Macro
stewardship

Introduction

As responsible investors, we recognise that we do not operate in a vacuum, and feedback loops exist between investment activity and the real-world upon which we rely to deliver long-term risk-adjusted returns. This means that all our investments impact, positively or negatively, environmental, societal and financial systems.

These real-world systems can affect the overall risk and return profile of capital markets. It is in our long-term interests to take effective action to ensure these systems have integrity, are resilient and function sustainably. When they don’t, and markets operate in such a way that leads to a sub-optimal outcome for society or destroys value, they may be said to fail. Unpriced negative externalities, such as companies not having to reflect the cost of the impact their carbon emissions have on climate change, is one example of a market failure, and leads to a distortion of asset valuations.

Left unchecked, market failures can perpetuate systemic risks that can disrupt the stability of the market and threaten investment performance.

In this sense, each of the SDGs is representative of one or more market failure. Collectively, the potential failure to deliver the SDGs represents a risk to the stability and integrity of financial markets, with concurrent risks for market participants, including our clients. As such, we have a duty to act to highlight and seek correction of market failures and systemic risks as part of our obligations to our clients and to the integrity of markets.

Our macro stewardship work represents a natural progression from our ESG integration and micro stewardship activities. We define the practice of macro stewardship as “taking action to accelerate systemic change with the intention of correcting market failures and mitigating systemic sustainability risks”.

Watch our video interview with Oliver Morriss, Manager, Sustainable Finance Centre for Excellence at Aviva Investors.

Watch our video interview with
Oliver Morriss, Manager, Sustainable
Finance Centre for Excellence at
Aviva Investors.

This requires engaging with policymakers, regulators and other key decision-makers who shape the rules of the game within which we operate. Through targeted programmes of engagement that intentionally and proactively identify policies and practices to mitigate systemic sustainability risks, we seek to contribute to the stability of the environmental, societal and financial systems upon which the assets we invest in rely.

This is not something that can be undertaken by us alone, or market participants more broadly, who are equipped to exploit market inefficiencies, not rectify market failures. But nor is it something that policymakers and regulators can do effectively or efficiently in the absence of multi-stakeholder engagement.

Identifying and establishing regulatory systems and policy interventions to correct material market failures and foster sustainable and more resilient capital markets therefore relies upon the existence of robust feedback loops between investors and policymakers.

The enactment of such policy and regulatory shifts presents threats and opportunities for investors, with winners and losers arising from change. Those who fail to identify and respond to future transitions in the policy and regulatory environment risk missing investment opportunities presented by sustainability leaders that are well-positioned for the changing environment, and thus likely to attract more capital. Such a failure in the predictive power of investors is a prime example of a market inefficiency, and often results in the mispricing of capital.

As such, macro stewardship, and our work to bring about these corrections, is not only a key mechanism through which we aim to deliver sustainable outcomes, but also better connects us with the likely scale and pace of change. We believe this can provide an information advantage, which in turn enhances our ability to exploit market inefficiencies.

See how we use macro
stewardship to seek to
correct market failures:

Activity during the period

Advocacy for the transformation of the financial system to finance the transition to a low-carbon economy.

The world is currently way off track to limit warming to 1.5°C above pre-industrial levels by the end of the century. This is despite 198 countries being committed to the United Nations Framework Convention on Climate Change and the outcomes of the Paris Agreement as reiterated in the Glasgow Climate Pact from COP26.

To finance the just transition to a net zero economy, we need to transition finance so that it aligns with the temperature and sustainable development goals of the Paris Agreement. The “international financial architecture” (IFA) describes the international institutional governance arrangements that seek to uphold the effective functioning of the global monetary and financial systems. The IFA was not designed with the climate crisis in mind. In fact, it was not designed at all, but rather has evolved over time in response to successive financial crises.

The bodies within the IFA are taking some actions in respect of the management of climate risks, most notably in the area of increasing disclosure by financial market participants through initiatives like the TCFD (the recommendations of the Taskforce on Climate-Related Financial Disclosures).

