Prof. Tom Gosling, London School of Economics, on Whether Investors Reset, Recalibrate, or Retreat from Net Zero

Will investors reset, recalibrate, or retreat from net zero in 2025? Listen to Jason Mitchell discuss with Professor Tom Gosling, London School of Economics, about how to think about the exits among climate initiatives; what the future of net zero commitments could look like; and why, investors—despite their limitations in driving climate outcomes—are still able to have a material effect on climate policy development.

Recording date: 10 January 2025

Tom Gosling

Tom Gosling is Professor in Practice in the Financial Markets Group at the London School of Economics. He is an Executive Fellow in the Department of Finance at the London Business School and an Executive Fellow at the European Corporate Governance Institute (ECGI) where he contributes to the evidence-based practice of responsible business by connecting academic research, public policy, and corporate action. Tom sits on the FCA’s Sustainable Finance Advisory Committee and the FRC’s Stakeholder Insights Group.

Episode Transcript

Note: This transcription was generated using a combination of speech recognition software and human transcribers and may contain errors. As a part of this process, this transcript has also been edited for clarity.

Jason Mitchell:

Welcome to the podcast, Dr. Tom Gosling. It's great to have you here, and thank you for taking the time.

Dr. Tom Gosling:

It's a real pleasure. And I have to say, it's a privilege to be back on this podcast again.

Jason Mitchell:

I was going to say, yeah, you're a repeat podcaster. So, looking forward to this. So Tom, a year ago in that podcast that we recorded, we talked about your assertion that investors are on a collision course between their net-zero commitment and fulfilling their fiduciary duty. Now, I think you'd agree, but a lot has certainly happened since then. Notably, high profile exits from both net-zero commitments and Climate Action 100.

Indeed, the net-zero insurance alliances essentially dissolved. And now, following the exit of all the biggest US banks, around 41% of global assets and the net-zero banking alliance have disappeared. So, what do you make of this? Especially considering that banks and insurers arguably have more leverage in linking climate oriented conditionality terms to financing relative to investors in secondary trading markets.

Dr. Tom Gosling:

Well, it's an obvious thing to say, but the change in political weather in the US has a lot to do with this. The threats of antitrust action against alliance members have, I think, been particularly damaging. Even though, as I understand it, the antitrust case is quite weak. Firms want to avoid getting tied up in lengthy, expensive, politically damaging legal cases, which do have a very severe and improbable terror risk if the case is lost. But I think it would be a mistake just to blame it on US politics. I think some of these trends were underway anyhow. I think banks, especially who do a lot of business with heavy emitting sectors, find it increasingly difficult to reduce financing to sectors that they see as being economically important well beyond the time horizon of their loan books, and their willingness to leave fees on the table in the cause of climate action was already declining.

And I think, in the US in particular, the perceived political or PR advantages of so doing have reduced really significantly, which has, obviously, accelerated the trend. But it was already there. I think banks were essentially saying, this isn't our fight. Interestingly, the asset manager alliances, and especially [inaudible 00:02:17], notwithstanding some recent announcements of departures, seem to be showing a bit more staying power. And I think there are a couple of reasons for this. One is that I think it's easier for asset managers to meet the decarbonization targets they set without major disruption to their portfolios. And this is because heavy emitters have relatively low weightings in market indices. But perhaps more importantly, there's still a really vocal segment of their asset owner clients who definitely do see climate change as their fight and they want their asset managers to act accordingly.

But as you point out, I think a consequence of all of this is that the financial sectors that have the potential to have most impact through insurance and primary debt financing are now less engaged. And instead, we're left largely with secondary market investors where the evidence suggests scope for impact while not nothing is quite limited. And overall, I think we probably shouldn't be surprised by these developments. I think it was quite clear pretty quickly, after GFAN's commitments were announced, that in the absence of supportive government policy, this misalignment could quickly grow. And the idea of willing decarbonization [inaudible 00:03:26] voluntary targets always seemed, to me, to be a theory of change that required an optimistic mindset to take seriously given the powerful economic incentives at play.

