Marketwide stewardship for sustainable outcomes

Systemic risks are risks that are so material that they threaten the continued smooth and sustainable operation of the economy, our society, and even the planet. Many of the systemic risks we face today have their origins in environmental or social issues. In regard to both climate change and nature loss, the scientific evidence of systemic risk is overwhelming, and there’s virtual unanimity in the global scientific community that we look no further than ourselves to find the cause of these risks.

The connection between these risks and the health of the economy has also been clearly established, most recently by the Dasgupta Review in relation to biodiversity loss. This has resulted in wide recognition by central banks and financials sector regulators that climate change and biodiversity loss are risks that threaten the stability of the global financial system. This scientific and regulatory consensus has also led to broad agreement among global leaders that these risks are among the most severe risks the world faces over the next 10 years.   

What is to be done about environmental systemic risks?

A major challenge with systemic risks is getting a consensus to tackle them swiftly. It’s human nature—and a political problematic—to call for more evidence before acting to promote far-reaching change. Some will argue that the overall impact several years out will always be subject to a degree of uncertainty. Others will even suggest that it’s better for each company they invest in to leave it to others to resolve and remain content that inaction might be financially advantageous in the short term. But avoidance and myopia are most likely to only speed the materialization of environmental systemic risks.

As investors, we’re aware that in addition to assessing the immediate and clear risks we face, we must also assess the knock-on, second- and third-order effects that we can’t avoid through diversification and that could carry significant consequences. While we can never be absolutely sure of the future, we’re used to assessing the knowns and unknowns and making reasoned judgments. As an illustration, we can be relatively confident of the first-order impact of climate change; for example, a facility by the shoreline in an area with rising sea levels is exposed to substantial physical risk from rising seas. But it can be far more difficult to predict the knock-on effects of climate change: Some parts of the globe may be rendered uninhabitable through desertification and persistent flooding; that makes significant migration a likely fallout, and the systems that support people, companies, and communities are likely to come under significant strain.

"Avoidance and myopia are most likely to only speed the materialization of environmental systemic risks."

It’s this type of feedback loop in which the initial impact is supplemented and magnified that makes it systemic. The proliferation of known and unknown risks becomes so complex and challenging to predict that it leads to our conviction that we need to act in a systematic and structured way to prevent a negative feedback loop from starting. Our approach to systemic risks stems from our conviction that it’s strongly in the interests of our clients that we act to try to avoid, or weaken, the materialization of those risks as swiftly as possible by using levers at our disposal.

As investors who bear a fiduciary duty to our clients, we believe these systemic risks are highly relevant for the financial health of our clients’ portfolios and the long-term preservation of capital. But it’s exceptionally difficult—and perhaps impossible—to construct a portfolio that completely diversifies away the impact of environmental systemic risks. The potential impact of these risks is far reaching, and their feedback loops could drive unpredictable additional effects that could be unavoidable in the context of a broad portfolio. This is precisely why central banks are taking action—the European Central Bank, for example, has outlined a detailed climate action plan and acknowledges the “need to assess how climate change and the transition to a carbon-neutral society affect our economy, so that we can account for their influence on our work as a central bank and banking supervisor.”

What we mean by marketwide stewardship

Historically, most engagement activities with companies were one-to-one activities focusing on managing risks and opportunities at the enterprise level. This included encouraging companies to manage the implications of systemic risks and to act responsibly, for example, by promoting energy efficiency and reducing greenhouse gas (GHG) emissions and encouraging risk assessment; however, it’s now clear that this isn’t enough. We believe, therefore, that we must tackle these challenges through stewardship activities focused on addressing systemic risk. As an investment manager, we consider this marketwide stewardship as part of our fiduciary obligation.

Over the past years, we and other investors have worked together in a coordinated approach to engagement on climate issues where necessary, and it’s something we’ve committed to as a global asset manager. We’re also acutely aware of the importance of managing and trying to reverse nature loss alongside work to address climate-related issues. We know that both of these sources of risk carry severe implications for asset prices, credit conditions, and global economic stability. Therefore, we can support climate mitigation and adaptation along with reversing nature loss by, as examples, encouraging the development of the Taskforce on Nature-related Financial Disclosures (TNFD), signing the Finance for Biodiversity Pledge, and committing to actions through our business activities.

We not only engage with investee companies, but we also look to encourage a more resilient operating environment for our investments. We believe we can achieve this across multiple pillars of action. We collaborate with regulators and governments to encourage sustainable outcomes for environmentally affected populations and ecosystems. We work with standards-setting bodies and expert groups in an effort to create the most efficient language, metrics, and targets possible to measure climate and natural capital-related risk and performance and then encourage adoption of those frameworks. We engage with environmental, social, and governance (ESG) data vendors on ratings methodologies to ensure accurate and comprehensive data sets. We also believe it’s incumbent on us to do our best to offer education to our investor stakeholders, from individuals to institutions, around sustainability principles and practices. Many of these activities are supported through collaboration with investor peers.

