From 2021’s unprecedented heat waves to its record environmental damages, one fact is clear: for the financial sector, climate risk is no longer theoretical. Leading experts warn that trillions of dollars in investments are prone to disruption in the course of the energy transition, and few assets face greater risk than fossil fuel holdings.
Increasingly, institutional investors are taking two paths. Some are divesting, while reinvesting in climate solutions. Others are engaging in favor of changing companies from within. But while the shareholder engagement approach may seem appealing, it has two key flaws – it’s not clear whether it works, and it’s not clear whether it’s legal.
This all begins with a simple problem. The fossil fuel industry is structurally unprepared for a low-carbon future. Having passed up opportunity after opportunity to diversify, these companies remain reliant on their core business model of carbon extraction. And since the majority of fossil fuels must remain in the ground to meet global climate agreements, trillions in industry valuation stand to be wiped out as these assets become stranded and unburnable.
That presents an issue for shareholder engagement. While the tactic has proven itself viable in changing business practices, there’s little precedent of it successfully changing business models. Although a company may have good reasons to hear out investors on specific ESG issues, there are no structural incentives to fundamentally abandon its entire business, as the fossil fuel industry needs to do. When the business model is the primary source of risk, an engagement-only strategy is the wrong tool for the job.
Fossil fuel companies know this, which explains their remarkable bad faith in dealing with well-intentioned investors. When ConocoPhillips’ shareholders voted for the company to adopt full emissions reductions, the company simply ignored them. Ever since proxy voters humbled Exxon in director elections, the new board has proceeded to act in much the same way as the old. And despite years of boardroom lobbying, no major fossil fuel company is even close to alignment with the goals of the Paris Agreement.
An investment strategy that relies on the fossil fuel sector to meaningfully transition itself has become like a personal finance plan that relies on winning the lottery — fine to hope for, but hardly responsible to bet on.
Shareholder engagement absolutely has a time and a place. Responsible investing can and should involve engaging at scale with sectors structurally capable of decarbonization. And on fossil fuels, it need not be either/or. Many leading investors have sought to structure targeted and focused engagement within broader divestment commitments, and have found that a willingness to divest can actually increase the odds that a company listens.
But when asset managers refuse to consider real divestment even where alternatives have plainly failed, they miss this nuance — and jeopardize the fund’s bottom line.
The uncertain efficacy of shareholder engagement with the fossil fuel industry raises serious questions about fiduciary duty. Divesting may be not only the most prudent practice, but one investment managers may be legally obligated to execute.
Countless studies, including those by firms such as BlackRock, have shown that divesting poses no harm to a portfolio’s diversification, and that divested portfolios – now representing more than $40 trillion in assets under management – either match or outperform non-divesting portfolios. By shifting capital away from dirty energy and toward climate solutions, divestors aren’t just protecting their own interests, but helping cut global carbon emissions in the process.
Meanwhile, it’s unclear whether investment in fossil fuels meets the standard of prudence. Trustees of endowments and pensions are legally required to invest with the care and caution needed to provide stable, intergenerational equity without assuming unwarranted risks.
Legal exposure is no longer just hypothetical. Last month, student-led divestment campaigns at Stanford, Princeton, Yale, MIT and Vanderbilt (collectively representing more than $155b in assets) filed official complaints with their states’ attorneys general, requesting probes into whether continued fossil fuel investments meet the fiduciary standards set by the Uniform Prudent Management of Institutional Funds Act. Such tactics have been working – a similar complaint likely played a major role in pushing Harvard to divest last year.
As the dangers of continued fossil fuel investment pile up, investors may want to ask themselves if an engagement-only strategy is worth the risk they are taking on – and for the returns they’re expecting.
Joshua Doh is a senior at Vanderbilt University and member of the Dores Divest campaign. Connor Chung is a junior at Harvard University and member of the Fossil Fuel Divest Harvard campaign.