They are also increasingly considering climate risks, principally transition risks, through their financial stability mandates. However, as with so much in the realm of climate action, their work to date is insufficient to the challenge that the systemic risks and market failures linked to the climate crisis pose. The Sustainable Finance Roadmap of the G20 Sustainable Finance Working Group and publications like the Financial Stability Board’s Roadmap for Addressing Climate-Related Financial Risks provide a starting point. But the world lacks a comprehensive plan for the orderly and just transition of the financial system to net zero by or before 2050 and the realisation of the aim of Article 2.1.c of the Paris Agreement to make “…finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.”

Building on the proposals for reform of the IFA published in April 2021, and the ongoing work of the Aviva Investors-convened Coalition for an International Platform for Climate Finance, at the start of November 2022 we published Act Now – A climate emergency roadmap for the International Financial Architecture. This report was timed to be issued just before COP27 in Sharm el-Sheikh and formed the focus of the advocacy of our delegation at the Conference.

The report outlines the risks to the integrity and stability of the financial system that are posed by the long-term physical impacts that the current 3-degree plus trajectory of climate action will produce by the end of the century. The financial system as we know it and the economic and development benefits that its growth has delivered are at risk if extreme consequences of the warming planet are not avoided by actions that must be taken now, as the tragedy of the horizon means that once climate change becomes a defining issue for financial stability, it will already be too late to take actions to avoid it.

In “Act Now” we set out five clear policy asks for each of the institutions within the IFA:

Create a Roadmap or Transition Plan to place the supervision of the just transition to net zero on or before 2050 on a science-based pathway at the centre of its purpose and work programmes.

Review its mandate and constitution and request relevant stakeholders to implement any changes necessary to support the reorienting of the institution towards putting climate at its heart.

Report annually on the progress of the institution and those it supervises, regulates, coordinates and oversees, towards delivery of the net-zero ambition.

Collaborate with the other elements of the architecture to create and collectively steward a global net-zero transition plan for finance, reporting annually on global progress and making recommendations to governments for the policy action needed to deliver the enabling environment for the successful transition of the global finance system.

Convene a summit or summits to agree and implement necessary reforms, for example celebrating 80 years since the original Bretton Woods conference and plotting a pathway for the global financial system to be harnessed to tackle the pre-eminent challenge of the next 80 years – the climate emergency.

COP27 saw the reform of the IFA as one of its defining narratives on finance. Momentum built from the World Bank and IMF Annual Meetings in October, and the powerful advocacy from Barbados Prime Minister, Mia Mottley, for her Bridgetown Agenda that found supporters in the halls of Sharm, most notably from French President Emmanuel Macron.

COP26 President, Alok Sharma, used his speech at the Wilson Centre at the World Bank Annual meetings to outline the need for institutions like the World Bank to put tackling the existential climate crisis at the heart of everything that they do. He also spoke repeatedly at COP27 about the need for a “Bretton Woods 2 moment” to repurpose the IFA for climate action, including at the launch of a report of a meeting of leading businesses at Chatham House setting out actions focussed on the achievement of the 1.5°C goal, including IFA reform.

Our own advocacy for IFA reform and the policy recommendations of the Act Now report included meetings and events with finance ministers, heads of bodies within the IFA and the Glasgow Financial Alliance for Net Zero (GFANZ), the UN Secretary General’s Global Investors for Sustainable Development, WWF, and the UK Transition Plan Taskforce.

The outcome text from COP27, the Sharm el-Sheikh Implementation Plan includes, for the first time, acknowledgement that delivering the investment needed for the transition to a low carbon global economy will “… require a transformation of the financial system and its structures and processes, engaging governments, central banks, commercial banks, institutional investors and other financial actors”.

This progress is welcome. But it is only the start of the systemic change that is needed to transition finance such that it can finance the transition. Encouraging those with their hands on the levers of power to deliver the scale of reform needed to match the scale of the climate challenge, will be a key focus in 2023. Another forward-looking focus of our macro stewardship activity will be towards strengthening the UK’s net zero policy to support economy-wide decarbonisation. This work will look to develop, and subsequently advocate for, ambitious and specific policy interventions which unlock private sector investment in low carbon infrastructure and solutions to get to net zero in key sectors of the UK economy.