Combating climate change risk - with Naomi Clark, head of investment product management for USSIM

Speaker A: Foreign. Hi, welcome to the professional Investment podcast. I'm Charlotte Moore, award winning journalist and co founder of Moore Squared Communications. Each episode I welcome a guest to the show to share their new story of the week. And I'm delighted to welcome Naomi Clark, head of Investment Product management at uh, USSIM to the show. Welcome Naomi.

Speaker B: Thanks Charlotte. I'm delighted to be on the show with you today.

Speaker A: It's great to have you here. Do tell us what is your news story of the week?

Speaker B: So my new story of the week is an article from the Financial Times. Um, while temperature swings are becoming the new normal, EU agency says.

Speaker A: And tell us what made you choose this as your new story of the week.

Speaker B: So, well, a number of perspectives really are a number of reasons. Um, I thought the article was um, really interesting how it focused on the recent heat wave that we've seen in um, in the UK but also more broadly in um, Europe, um, and the fact that you know, these kind of unusually early and intense heat waves are really demonstrating how climate extremes are becoming the new normal, um, across the world. And um, this just really kind of resonates with me, um, particularly sort of thinking about a lot of work that we do at uss, um, around the energy transition. I mean for us these climate change is just a hugely significant financial risk that's really reshaping the investment landscape globally. Um, and the small changes like the one that's mentioned in this article in environmental variables like temperature or sea level can trigger sort of really disproportionately large impacts. Not only community but also ecosystems and financial economies. Um, from our perspective, traditional economic models really underestimate these risks. Um, and we believe that climate change could threaten the stability of entire systems. So yeah, this really resonated with me thinking about a lot of the work that we do internally and in conjunction with academics like Transition Risk Exeter on this topic.

Speaker A: Yeah, and I mean this is a topic that obviously has been at the heart of sort of the investment industry for a long time. I think sometimes what we put quite a lot of burden on investors and asset owners. Uh, even if you do have the odd 80 billion to invest, you can't do everything. We do need policymakers to get involved. Can you talk to us why that is so important to have policymakers thinking about climate change and the risks it's actually going to pose to the economy?

Speaker B: Yeah, I mean I think that's exactly sort of what we believe. We believe that governments, regulators need um, to play a really decis role in accelerating the transition, um, to sort of clean and renewable energy. Um, and these, if we see or when we see clear, coherent, credible policy frameworks, it really reduces uncertainty which in turn uh, lowers the cost of capital and can unlock significant private investment at scale. Sort of in contrast to that, when you see policy volatility, when you see weak regulation, when you see inconsistent signals coming from governments and regulators, the transition just slows down. This raises costs for everyone, it raises risks for everyone. I think also what we see or what we believe from our recent research is that what we need in the early stages of the transition in terms of policy landscape aren't the same as at the later stages. Um, and it actually won't be the same across different sectors or countries. So what we need is really tailored policies, but we also need kind of clear commitments and longer term frameworks from government to support progress at every stage of the transition. I think if we have this, it's pretty encouraging for investors. I think the transition to clean energy presents probably one of the biggest investment opportunities of our time. Um, and a fast transition will save global economies trillions in energy costs. So you know, there's real positives I think in this sort of potentially quite negative um, news article if decisive action can be taken.

Speaker A: Yeah, and I mean it's great that you think that um, one of the kind of like irritations of working in the financial services industry and particularly with US owners and asset managers sometimes is you feel like everybody forgets they're in a regulated industry and that people kind of, and I'm not saying this is USS at all, people kind of moan and whinge when sort of regulation policy lands on their lap, but they haven't done anything to shape it. So how are you taking the bull by the horns and moving? You know, taking. Because you have a good position, a strong position and you can, you can campaign effectively and people are going to listen to what you say. So what are you doing to make that climate change policy happen?

