Where are the green sovereign wealth funds? by Håvard Halland & Günther Thallinger
Much of the global financial sector is rallying behind the mid-century net zero emissions goals, recognizing the opportunities that will come with the transition to a low-carbon economy. The longer SWFs sit on the sidelines, the more they and their countries stand to lose.
PARIS / MUNICH – Institutional investors are increasingly committed to the goal of achieving zero net greenhouse gas (GHG) emissions by 2050. Some are already implementing portfolio measures and integrating climatic factors in their decision making. The Net-Zero Asset Owner Alliance, convened by the United Nations (which one of us chairs) has already welcomed 46 members, comprising pension funds and insurance companies representing some $ 6.7 trillion in assets under management (AUM).
The actions taken this decade will be decisive in achieving the mid-century goal. Among Alliance members, 23 have publicly released 2025 GHG reduction targets, meaning they have committed to act immediately. The other five members who are due to set targets this year will soon declare similar milestones. Net zero initiatives are also being implemented in the investment management and banking sectors, representing respectively $ 43 trillion and $ 37 trillion in assets under management. And yet sovereign wealth funds (SWFs) – representing AUMs totaling around $ 10 trillion – are conspicuously absent, even though some are owned by governments that have adopted ambitious climate goals.
Under existing international agreements, GHG emissions are measured at the country level, which underestimates the potential impact on the climate of countries with significant foreign assets. For example, the Norwegian sovereign wealth fund’s total holdings are three times the size of the Norwegian economy, and its carbon emissions in its equity portfolio are roughly double the country’s total emissions.
Norway is not alone. A recent report from the International Sovereign Wealth Fund Forum (IFSWF) shows that sovereign wealth funds around the world are lagging behind. About three-quarters say they have less than 10% of their stakes in climate-related strategies, while only 14% have made divestment decisions related to climate or environmental goals. While 24% of SWFs see climate action as part of a larger ESG (environmental, social and governance) framework, only 12% have an explicit climate change policy.
To be sure, the IFSWF’s own generally accepted principles and practices (the “Santiago Principles”) do not specify sustainability requirements for SWFs. But governments of countries that have sovereign wealth funds should see the United Nations Climate Change Conference in Glasgow (COP26) in November as an opportunity to fully commit to the net zero agenda.
There are several reasons why they should do this. For starters, the 2050 net zero goals are becoming a common expectation for all large institutional investors. If a government chooses not to commit its sovereign wealth fund to this goal, it will benefit from the growing share of the private financial sector that is already going green – a climate finance paradox if ever there is one.
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Additionally, it does not make sense for governments seeking to be consistent in their climate commitments to separate SWF portfolio emissions from overall climate goals. The national focus of international climate agreements should not be interpreted as a pass for emissions associated with foreign investment. Instead, governments should use the financial weight of their sovereign wealth funds to drive climate action internationally.
Last but not least, the transition to a low carbon economy represents the greatest investment opportunity in decades. The shift from “brown” to “green” will require changes on the scale of another industrial revolution; those who create or enter new markets early should reap huge rewards.
As one of the few sovereign wealth funds to have an explicit emissions reduction target, the New Zealand Superannuation Fund has already started to seize these new opportunities. Between 2017 and 2020, the fund’s low-carbon benchmark portfolio, which comprises 40% of its total assets, generated returns 0.6% higher than its standard benchmark portfolio. In contrast, the Norwegian sovereign wealth fund missed out on $ 126 billion in potential returns over the same period as it invested in oil and gas rather than green stocks.
Since many countries with sovereign wealth funds have historically been heavily dependent on their oil and gas sector, the transition from fossil fuels exposes them to greater economic risks. But governments can mitigate these risks by aligning their sovereign wealth funds with climate goals. A holistic portfolio approach would allow these governments to begin to decouple national economic growth from sovereign wealth fund returns, thereby strengthening the robustness of the economy as a whole.
For sovereign wealth funds, as for other institutional investors, staying on the sidelines of the global effort to mitigate climate change is no longer an option. But it is also not enough to focus solely on climate-related portfolio risk while ignoring the broader climate impact of a fund. If SWFs got serious and joined the Net-Zero Asset Owner Alliance, they would be required to set stricter emissions targets every five years, reporting annually (in addition to the usual financial disclosures) on their progress for reach them. One would also expect them to invest not only in green assets, but also – and most importantly – to develop new sustainable assets themselves.
Countries like France, Ireland, New Zealand, Norway, Singapore and the United Arab Emirates are well positioned to lead a global movement of sovereign wealth funds towards net zero liabilities at COP26. If they do, other funds with large investment teams and sophisticated operations may soon follow, and those with fewer resources would hopefully be closely behind them.
Most sovereign wealth funds were created as savings vehicles for future generations. It goes without saying that these funds should contribute to the conservation of the climate on which these generations will depend.
The opinions expressed in this article are those of the authors and do not necessarily represent those of the OECD.