Jason Mitchell:

Well, to be fair, the banks that have left the net-zero banking alliance haven't backed away from their net-zero targets. So, to what degree do you think this is an exercise more in, I guess, green hushing than actually climb back climate commitments? Do you think Jill Fish at the University of Pennsylvania is correct in saying that, quote, "Membership was more likely a case of virtuous signalling than meaningful climate impacts"?

Dr. Tom Gosling:

I think it's certainly the case that one of the motivations for joining these alliances was to burnish environmentally concerned credentials at a time when that was part of the zeitgeist. But I don't put it down entirely to virtue signalling in the sense that there is an undercurrent of genuine concern about climate impacts amongst financial institutions and their clients. And these alliances were a way of sharing best practises and developing methodologies that could help to make progress. And that's where I think that the most immediate proximate cause for the withdrawing from the alliances themselves has been some of the kind of legal and political threats in the US.

But I think it's still true to say that the level of vigour with which the underlying commitments were being pursued was pretty variable and, in some cases, declining, particularly where pursuit of those targets conflicted with the economics. And we'd already seen banks who were in the net-zero banking alliance really trying to push back quite strongly on this idea that they should be driving decarbonization rather than following the economy's path to decarbonization. So on the one hand, I agree with you that the withdrawal from these alliances doesn't necessarily mean a dramatic slowing in the pace of action towards these commitments. But that was, perhaps, because the strenuousness with which those commitments were being pursued in the first place was not that great.

Jason Mitchell:

I remember when the phrase keep 1.5 alive became kind of a rallying cry in the run-up to COP26 and during it back in 2021, which feels like a completely different time versus now. Do we need to be honest and admit it's no longer viable as a target? In other words, when will the science change for 1.5 science-based targets? The current 1.5 C pathways seems, frankly, out of date. IPCC AR7 isn't due until the second half of 2028. But Copernicus, the EU's Earth Observation Agency, states... In fact, actually there's an article in the FT today about this, that the world breached 1.5 C of warming for the first time last year. So, does that mean that 1.5 C pledges are in a sense now post-truth?

Dr. Tom Gosling:

I think the first thing to say here is that 1.5 C as a benchmark is still very relevant, although I think we sometimes imbue 1.5 C with more scientific precision is really justified. I mean, ultimately, it was chosen, as you say, as a kind of political rallying cry. It does also, at least broadly, represent a safe level of warming. That is the scientific evidence suggests that we can be reasonably confident that humanity can carry on broadly as we have been doing, sustaining our current numbers without major disruptive changes caused by climate change. I do think it's worth always having in the discussion, as we get beyond 1.5 C, how far into the danger zone we are going.

And of course, we are recording this at a time when we are seeing terrible scenes in Los Angeles. And while we need to be careful about shouting climate change every time something bad happens, we also need to remind ourselves that, as weather-induced natural disasters increase, as temperatures increase, that this is exactly in line with what some pretty basic physics predicts. But what about pledges for investors or companies? And this is where I do think that 1.5 C has passed its sell-by date. And sometimes people push back on me for this and say, well, we can't give up on it. And that 1.5 C is a statement of ambition rather than as a guide to specific action. And I think I disagree with that because, for me, a pledge made by an investor or a company, in order for it to be meaningful, it has to be a basis for action in some way. And a 1.5 C pledge has to be more than, wouldn't it be nice if government's got their act together and put 1.5 C aligned policies in place?

And another argument sometimes put to me is that when investors say, well, we can't identify any actions that would be different for us if the target is 2 C rather than 1.5 C. so we shouldn't change the target. I have to say I find this pretty surprising and it kind of suggests to me that they can't, in any meaningful sense, have been pursuing the 1.5 C target in the first place. So yes, I do think, in your words, that 1.5 C pledges are now largely post-truth. And I say this with sadness, not glee, because my personal perspective is that we are, as a society, taking far too much risk with climate change, and I expect we're in for a rough ride over the rest of this century.

Jason Mitchell:

I want to come back to the reaction function in a little bit. But first, I guess I want to meditate a little bit more on 1.5 C. Does the notion of overshoot mean that net-zero is now not enough since... Obviously, the implication is that we've got to get to net negative to get back to a 1.5 C pathway, if one supports that. I mean, the more that short-term target slip means that the more back unloaded and tougher long-term net-zero targets become. Or is the 1.5 C versus 2 C question, in another sense, a red herring given the huge error bars around climate modelling?