Speaker B: Yeah, I mean we sort of hope people listen to us. Um, we're quite a large scheme. We've got about £80 billion worth of assets and um, we um, we support the academic sector. So we're not kind of asset gathering or asset raising, trying to grow. We focus purely on serving the academic community and the kind of 350 odd employers that are part of our scheme. Um, but we, and we work, our corporate affairs team sort of works tirelessly to work with governments and regulators. But you know, recently we've really realized that actually this isn't something we can solve on Our own. And so we've actually convened a group of UK asset owners together. Uh, and um, we've been working really hard to try to convince other UK asset owners join with us in some of this, um, governmental or regulatory, um, I mean intervention is maybe a strong word but you know, making sure that regulators understand the financial benefits um, to the sector. And I think also, particularly in the uk, we look at um, pensions and it's getting a lot more interest from the government than it ever has done in my sort of 15 years I've been in pensions, um, and with things like the Mansion house, the sterling 20, the government, the government expects a reasonable amount from the pension sector and I think it views it as a significant opportunity to drive growth in the uk. I think that does give us as a sector some leverage. Um, it certainly gives us more opportunities to have conversations with governments and policymakers that wouldn't have had 10 years ago. And so I think if we can get a group together, um, as we, as we have done, um, and we can agree on some things that we think are particularly important, uh, like for example, you know, electrification of the, of the economy, having, having that collective group singing from the same hymn sheet, um, you know, whether it's publicly or privately. And we really recognize that different schemes will have different kind of levels of appetite, opportunity, risk tolerance around what they can and can't say in public versus private environments, um, or even in consultation responses to government. But I think if we're all asking for the same things then we can be much more powerful as a group. And so I've been working, we at USS have been working really hard on that all of this year. Um, and we're starting to, we're starting to see some real positive, um, some sort of positive action. And the group is now identifying topics that we can commonly agree on. So, um, yeah, it will continue to be a huge area of focus for not just the rest of this year but well into the following year.

Speaker A: And that kind of feels like it's a bit, maybe in the UK it's less situation, but it feels like it's a bit harder to do than it used to be because we've seen those big groups, international groups of investors like climate action 100/ kind of be eroded over in recent years. And we're seeing obviously a very different policy direction in the US compared to the UK and Europe. But the thing about climate change is that, uh, it's. Well, it's a bit like technology really, isn't it? It's, it's Not a specific country problem. It's, it is a global problem and it is a globe. A problem that you do have to solve globally. Because even if the UK had the most forward thinking, you know, climate change policy in the world and we were already completely transitioned and didn't use any me, you know, carbon in our economy, we would still be at the whim of what everybody else in the world does. So can't really stop at our borders. Do you take that campaigning fight beyond the UK internationally?

Speaker B: Uh, well, sort of interesting timing um, to have this conversation. Um, I actually just came back from Singapore yesterday where I'd been meeting with a group of global um, asset owners, predominantly pension funds, sovereign wealth funds, um, and um, speaking actually to them, trying to kind of convince them to join us in this systemic stewardship, um, activity. Um, and I think it was, it was a really well attended forum, um, run by the International Centre for Pensions Management, which is kind of an academic body. Um, and because it was just a collection of asset owners and pension funds, there was an ability to have really good conversations kind of effectively behind closed doors without any sort of service providers, asset managers in the room. Um, and yeah, I was really, I was really encouraged by what I heard from many, many other peer funds globally. Um, and I was pretty clear about what I, what we were doing in the UK and what I thought we needed to be doing globally. Because of course the Australian government isn't very interested in what USS is doing or really any other Ukraine funds, um, quite reasonably. But they, they, they will be very interested if large portions of the Australian superannuation market are logging on, on, on these topics. And you know, in, in some countries like Australia for example, the, the super funds are enormous and have huge economic power. You know, some of the Canadian funds and, and actually we even had really good conversations with some of the American funds like notwithstanding some of the challenges that are happening in the us But I think it's definitely not impossible to do.

Speaker A: Yeah, no, uh, I think that's it's the right thing to do. I mean the kind of countervailing wind to all of that is that as we can see from this year and the whole straight of Hormuz situation, we live in a time of kind of fragile geopolitical um, volatility and we've got more volatility in geopolitics now than we used to and that tends not to be conducive to the long term. So is that a concern of yours and is there anything you can do to kind of mitigate M against that. Yeah.

Speaker B: And I mean, look, I think we also shouldn't be too negative. Like, I think obviously some of what's happened, um, in the Straits of Hermes has actually been directly, really, really beneficial for the electrification, um, of economies globally. And in the US You've definitely got some political headwinds against things like wind, for example, which is clearly, uh, not a topic that Trump is keen to pursue at the moment.

Speaker A: Nice pun there though. I love that. Namely headwinds against wind.

Speaker B: Um, but there have been other real beneficiaries and actually there's been lots of other real advances in renewable energy, um, even within the U.S. um, which I think have directly been driven by some of these challenges around energy security. I think also when we look at AI and the energy consumption needs of AI and people looking forward to that, it's pulling forward the transition, um, which I think is really positive and perhaps sometimes we are a bit kind of doom and gloom about these things. Um, but I think there are some real positives that are going on under the surface, um, and in other emerging market economies as well. There's been really significant progress in, in the last kind of six months to a year that potentially wouldn't have happened without those two driving forces.