In what follows, we highlight selected examples of engagement that, when taken together, exemplify our strategy of marketwide stewardship. This is how we seek to move the dial on managing, mitigating, and adapting to different types of systemic ESG risks. For the full and most up-to-date list of our engagements, readers can refer to the Appendix of our stewardship report.

1 Encouraging development of robust regulation

Coming out of the UN Biodiversity Conference meeting of the Conference of Parties to the Convention on Biological Diversity (CBD COP 15) in December last year, we saw broad consensus and understanding regarding the overall benefits to the economy from nature and the fact that our broad level of overconsumption is currently beyond regenerative levels.¹ Nature—including ecosystem services as elemental as water, soil health, and pollinators—are woefully undervalued. These forms of natural capital can even be negatively priced, a perverse market-based assessment that’s in dire need of correction.

Governments, however, must now respond through policy development so that companies and investors will be incentivized to act in the right way to preserve the natural environment. As an example, the European Union has acted to prohibit the sale of certain commodities linked to deforestation, which should cause companies to scrutinize their supply chains and encourage more sustainable sourcing practices. The U.S. Inflation Reduction Act of 2022 aims to address several marketwide risks, including emissions reductions, reducing the cost of healthcare, and strengthening taxpayer compliance to fund these and similar risks.

In our role as investment manager, we believe it’s important that we encourage these developments and provide feedback to regulators to strengthen the policy frameworks that will protect investments over the long term for our clients. This is why we continue to engage with governments directly and through collaboration. In 2022, for example, we signed the Global Investor Statement to Governments on the Climate Crisis. This statement calls on governments to take specific actions to address the climate crisis, including adoption of 2030 nationally determined contributions in line with the goals of the Paris Agreement, acceleration and dissemination of technologies that enable the transition to net zero, and scaling up the provision of green finance. In Japan, we’ve been fortunate to work with peers and several different government ministries on positive outcomes, including the creation of green bond guidelines and a road map for promoting transition finance across seven sectors—iron and steel, chemicals, energy, gas, oil, pulp and paper, and cement.

2 Building global standards

Governments, however, don’t need to start at the drawing board to build standards of practice and disclosure. Third-party standards setters such as the International Sustainability Standards Board, for example, pave the way for regulatory frameworks. It remains important for us, therefore, to engage with these standards setters as preregulators and to encourage early action from systemically important actors.

Compared with action and disclosure on climate risk, for example, we’re at a much earlier stage of development for nature. To that end, one of our most urgent engagements on standards setting concerns nature-related risk disclosure and accounting for natural capital. Through both our support of the TNFD and our contribution to the committees of the Finance for Biodiversity Pledge, we’ve worked with peers to define what we believe will be effective frameworks for disclosure and action around nature-related risks, such as biodiversity loss and natural capital degradation.

There have been many challenges to establishing a global framework for this disclosure and behavior, including, first and foremost, defining what nature-positive behavior looks like. Our work with colleagues at the World Business Council for Sustainable Development is advancing what it means to contribute to a nature-positive world. In addition, contributors to this effort have been busy devising technical standards and activities that further develop nature-related accounting methods, as well as publishing prototype standards that adequately address the need for comprehensive and comparable data on nature-related risks.

We believe that with the support of market uptake and regulation, disclosure frameworks with well-designed metrics and targets for nature-related risks could act as a powerful corrective to corporate, sovereign, and investor behavior that continues to undervalue nature.

3 Collaborating to address systemic issues

We work to spur action to address systemic risks by collaborating with peers to engage systemically important and influential issuers. While voluntary and regulatory frameworks are a strong catalyst for action, they’re frequently not sufficient alone. Not only does such positive action from large operators reduce systemic risk, but it also acts as a catalyst for entire industries to follow suit.

One of the most significant of these engagements has been our work as a founding member and an engagement lead within the Climate Action 100+ initiative. Now in its second five-year phase for engaging with the world’s largest GHG emitters, the initiative helps bring together a critical mass of investors, representing trillions in assets under management, who share the objective of ensuring the world’s largest corporate GHG emitters take action on climate change.

The initiative has made strides, as evidenced by corporate commitments for transition-related target setting, board oversight of transition progress, and the fact that 91% of focus companies were aligned with the TCFD recommendations as of December 2022. Climate Action 100+ continues to encourage 168 systemically important issuers to progress toward a net zero future. We continue to believe this collaborative engagement is one of the most powerful global expressions of stewardship activity focused on this systemic risk.

4 Improving the data environment

The global financial system doesn’t yet have the comparable, consistent, and reliable data sufficient to enable market participants to correctly price sustainability risks and opportunities. That said, we’ve seen some acceleration of policy recently with the SEC acting on climate disclosure requirements. The market needs accurate, comparable, and consistent data to price in sustainability risks and opportunities and encourage capital flows to the investments that could be said to be more diligent in their efforts to manage those factors. ESG data, therefore, has risen in importance as an investment tool, with broad applications inside ESG integration, stewardship practices, product development, and investment decision-making. Because this data touches all of these aspects of investing, we engage with data providers to continuously improve their provision of that information.