Dr. Tom Gosling:

Well, yeah, there's a lot in this, isn't there? Well, first of all, I mean, warming is a function of cumulative emissions. So yes, if we overshoot our target temperature, then to get back to it, we're going to need to move to negative emissions, which is very tough. And this is why the basis of the UN race to zero targets underpin the GFANZ commitments were pathways that qualified as 1.5 C with limited or no overshoot. Now, it could be argued that we just lose the qualifier and retain the 1.5 C target with some overshoot. I think a problem with this is that it's just setting us up for the same argument a little bit down the road because there seems to me to be some but quite limited capacity to go into reverse gear. I mean, natural carbon sinks are finite. There are already quite optimistic assumptions for carbon capture and storage to deal with residual emissions. And geoengineering, like seeding the upper atmosphere with sulphur, probably only gets you a couple of tenths of a degree on any sort of sustainable basis.

So in a way, I think that sticking with the target but making heroic assumptions about reversing overshoots in future runs the risk of just disguising how far off target we are. I also agree with you that the temperature target is also slightly arbitrary because there is quite a scary level of uncertainty about the relationship between a given level of emissions and the ultimate level of warming. So, this precision about what warming we're going to get is probably not warranted. So, although directionally the physics is very clear, the precise net effects of emissions depends on a whole set of offsetting effects that have a high degree of uncertainty in them. And I think because of all of this, I actually think it would be helpful if we decoupled net-zero language from 1.5 C, because I think these are two quite different things that have come to be conflated in a lot of the public discourse.

And I distinguish them as follows. Net-zero, to my mind, is an imperative based on some fairly straightforward laws of physics that we must attain at some point if we want to avoid the planet warming indefinitely. This seems to be something where we should be able to get some degree of consensus that it's a necessary destination at some point in time. And I do worry that in saying, let's forget about 1.5 C, we somehow lose track of the fact that we do need to get to net-zero at some point or we are literally toast. There's then a separate question of how quickly we should get there, which is where the temperature targets come in. And supporters of 1.5 C target claim it's science-based in some immutable sense. But I think that's slightly misleading because, in fact, what we have here is layers of uncertainty.

It's uncertain how much temperature increased results from a given emissions increase. It's uncertain what the weather and other physical risks from a given temperature increase will be. It's then uncertain how much humans will be able to adapt, how the economy will react. It's uncertain how financial markets will be affected by changes in the underlying economy. All of these uncertainties compound as we go through that change, which is why climate change is really a risk management problem rather than an optimization problem. So, I think these risks, for me personally, are very much on the downside. I think the application proportionally principle suggests we should be more aggressive on mitigation of climate change than we're being.

But then, on the other hand, we have to accept that we face some other very major threats over possibly even shorter timeframes. I mean, for example, in Europe we've let ourselves get in a position where we have essentially no missile defences in the face of a revanchist Russia. Another pandemic in the next two decades is pretty likely, but we haven't invested much in ongoing monitoring. Antimicrobial resistance is getting really worrying. My point here is that society faces many risks and massive uncertainties. We have limited resources to deal with them before we get to even the more immediate concerns of voters. So ultimately, how we trade them off is a political question as much as it is scientific or financial question. I think the way that investors think about climate targets needs to reflect that.

Jason Mitchell:

Really, really interesting. You've talked about a scenario where governments pull back from their net-zero commitments, widen the pathway gap, which would force investors to have to make effectively a decision to either double down on their net-zero commitments or exit. Now, according to the Climate Action tracker following COP29, the world is roughly on a 2.7 C pathway in terms of policy action, not commitments. Moreover, the US election results would seem to suggest that the pathway gap continues to widen. Is this the net-zero hand break that you've kind of described over the past year? And if so, and this is the big question I'm thinking about this year, are we facing a reset, effectively a recalibration, in commitments, potentially back to 2 C? Or are we facing a larger retreat away from decarbonization efforts?