Speaker A: I mean, you are right. The upside of geopolitical risk is as soon as, you know, oil price spikes and you know, everybody gets, everybody starts thinking about the security of their energy supply, number one. And then number two, you know, the economy, the economics of the green transitions start to add up because the oil price has spiked. So there is, there is, there is an upside for transition from a more fragile geopolitical situation, even if it does make it trickier to kind of get the long term policy change and the cohesive policy changes.

Speaker B: I think that's right. But we've, we still have, we still have pulled forward some of the activity and that will remain, which I think is really positive and I think coupled with really strong policy, we can be in a really good position, um, in the medium term. But we do need, we do need that strong policy and we do need to, you know, it won't happen on its own, I imagine.

Speaker A: No. And if people don't speak up and try and make the changes, then they're never going to happen. Right, yeah. Uh, so we are the professional investment podcast and I, I, we love talking about policy here because everything, as we said, we're in regulated sector. So policy does influence everything that we do. Sometimes it gets forgotten. But you can see from how all the different pots of capital Invest and how different that is, just how important regulation and policy is. Um, but if we would kind of like to look a bit closer at your actual investment portfolio, can you talk to us a bit more about how you think about climate change risk or transition risk when you're actually designing that uh, portfolio and what levers you do have to pull? More levers you don't have to pull.

Speaker B: Yeah, I think there's kind of, there's two, I think there's like two ways of looking at it or two ways that we look at it at uss. So we're a universal owner, we've got a really large pool of capital that we have to invest. Um, so for us the option of not owning things is not really available to us. We're effectively sort of everything in the market. Um, and we can't kind of stock pick our way out of these risks. Um, and you know, we can't even really stock pick our way out specific country exposures like we are, we are exposed to the macro economy. Um, and that's, that's challenging and I think for us that's why um, systemic stewardship or policy maker intervention is, is basically. I mean this hasn't always been our approach by the way, but for the last few years I think the view really is that is almost like an investment response, um, that we really feel, that. We really feel that the best way for us to have kind of a good market to invest in, in the medium to long term is using all the tools in our toolbox to do as much systemic stewardship as we possibly can. And that's why we're putting a huge amount of effort into this and why we really would love to work with other asset owners and we think it's really financially material to outcomes for our members. So although it's um, yeah, it doesn't seem like a kind of investment activity and historically we might have been more, more concerned about engaging with specific companies. You know, we might have thought about excluding companies. Um, I think for us we, we sort of feel that you know, we can get much better return on investment of our time by, by, by undertaking these wider systemic stewardship activities. And we believe it is genuinely financially material to, to our scheme. And um, I think what's led us to that is the other sort of way that we look at this and the other thing I would talk about which kind of came first a few years ago, but we started working with the University of Exeter around looking at um, climate transition scenario analysis and um, really that's where we've developed some qualitative, much more qualitative scenarios that think about different ways in which climate change, but also actually increasingly things like geopolitical risk play out. Um, and we use these scenarios when we're constructing our asset allocation to think about how we can build resilience into our portfolio. I mean we're largely a defined benefit scheme and we have a fiduciary obligation to pay pension benefits as they ford you. And that, that is ultimately what we all get out of bed to do to make sure that academics can have great financial stability in retirement. Um, when we look at these scenarios, we see the impact of climate change, um, and we aim to build diversified and resilient portfolios. But looking at these scenarios ultimately leads us to the belief that actually we can't really mitigate this risk in any material way. Um, there are too many potential kind of tipping points and um, other factors that are modelled in. So so much as we can create as resilient portfolios as possible and we look at, you know, things like physical risks across our portfolio, we're working on incorporating nature and biodiversity risk into kind of our heat maps. Um, it's just, it's, we know it's not the answer. Um, and we know that there needs to be more, we know we need more policy intervention.

Speaker A: Um, yeah, so did that. So that research with extra kind of like took the scales from your eyes, so to speak, and kind of revealed the scale of the problem and that, you know, that engagement or diversification.

Speaker B: Yeah, exactly.

