Managing nature-related risks requires a holistic, whole-portfolio approach. Almost all companies are affected by nature risks. They are both dependent on nature and have an impact on the environment. As a result, a company that uses nature unsustainably will soon face regulatory or consumer pressure to change its practices, which may also impact its stock value. When looking at an overall portfolio, the externalities of some companies will create more nature loss and hence will affect the value of other companies reliant on healthy ecosystems.

A first step for sovereign wealth funds can be to model their portfolio’s impact and dependency on nature. Although biodiversity loss can be more challenging to measure than climate risk, partly due to the lack of a standardised measurement unit such as carbon emissions, the science is clear that these two risks are intertwined. It is difficult to tackle climate change without considering preserving the ecosystems that sequester carbon, and conversely, climate change is a key driver of biodiversity loss. A coherent solution is needed for both. Sovereign wealth funds can, for example, explore tools such as Natural Capital Financial Alliance’s ENCORE tool to understand better their portfolio’s dependency on ecosystem services. This, in turn, can inform risk management efforts such as scenario analysis. There will be a unique solution for each sovereign wealth fund, depending on its mandate and portfolio composition.

Sovereign wealth funds can also consider developing expectations directed at portfolio companies to encourage the companies to manage their impacts and dependencies on nature. Most sovereign wealth funds are not large, universal asset owners, like NBIM, which can influence the market as it owns an average of 1.3% of all listed companies. Consequently, they may want to focus on those portfolio companies, particularly in the unlisted space, where they can influence the company’s management. These expectations, like those published by NBIM, may be shaped by existing frameworks, such as the UN Global Compact, the UN Guiding Principles on Business and Human Rights, the G20/OECD Principles of Corporate Governance and the OECD Guidelines for Multinational Enterprises.

As long-term investors, whether they invest domestically or internationally, sovereign wealth funds can think about measuring, managing and mitigating nature-related risks at three levels:

• Market level: supporting the development of standards and business practices that enable sustainable growth because the portfolio will derive financial benefit from sustainable economic growth in the long run.

• Portfolio level: ensuring that their investments are resilient to global and local environmental and social developments and capitalising on the opportunities created in the markets. Sovereign wealth funds can analyse their exposures and integrate this information into their processes, thus adapting their portfolios by investing less in companies with heightened sustainability risk and more in those that provide solutions to sustainability challenges.

• Company level: working with portfolio companies to ensure they are within the scope of the sovereign wealth fund’s expectations. This engagement will include voting at their annual general meetings to hold the board accountable for their decisions about how their company impacts the environment and, if appropriate, sitting on the company’s board.

Sovereign Wealth Funds’ Progress on Climate Change 2022

You’ll soon receive in your inbox the latest OPSWF-IFSWF report on sovereign wealth funds’ attitudes to climate change. This year we took a slightly different approach to the survey. Instead of looking at investment beliefs, we focused more on the policies and practical steps sovereign wealth funds are taking to implement their climate-change policies. Such an approach makes the survey more relevant to our respective members and provides a better representation of where sovereign wealth funds are in this shift of investment practice. The new format also enabled us to provide more granularity on their implementation of climate-change-related standards.

In Full Flow: Sovereign wealth funds mainstream climate change, our report on IFSWF and OPSWF’s 2021 climate change survey revealed the significant progress sovereign wealth funds had made in considering climate change in their investment process over the previous twelve months. Given such rapid advances, in 2022, we expected to see a levelling off of this process and perhaps less dramatic trends. However, sovereign wealth funds continue to prioritise integrating climate-related issues into their investment process and understand the impact of climate change on their investments.

Over the last three years, our surveys have revealed how sovereign wealth funds have embraced the issue of climate change. In 2022, a third of our respondents reported they had adopted a climate-change strategy since our first report in 2020. The issue is also becoming more formalised as part of their mandate. In 2021, only 9% of respondents said that “addressing the effects of climate change [was] part of [their]” mandate”. However, 65% said that while climate change issues were “not strictly part of our mandate” but did consider it when investing. A year later, 91% of our respondents said that they believed addressing climate change was consistent with their mandate, while 74% said it was actively part of their mandate. 

Do you believe that addressing the effects of climate change is consistent with your investment mandate? (Comparison 2022 vs 2021 Responses)

We have also observed a change in the motivations for sovereign wealth funds to include climate-related criteria in their investment process. In 2021’s survey, half of the respondents said they had decided to consider climate change in their investment decisions because it was “the right thing to do” rather than for any financial benefit. Only 23% believed doing so would improve long-term returns or reduce risk. However, fast forward to 2022, and 60% of respondents told us that they integrated climate change considerations into the investment process to minimise risk and improve long-term returns, with 40% saying it was “the right thing to do”.

In the report, you will discover how sovereign wealth funds’ implementation are going forward and how they have reported significant progress in their understanding of the detrimental effect climate change may have on their long-term returns and how they monitor their impact. They have also become more transparent, requiring better reporting from their asset managers and portfolio companies, and now produce more information on how they approach the issues.

Nevertheless, they still report significant barriers to their progress, particularly in gathering data on climate impact from portfolio companies (particularly unlisted firms) and asset managers. Without accurate data, it is difficult for sovereign wealth funds and other investors to understand their risk exposure to climate change accurately and their portfolio’s contribution to carbon emissions. While it is true that sovereign wealth funds can request this information, it is also important to not overburden these companies and asset managers by standardising the data requested.