us) is Maryland State Treasurer.

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