Speaker A: Isn't really going to help I think

Speaker B: because for example, you can, you know, there is kind of a temptation to believe that, that energy transition can succeed through financial markets like, you know, reallocating capital, decarbonizing portfolios, divesting from the worst or highest emitters. And like those tools do matter to an extent. But ultimately you sell a polluting asset which you know, reduces the individual portfolio's carbon footprint. But what does that do to reduce real world emissions like these emission. These, these assets don't disappear when we sell them. They're, they're owned by someone else and, and it might be that that's actually someone with less incentive to drive change for that organization. So for us, we think that if we're genuinely targeting decarbonisation, we have to help these high emitting sectors transition, not walk away from them.

Speaker A: Um, no. Yeah, that's the point. You could have the most perfect, beautiful green portfolio in the world and you could stand on your doorstep and still see the planet burn around you. Right. It's not necessarily going to help. I would say that you have to go brown to go green and you have to. What your point is you have to sort of get your hands dirty. I just wonder, um, in terms of, you know, like you've decided that you really do need to do systemic change and policy change, what does that mean for kind of like the engagement side? Does that de. Emphasize it or is this just something that you, you just want to be realistic about the changes that you can, you can make there and run this program the same at the same time? Yeah, I mean I think we. Are they in parallel or is one more important than the other?

Speaker B: They are definitely in parallel and I think we will always engage with the companies that we own. Like we're an active owner, uh, um, where our managers are active owners. We expect them to be engaged with the companies they own. Um, and I think it's, you know, we must be genuinely good, high quality stewards of all the assets that we own and we must make sure we have clear engagement plans and we hold companies to account and make sure that, you know, for us it's actually really important to track engagement activity to understand why is it that we talk to this company for, you know, twice a year for three years and nothing happens. I mean that doesn't demonstrate that they're listening to their investors. Um, so that is, that is material, um, to us and we engage on a wide range of issues with, with companies actually, you know, obviously not just climate change, many, um, other financially material risks. And I think it is a, it is a big part of what we do. But I think it is, I think realism is, is kind of the word you use and I think that's right. I think it's about being realistic about what any individual shareholder can achieve with a company, um, relative to a group of shareholders who might represent hundreds of billion pounds of assets, speaking to governments who genuinely want those pounds invested in their local economies, um, and who probably actually need and want those pounds invested in the energy transition to a certain extent and just making sure that the policies are there to support that, that investment. Um, because without that stable policy landscape it is really difficult for capital to be deployed. Um, and it's helping governments and regulators to understand that really. Um, but it is very much a joint joined up effort between all different teams within the organisation. And I think we would not want to be sort of misconstrued to be saying that we think company engagement is not, is not working or not useful. I think it's absolutely useful. I think it's imperative for managers to engage with their companies. You know, it's a hygiene factor for me really when I, when I look at our internal or external managers, um, it just is. I don't think you can do that and think you've done everything

Speaker A: as you said and you reiterated what I said. Yeah, it's the, it's the dose of realism about it all which is going to, it's always going to be pragmatic and realistic rather than living clink pink fluffy clouds. I think. Um, and we talked about, you know, you know, that you've come to this conclusion about systemic risk that you know that needs to be done and we talked about diversification, we've talked about allocating to private markets. I mean do you see that as a way to manage the risk within your portfolio, even if it's not as perfect as you would like it to be? But does private markets give you a good way to invest in all of that green tech and in the transition, or can you do that kind of transition through the universal ownership of big passive equities as well?

Speaker B: I mean I think we have a belief that we want to build diversified, resilient portfolios and um, we allocate a lot to private markets, um, kind of globally but also a lot within the uk. Um, we do allocate to renewables. Um, and we also spend a lot of time on the asset management of our assets that we own. We own a lot of our assets directly ourselves. Um, and obviously there you have more control, um, and you can engage, you know, asset, manage the activity, um, much more and we've had some really great successes with some assets that we've, we've owned around kind of um, increasing the energy efficiency of those assets. And we also do own some renewables and that sort of thing as well. Um, I think you know, for us kind of uh, it all goes back to the portfolio construction point and the scenario analysis that we use and that being the main tool that we drive to think about the resilience of our portfolios and the exposures that they face to different scenarios, different plausible um, long term scenarios. And that's really, everything starts there. Uh, um, it's pretty sort of disciplined approach and, and we find the scenario analysis incredibly valuable.

Speaker A: So is there um, as an asset, ah, as a universal asset owner, do you, I understand your, your logic. I think we've explained that. Well, as a universal asset owner, when you did this research with Exeter, you, it led you to think, led you to understand that you have to do More that it has to be about systemic change. You have to do, you have to make those policy changes. Aside from that and the engagement process, is there anything else that you can do or that you feel stymied by because you can't make sufficient changes as that universal asset owner?

