Who will be left holding the bag?
I have always been skeptical of the divestment campaigns that try to convince institutional investors not to hold assets of companies that destroy the climate. After all, such divestment campaigns are active in the secondary market and hence have no direct influence on the money corporations raise through stock or bond issuance. The only way divestment campaigns can really create pressure on companies is if the movement gets big enough to materially influence share prices. So far this has not been the case, but now the Swiss parliament is discussing legislation to force the Swiss National Bank (SNB) to divest from fossil fuel companies and reduce the CO2 footprint of its $800 billion asset portfolio. Now, the way Swiss politics works, this legislation will end up as a referendum before the people so it will be years before the SNB has to divest from fossil fuel companies, if ever. But if it does come through, you suddenly have the world’s fourth-largest pool of assets divesting from fossil fuels.
Other major investors like the Norwegian government pension fund are considering similar moves and with the announcement of the European Green Deal, the pressure on the ECB to take sustainability into account will mount as well. In fact, Europe’s Green Deal is unlikely to be implemented as is since the European Commission cannot dictate sovereign member states what they should and should not do in terms of climate policy. But it can nudge governments and create incentives for them to become climate neutral by 2050. One way to do that is through the ECB and other regulators, which have many potential leavers to pull. A recent article in Nature Climate Change by Emanuele Campiglio and his colleagues discussed how and the table below is an overview from this article that shows all the actions a central bank could take to incentivise a transition to climate neutrality.
Ways for a central bank to foster sustainable finance
Source: Campiglio et al. (2019).
If demand from large pools of capital is declining to zero, the share prices of fossil fuel companies are likely to drop, and the question investors have to ask is who will be left holding the bag?
On the one hand, we have all the investors who like fossil fuel companies and will remain invested no matter what. But it may also be you. If you invest in an ETF that tracks a common index like the S&P 500 or the FTSE 100, the ETF has significant exposure to fossil fuel companies like Exxon, Chevron, BP and others that are hit by the divestment campaigns. And while ETF providers increasingly take their responsibilities as shareholders seriously and actively vote on issues discussed at the general meetings of companies, they cannot divest from fossil fuel companies. They are forced buyers (and holders) of these stocks.
Luckily, there is an increasing number of sustainable index ETF available that track indices with a focus on high ESG rated companies or low carbon emissions. And as I have shown in a previous post, the performance difference between a traditional index and a low carbon index isn’t that big at all. Hence, investors may want to start thinking if they want to get ahead of the curve and divest from fossil fuel companies by switching from traditional index ETFs to low carbon or ESG index ETF. Of course, if the divestment campaigns are successful, the share prices of fossil fuel companies will become so low that they will have exceptionally high expected returns. At that point, it may be beneficial to go back into fossil fuel companies to enhance returns, but only if these companies by then are still valid as a going concern. After all, the buggy whip producers of this world saw their shares become deep value stocks after the invention of the car as well. It’s just that they never recovered again.