We engage data providers, for example, to increase the scope of market coverage, to correct erroneous data, and to consider provision of additional data points, as these improvements not only help us make better and more informed investment decisions, but they also provide needed transparency to the market as a whole. In one case, we worked with a data provider to adjust its climate risk temperature gauge model by addressing a category of scope 3 emissions that we believe was being accounted for incorrectly. We engaged another provider to highlight data sources available that demonstrate societal impact of financial entities, such as regional banks, on small and midsize enterprises.

Each of these engagements represents an incremental improvement in the overall data infrastructure that supports sustainable investment. Ultimately, this engagement with data providers not only ensures that we can make better informed decisions for our clients, but also that the market has the right information to encourage capital flows toward the more systematic and potentially effective practitioners in the management of ESG factors.

In our work with regulators, we’ve frequently joined peers and industry groups in sharing our opinions on the potential benefits and blind spots of proposed regulation. A recent example was our June 2022 comment letter to the SEC in response to that body’s proposed climate-related disclosure rule, in which we stated:

"Consistent, reliable, and comparable climate data will significantly enhance our industry’s ability to measure, assess, and manage climate-related risks and opportunities across client assets over the short, medium, and long term."

In our comment letter, we went on to explain how our investment teams use emissions data in due diligence with investee companies, valuation analysis, product design for climate-themed strategies, and assigning a carbon cost in financial models.

We remain mindful that regulation needs to be developed carefully to ensure that the cost of compliance is managed, that companies are genuinely able to respond to the regulation, and that measurement aligns well to investors' goals. We believe that a regulatory framework that leads to the disclosure of the material impacts that companies have on the environment and society will enable investors to make better informed assessments of the risk/reward profile of those companies, and therefore to deliver more effective investment solutions to clients.

5 Building sustainability literacy

We believe that a better understanding of sustainability issues and the systemic risks they present encourages action across the value chain and therefore increases the chances of capital being effectively deployed in consideration of sustainability risks and opportunities. Sustainability literacy, like basic financial literacy, entails acquiring specific knowledge and skills, and we believe it has the potential to advance more comprehensive adoption of sustainable investing strategies given the exigencies of climate change, biodiversity loss, and other systemic risks. We know from our work with institutional and retail investors across the globe that the desire for more education in sustainability is strong, particularly as the actual impacts become more widely apparent as we continue to see climate change affecting our lives in increasingly material ways—not just in investor portfolios but also in live economic and social experiences of the world population.

Our efforts in marketwide stewardship seek to meet the growing need for sustainability training by providing education for asset owners, investors, and the broader investment community. In the past year, we launched an online educational series for Canadian investors covering sustainable investing basics with more advanced topics in development. In addition, we’ve highlighted some of our engagement activities through a series of sustainable investing case studies, which feature examples of our ESG integration, stewardship, and collaboration. We believe this helps our clients and other stakeholders visualize the actions we’ve taken and the outcomes we’ve achieved in the pursuit of sustainable risk-adjusted returns on a more regular and detailed basis than our annual reporting provides.

We’re also currently developing a curriculum and content with a third-party education technology company that explores sustainable investing. With this platform, we hope to reach a significant number of secondary school students and adults across North America, Europe, and Asia over the next two years​.

This activity is further aligned with that of our parent company, Manulife Financial Corporation (Manulife), which, as part of its impact agenda, is a founding partner and exclusive funder of the National Geographic UNESCO World Heritage site impact mapping and resiliency project. Announced in December 2022, Manulife formed this partnership with the National Geographic Society to safeguard several historical and culturally significant heritage sites from the impacts of climate change and to protect the physical, cultural, and financial well-being of the communities that depend on those sites for their livelihood and connection to their past.

Looking ahead through the lens of marketwide stewardship

Ultimately, we’re dependent on the ongoing health of the planet and the stability of our communities. It’s highly unlikely that any company can insulate itself financially from substantial increases in systemic risk driven by significant global upheaval resulting from climate change, biodiversity loss, or other systemic threats we face. As investors, we believe we can help manage these risks for our clients by seeking to address their systemic challenges through multiple channels of investment stewardship. Periods of substantial uncertainty or instability are typically not positive economically, so helping address global challenges isn’t just morally but also potentially financially beneficial. We encourage a regulatory environment that promotes action and wider-ranging and more comparable disclosure, and we seek to play our part in educating a wide range of stakeholders on the potentially positive effects of sustainable investing.

1 See, for example, “State of Finance for Nature: Tripling investments in nature-based solutions by 2030,” United Nations Environment Programme, World Economic Forum, Economics of Land Degradation Initiative and Vivid Economics, 2022. More than half of the world’s total GDP is moderately or highly dependent on nature. Agriculture, food and beverages, and construction are the largest sectors that are dependent on nature and these generate USD 8 trillion in gross value added.