Speaker B: Um,

Speaker A: certainly, sort of.

Speaker B: Particularly, I think, um. You know, I think it's probably no secret that we'd like to see, um, faster pace. Um, we'd like to see things progressing more kind of domestically and internationally. Um, we'd like to probably see more asset owners coming together, um, to do this kind of good work. Um, understanding that different schemes have kind of different ways of working and understanding that. Actually, I think a lot of meaningful conversations don't play out publicly. Um, they play out privately. Um, but. And so I think, you know, often it's quite difficult to kind of understand and measure the success of those sorts of things. Um, but. But yeah, I think that's kind of. That's. That's probably the main, our main aim at the moment, really.

Speaker A: Yeah. And I mean, one thing I've Learned from these 20 years of being involved in this sector is you can kind of have some broad brushstrokes about how different within different pots of capital. But basically it seems to me that every single pension scheme provider or insurance company or Master Trust, closed DB scheme, everybody has their own peculiarities and their OpenDB scheme too, that it just. No one is the same. There is no real one size fits all. There is no shortcut. There is, it is about really, if you're an asset manager and trying to sell to that market, you really have to take your time to get to know everybody. It could be a potential client. It's just, it's just. It's a very, very heterogeneous sector and we kind of understand why because it's sort of evolved over time and regulation and stuff has changed it and you know, it's kind of layers upon layers. It's not. If you, if you were to start today with blank sheet of paper, you wouldn't start here. Right. But we are where we are and so the complexity is kind of built and fragmentation is built into the system, which makes it harder. Right.

Speaker B: But I think in the UK we are moving quickly towards a more homogeneous market, particularly in dc, with a lot of the consolidation, um, and M much larger pools of capital as well. Um, so we've been probably the largest, uh, pension fund in the UK for a pretty long time and that's no longer the case. And um. M, there are some Enormous schemes now that are, that are, you know, pretty, pretty new. And so I think I, I feel really encouraged actually by the kind of the potential for, um, the potential sort of success of some of this systemic stewardship. When I look now at uh, you know, we have many more kind of peer funds, there's many more funds looking at internal management, um, there's many more funds now looking at investing in private markets, um, even within the DC space. Um, so I think, you know, I think the market is homogenizing and we are going on a bit of a transition. And, and you look, if you look at the Australian market, it's obviously been on this journey, you know, a while before us M. And um, look at kind of the product and opportunity set there and the types of investments that are made. I think our market will start to look much more similar to that in the next kind of five, 10 years. It's happening really fast. This, um, this consolidation. And I think that that does drive a lot of opportunities, opportunities for investment, um, within the UK economy as we have more and more, more of that capital being able to be deployed, particularly private capital, I think, um, which often when you look at things like the climate transition, these are often more private market opportunities, um, far more opportunities for schemes to get together, um, um, and far more conversations going on, I think, between the government and some of these large schemes and between regulators in these large schemes. So I think all the ingredients are really there, ah, for the next kind of five years. And I think that's probably why for us, we feel this time is the right time to be doing a lot more of this activity, um, both kind of domestically, but also internationally.

Speaker A: I mean, you're right, within a few years time we're going to have several hundred billion schemes in the uk. So I'll give you the last word to you, obviously, Naomi, um, if you could say one thing to other asset owners, what would it be? Be?

Speaker B: I would say let's all join together and collectively think about systemic stewardship. Let's think about the climate transition. Let's think about what we need, um, for the future that our members are going to retire into, um, and for the economic landscape that we're going to be investing into. And let's be bold. We need bold policy, um, we need bold asset owners to come forward.

Speaker A: Okay, great. Well that is a really excellent place for us to end the podcast. So I just want to say thank you so much for being on the podcast, Amy, given that you've just come back from Singapore, you've done extremely well. I wish I looked as good as you do after a long flight. You look fantastic. Uh, you've been a great guest. Thank you for all of your insights and expertise. We really appreciate you sharing that with us.

Speaker B: Thank you for the opportunity.

Speaker A: Wonderful having you on the show. Um, listeners, if you want to make sure that you never miss a future episode of the Professional Insight Investment Podcast, make sure you hit that subscribe button. And do interact with us, share your comments, take part in the Spotify poll if that is the platform you use to consume your pla. Your podcasts. And as ever, thank you so much for listening.