The world needs green sovereign funds

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Institutional investors are increasingly embracing the effort to achieve net-zero greenhouse-gas emissions by 2050. Some are already implementing portfolio measures and incorporating climate factors into their decision-making. 

The United Nations-convened Net-Zero Asset Owner Alliance, which one of us chairs, has welcomed 46 members, comprising pension funds and insurance companies representing some $6.7-trillion in assets under management.

The steps taken this decade will be decisive as regards hitting the mid-century target. Of the alliance’s members, 23 have publicly issued greenhouse gas reduction targets for 2025, which means they are committed to acting immediately. The remaining five members that are required to set targets this year will declare similar interim goals soon. Net-zero initiatives are also being established in the investment-management and banking industries, representing $43-trillion and $37-trillion in assets under management, respectively. 

And yet, sovereign wealth funds — representing assets under management totalling about $10 trillion — are absent, even though some are owned by governments that have adopted ambitious climate objectives.

Under existing international agreements, greenhouse gas emissions are measured at the country level, which understates the potential climate impact of countries with large foreign-asset holdings. For example, the Norwegian sovereign wealth fund’s total asset holdings are three times the size of Norway’s economy, and its equity-portfolio carbon emissions are about twice the country’s total emissions.

Norway is not alone. A recent report by the International Forum of Sovereign Wealth Funds (IFSWF) shows that sovereign wealth funds around the world are lagging behind. About three-quarters report having less than 10% of their holdings in climate-related strategies, and only 14% have made divestment decisions related to climate or environmental targets. About 24% of sovereign wealth funds consider climate action part of a broader environmental, social, and governance framework, and only 12% have an explicit climate-change policy.

To be sure, the forum’s Generally Accepted Principles and Practices (the Santiago Principles) do not specify sustainability requirements for sovereign wealth funds. But governments of countries that have sovereign wealth funds should view the United Nations Climate Change Conference in Glasgow (COP26) in November as an opportunity to commit fully to the net-zero programme.

There are several reasons they should do this. For starters, 2050 net-zero targets are becoming a mainstream expectation for all large institutional investors. If a government chooses not to commit its sovereign wealth fund to this goal, it will be free-riding on the growing share of the private financial sector that is already going green.

Moreover, it makes little sense for governments seeking to be consistent in their climate commitments to separate sovereign wealth fund portfolio emissions from overall climate objectives. The domestic focus of international climate agreements should not be interpreted as a free pass for emissions associated with foreign investments. Instead, governments should be using their sovereign wealth funds’ financial weight to drive climate action internationally.

Last, the transition to a low-carbon economy represents the biggest investment opportunity in decades. Shifting from “brown” to “green” will require changes on the scale of another industrial revolution; those who create new markets or enter them early stand to reap huge returns.

As one of the few sovereign wealth funds with an explicit emissions-reduction objective, the New Zealand Superannuation Fund has already begun 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 that were 0.6% higher than its standard benchmark portfolio. By contrast, Norway’s sovereign wealth fund missed out on $126-billion in potential returns during the same period, because it invested in oil and gas instead of green stocks.

Because many countries with sovereign wealth funds have historically been heavily dependent on their oil and gas sector, the transition away from fossil fuels exposes them to larger economic risks. But governments can mitigate these risks by aligning their sovereign wealth funds with climate targets. 

A total portfolio approach would enable these governments to start delinking domestic economic growth from sovereign wealth funds returns, thereby enhancing the robustness of the economy as a whole.

For sovereign wealth funds, as for other institutional investors, staying on the sidelines of the global climate-mitigation effort is no longer an option. But nor is it enough to focus solely on climate-related portfolio risk while ignoring a fund’s broader climate impact. Were sovereign wealth funds to get serious and join the Net-Zero Asset Owner Alliance, they would be required to set stronger emissions targets every five years, reporting annually (alongside the usual financial disclosures) on their progress toward meeting them. They would also be expected not only to invest in green assets but also to develop new sustainable assets themselves.

Countries such as France, Ireland, New Zealand, Norway, Singapore, and the United Arab Emirates are well placed to lead a global sovereign wealth fund movement toward net-zero commitments at COP26. If they do, other funds with large investment teams and sophisticated operations may soon follow, and those with fewer resources would, one hopes, be close behind them.

Most sovereign wealth funds were established as savings vehicles for future generations. It stands to reason that these funds should contribute to the conservation of the climate on which those generations will depend.  

A point of concern relates to the expectations from emerging and developing nations that historically have contributed less to global emissions than the heavily industrialised nations. 

The tension point seems to be that at the time when such nations are finally harnessing the dividend from their natural endowments — for example, coal in South Africa — the global consensus seems to be shifting in the opposite direction. The question that arises is whether countries that have contributed a small fraction of global emissions should now be expected to embrace the shift towards the green economy at the same pace and scale that industrialised nations are doing. Nevertheless, it is noteworthy that one of the largest asset managers in South Africa, Ninety One, has committed itself to the net zero alliance. 

A secondary question relates to the practicality of the shift towards a green economy. According to former Glencore chief executive Ivan Glasenberg, the world does not have enough green energy sources to replace the energy being harnessed from fossil fuels. In other words, a roadmap towards a green economy will, in the short term, take place alongside a continued reliance on fossil fuels. 

To this end, while mining giants such as Anglo American have actively divested from fossil operations, Glencore has been maintaining — and in some cases acquiring — such assets under the proviso that they would rather keep such assets operational and viable to keep producing energy for the world, while gradually shifting towards green energy.

The cost of the transition itself remains another tricky aspect, particularly for developing nations. In one anecdotal example, countries such as South Africa that suffer from a shortage of electricity would struggle to provide electricity required by electric cars, for example. 

In simple terms, the transition would first require a stable energy supply using the current fossil-based sources and then shift to electric vehicles as a secondary step in the transition. This anecdote is relevant across far too many countries in Africa that still suffer from energy shortages.

For South Africa in particular, many employees in the fossil industry would be displaced in the absence of alternative employment opportunities. That risk, in a country with high unemployment levels, will be a critical consideration in the country’s roadmap towards 2050.

Håvard Halland is senior economist at the OECD Development Centre. Günther Thallinger, a member of the board of management of Allianz SE, is chair of the UN-convened Net-Zero Asset Owner Alliance. The views in this article, which was written for Project Syndicate, are the authors’ own. Khaya Sithole is a Mail & Guardian columnist and host of Power Perspective on Power FM