Asset Allocation, Corporate Funds, Defined Benefit, Endowments/Foundations, ESG/SRI, Governance, Institutional Investors, Insurance Companies, Pension Funds, Public Funds

Aussie Coal Mine Court Ruling Illuminates Reg. Risk in ESG Investing

The decision by an Australian court earlier this month to prohibit the opening of a coal mine because the mine would contribute to greenhouse gas (GHG) emissions and set back the fight against climate change is being characterized by some socially responsible investing specialists as a judicial first in the environmental, social and governance (ESG) area that may prove a watershed in the field. They add that the court’s decision represents another lesson to investors on how ESG issues can be reflected in regulatory risk—a real-world business risk that can negatively impact shareholder value.

Sudhir Roc-Sennett, head of thought leadership and ESG, Vontobel Asset Management’s Quality Growth Boutique

“The Australia decision is a watershed,” asserted Sudhir Roc-Sennett, head of thought leadership and ESG at Vontobel Asset Management’s Quality Growth Boutique in New York. “This is first time we are aware of a judge using climate change as a reason for a judgement against fossil fuel extraction; It’s the first time we have actually seen someone take that step. My personal feeling is that if there is a chance that we humans are involved in heating the planet then we’ve got to do something. I think this is a broadly held view which has the potential to shift from sentiment to regulatory impact—even if this specific ruling is appealed.”

The case involved mining concern Gloucester Resources Limited, which sought permission from the local Department of Planning to open the Rocky Hill mine in New South Wales to produce a total of 21 million tons of metallurgical coal, which is used in steel production. In summing up the verdict of the New South Wales Land and Environmental Court, Chief Justice Brian Preston wrote: “In short, an open cut coal mine in this part of the Gloucester valley would be in the wrong place at the wrong time. Wrong place because an open cut coal mine…will cause significant planning, amenity, visual and social impacts. Wrong time because the GHG emissions of the coal mine and its coal product will increase global total concentrations of GHGs at a time when what is now urgently needed, in order to meet generally agreed climate targets, is a rapid and deep decrease in GHG emissions. These dire consequences should be avoided.”

Roc-Sennett explained that the ruling goes to an area of risk to shareholder value of ESG issues that must be considered regarding sustainability as the basis of effective ESG policy. ESG issues, particularly in social and environmental, he said, are often reflected in regulatory risk, adding that he doesn’t see ESG as a short-term return performance driver. “There is very little impact on short-term investment returns. I don’t know how on earth there could be.  The ESG effect is like driving without mirrors—you may not have a problem on the first few trips (or months in the case of ESG investing), but the point is, eventually you are likely to have a worse outcome than if you used them. Fundamental risks can take time to show through.”  

To investors, ESG matters a great deal, particularly on the governance side, Roc-Sennett continued. “On the global warming and pollution side, that requires regulations and how those regulations impact shareholder value. Internally, we refer to it as ESGR—R for regulation—because we think regulation is important and like to keep it top of mind.  But it’s basically about sustainability.”

He observed that, generally, shareholder value is maximized if a franchise can sustain its growth over many years, pointing to Unilever and Disney as good examples of this. “For a business to sustain it needs to balance its impact on society while selling an attractive product or service as demand evolves. ESG catches important elements of a business that do not appear in the income statement.”

Amin Rajan, CEO, CREATE-Research

“This court ruling may be seen as a local Aussie difficulty. But it will be hugely consequential in hindsight, for miners and investors worldwide,” according to Amin Rajan, CEO of CREATE-Research, a U.K.-based think tank that specializes in future trends in global fund management. “[The ruling] provides a glimpse into how our march into a low-carbon future will create a massive pile of stranded assets. Doubtless, the mining industry everywhere will be watching the fallout from this ruling with hawkish eyes.”

Rajan added that supporters of the ruling will be taking comfort that, at last, the legal system is waking up to the reality of global warming caused by fossil fuels.  “Investors of ESG funds, too, will draw comfort from the ruling, since it will provide a fresh impetus for financial markets to price-in the climate change risk in earnest.”  

Jon Lukomnik, managing partner, Sinclair Capital

“Anyone who invests without looking at ESG risk and opportunity is willfully ignoring relevant and material issues. It’s not so much this individual ruling, or this jurisdiction, but the fact that ESG analysis links financial markets to the real world, and, ultimately, companies need to make money in the real economy,” argued Jon Lukomnik, managing partner at Sinclair Capital, a New York City-based boutique consultancy involved in corporate governance and institutional investment.

Lukomnik said it is important that the ruling be placed in proper perspective: “Though I have not seen a ruling like this before, I think that point misses the forest for the trees. ESG risks and opportunities manifest themselves in various ways. There are certainly regulatory risks and legal challenges to specific projects, but also to broader sets of companies. Looking at it narrowly makes it too easy to miss the similar-but-not-exactly-the-same risks and opportunities. So, for instance, there are environmental impact studies required for lots of projects. Various jurisdictions have emissions standards that impact different fuel-source projects differently.  I want to make sure that investors look through the right end of the telescope, starting from the ruling and expanding outward, not narrowing the focus so much that they miss the trendline, which is made up of a series of differentiated events.”

According to a recent estimate from investment research firm Opimas, the responsible investment market grew to more than $30 trillion globally in 2018, with half those assets located in Europe. It expects that number to climb to $35 trillion by 2010.

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