Universal Ownership - Why externalities matter to Investors

Dr Richard Mattison

Calculate the cost of global environmental damage and examine why this is important to the economy, capital

markets, companies and institutional investors.

Calculate the cost of global environmental damage and examine why this is important to the economy, capital

markets, companies and institutional investors.

Project summary

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Universal Ownership

• Large diversified institutional investors such as pension funds, mutual funds and insurance companies are “Universal Owners”.

• Universal Owners have a clear financial interest in the enduring health of capital markets and the economy.

• Universal Owners are the long-term owners of large companies that impose significant environmental costs onto the economy.

• Long-term economic wellbeing and the interests of beneficiaries are at stake. Institutional investors can, and should, act collectively to reduce financial risk from environmental impacts.

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Study Approach

Environmental costs are becoming increasingly financially material. Annual environmental costs from global human activity amounted to

US$ 6.6 trillion in 2008, equivalent to 11% of GDP.

Environmental costs are becoming increasingly financially material. Annual environmental costs from global human activity amounted to

US$ 6.6 trillion in 2008, equivalent to 11% of GDP.

Global Environmental Costs

Environmental costs are becoming increasingly financially material. Annual environmental costs from global human activity amounted to

US$ 6.6 trillion in 2008, equivalent to 11% of GDP.

Environmental costs are becoming increasingly financially material. Annual environmental costs from global human activity amounted to

US$ 6.6 trillion in 2008, equivalent to 11% of GDP.

Drivers of environmental costs

• Environmental impacts, including resource use, pollution and waste generation from business activities, contribute to the degradation or unsustainable use of two-thirds of ecosystems

• Economic growth and an increase in the global population from 6.8 billion in 2009 to 9.2 billion in 2050 will add growing pressures to finite resources over coming decades, many of which are being used unsustainably

• The global economy overall will become increasingly vulnerable to sudden, unpredictable and high-impact changes in ecosystems as “tipping points” are reached at which will accelerate and environmentally, socially and economically harmful effects

Examples of environmental costs

Environmental externalities result in significant costs to the global economy:

•Economic losses from natural disasters account for 3.5% of GDP in China in recent years, with climate-related disasters accounting for almost two-thirds of these losses.

•The World Health Organization estimates that air pollution causes approximately two million premature deaths worldwide each year and that reducing particulate matter emissions could save the European Union up to €161bn per annum – or over 1.7% of EU GDP in 2005

•Across East Asia, air pollutants could reduce yields of crops such as wheat and rice by 7%-15% by 2020.

Environmental costs are becoming increasingly financially material. Annual environmental costs from the top 3,000 public companies amounted to

US$2.15 trillion in 2008, equivalent to one-third of global costs.

Environmental costs are becoming increasingly financially material. Annual environmental costs from the top 3,000 public companies amounted to

US$2.15 trillion in 2008, equivalent to one-third of global costs.

Corporate Environmental Costs

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Summary

US$ 6.6 trillionThe estimated annual environmental costs from global human activity equating to 11% of global GDP in 2008.

US$ 2.15 trillionThe cost of environmental damage caused by the world’s 3,000 largest publicly-listed companies in 2008.

>50%The proportion of company earnings that could be at risk from environmental costs in an equity portfolio weighted according to the MSCI All Country World Index.“Environmental damage costs are generally higher than the cost

of preventing or limiting pollution and resource depletion.”

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Recommendations I

1. Evaluate impacts and dependence of investee companies on natural resources.

2. Incorporate information on environmental costs and risks into engagement and voting initiatives and seek to reduce environmental impacts of portfolio companies.

3. Join other investors and engage collaboratively with companies through platforms such as the PRI Clearinghouse to address key issues.

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Recommendations II

4. Engage individually or collaboratively with public policy makers and regulators.

5. Request regular monitoring and reporting from investment managers on how they are addressing fund exposure to risks from environmental costs and how they are engaging with portfolio companies and regulators.

6. Encourage rating agencies, sell-side analysts and fund managers to incorporate environmental costs into their analysis.

7. Support further research to build capacity and improve understanding of the relationship between corporate externalities, ecosystem goods and services, company financial risk and portfolio returns.

Data requirements