Great. Thank you very much for the invitation for me to contribute to this very important topic.
From the outset, I should say that I'm a strong ESG advocate. I understand the importance of taking ESG factors into account for both society and long-term financial value. However, my views on this topic will be somewhat more nuanced. I hope these nuances will be of help to this committee.
The text of the motion refers to alignment with the Paris Agreement and promoting “the reduction of inherent risks”. It's important to be clear on what these risks are. These could be risks to society, which we often call impact, or risks to the portfolio of a financial institution, which is often called dependency. Obviously, in many cases these overlap. A lot of my own research is on the overlap between what's good for society and what's good for shareholders, but they don't always overlap, and it's important to be mindful of these trade-offs. For example, if there's limited government action, then investing in fossil fuels poses limited risk to your portfolio. In fact, boycotting fossil fuels could lead to more risk, even though this is a risk to wider society.
I also recognize that it mentions alignment with the Paris Agreement. However, there is evidence suggesting that we might be going for 2.7°C rather than 1.5°C. It's not actually clear whether it's prudent to have a portfolio that will do well in a 1.5°C scenario. The question then is, what should the objective be? Should we only take into account risks to the portfolio, or do we think financial institutions have a moral or societal obligation to take into account risks to wider society? It's not clear.
It's clearly not for me to say what the objective should be, but let me give some guidance as to what might be the implications of different objectives.
In terms of banks—part of the motion mentions “banking institutions”—they do need to be solvent for their depositors and also for wider society. Otherwise, losses could be leading to some pain in bailing out the banks. It may well be that the investment lending decisions that are good for climate change might not actually be good for the portfolio. If they were good for the portfolio, then, as Professor Damodaran was saying in the early session, why do we need regulation to encourage banks to take this into account? They would do this anyway. As well, why climate risk and why not the risk of a cyber-attack or a pandemic? There are lots of other material risks for banks.
For pension funds, which are also mentioned, again it's not clear what the objective should be. The objective might be to maximize retirement income for pensioners. Now, for me as a pensioner, I actually don't have that as my objective. I invest in climate-conscious funds, but I can choose to sacrifice my return. I am able to afford it. Other people might not be able to, so it may be that their objectives are purely financial.
Now, let's say we do care about impact and that we do want the objective to be more than just financial returns but impact on wider society. It's not clear how we achieve this. One view is divestment. Indeed, net-zero alignment, or Paris alignment, often refers to a portfolio that divests fossil fuels, but there's a lot of academic evidence suggesting that divestment, particularly in equity markets, has limited impact. If you sell and somebody else buys, given the fluidity and the liquidity of capital markets, the actual cost of capital impact is pretty small.
Another view is engagement. Engagement many times can be micromanagement. It might be that investors who could be uninformed are imposing more one-size-fits-all rules on companies, whereas a company might be better placed to understand the risks that are most material to it.
Finally, let's say we do care about the impact on wider society. The impact on wider society is more than just the impact on the environment. I agree again with Professor Damodaran about the concerns of black and white thinking.
I just got back from the World Economic Forum in Dubai, where we were facing the just transition. One woman from Africa got up and said that in Africa, 600 million people do not have access to electricity. We were talking about a just transition when 600 million of her citizens have nothing to transition from. Another person referred to a doctor in Sierra Leone. There was a power cut, and babies died in a neonatal unit. These are issues that maybe we in the west don't acknowledge. Given that the committee is in Canada, maybe the focus is on Canada, but we often view the west versus Africa in black and white terms. There might be people in Canada who have energy poverty.
Now, this is absolutely not to say that climate change is not a serious issue; it is absolutely a serious issue. I've devoted a large part of my career to addressing this issue, but I'm hopefully highlighting some of the concerns and some of the difficult trade-offs that might come about from pursuing this.