Dr. Tom Gosling:

Yeah. Jason, I tend to respond differently to this question depending on what day of the week it is because I think there are different ways you could look at this. I mean, on the one hand I do fear that we are seeing a larger retreat away from decarbonization, not just in the business world, but also politically. I mean, we know what needs to happen to address climate change. We also know that, in the long term, it's probably quite affordable to do so. And indeed, the cost of not doing so could be pretty severe. But we still don't do it. And the problem seems to be twofold. One view is that mitigating climate change does, in my view, undoubtedly have some costs in the medium term. It's not win-win from the outset. And I don't think we've done a great job of preparing electorates for that, or explaining why those costs might be worth it over the long term.

Another is that the costs fall unevenly and involve disruption to the lives and careers of people who quickly become very salient. I mean, look at the European auto industry, for example. You can produce an economic model that says it's not a problem if we decarbonize by buying cheap Chinese EVs, and labour and capital in Europe is reallocated from the auto industry to other activities. But try telling that to a German or, for that matter, British politician. And politicians have very few incentives, voluntarily, to disrupt the lives of their electorates as the people that suffer are coherent and politically salient, and those that benefit probably don't even know they've benefited yet, so don't provide a political counterweight. So, that can make me pessimistic.

But on the other hand, there is a strong decarbonization trend already happening. That's partly been triggered by policy, but also because in various cases it makes sense because the clean solutions are either better or cheaper. So, there is an unstoppable momentum, I think, behind the growth of many clean technologies which are becoming economically viable. And the good thing about that is that market forces are very unsentimental about disrupting societies, normally in spite of rather than because of, government action. So, when I think about this, I become more optimistic. The world isn't just about the US and there are some views such as the work of the inevitable policy response think tank, which suggests we could actually be on track for less than 2 C. So I don't know, putting it all together, I think we have a shot at limiting warming to 2 C, but we'll probably need to be more lucky rather than unlucky with how the climate responds to emissions.

This then brings us, well, what does all of that mean for investors? And I think we broadly have two camps of investors. I think there are those that remain very committed to ambitious climate targets. But even here, I think there is a recognition that there needs to be some recalibration to meet reality. The Paris Agreement is still with us, even if one country may shortly withdraw. And I do think that this provides strong political backing for persisting with at least a 2 C target. And I suspect that we may see some element of fallback towards a 2 C position. However, there is also a growing group of investors and wider financial institutions who are being more explicit about their view, that it's really up to governments how fast we go on climate and it's not really investors battle to fight. And these two groups are fairly predictably split between the US and Europe.

Jason Mitchell:

Pragmatically speaking, how do you see net-zero working itself out given the issues you raise? Talk about what you're hearing from the combination of investors and initiatives that you speak to. Interestingly, and now it looks like GFANZ is distancing itself from net-zero alliances as a standalone body. I guess I'm wondering, do we need to build in more pressure valves to these commitments? Is it too late? And if not, what would these look like?

Dr. Tom Gosling:

Yeah. I mean, look, first of all, I'd say that this disconnect between the 1.5 C targets in reality is clearly now widely recognised as an issue. To be honest, I'm a little frustrated that it wasn't recognised earlier because, to my mind, it's been fairly obvious from the outset. And I think, through clinging on something that is plainly unrealistic, I think that the industry has exposed itself, ironically, simultaneously to accusations of greenwashing and of doing too much. So, I do think we need to think of a different way of setting targets, but I would really hope not to see as just a wholesale retreat from this being investor's problem at all. Because I do think that we all have a role to play in addressing climate change and investors have areas they can influence. But I think the really important starting point is to give greater prominence to the truth that investors cannot set the climate trajectory.

I think people talk a little bit too much, I think, about investors and companies directing capital flows. But really, they facilitate the flow of capital to profitable opportunities. And to my mind, there's very little mileage in the idea that their voluntary decisions can effectively push water uphill by directing capital to projects that aren't profitable. On the other hand, I do think it's perfectly credible for investors, particularly long-term asset owners, to take a position that they see it as being in their long-term financial interest for there to be less rather than more climate change and for us to get onto a stronger climate policy trajectory. So, I think the correct stance for climate concerned investors is to have a position of supporting the most rapid politically feasible decarbonization.

Now. That sounds a bit woolly, but I think that, given that that is the ultimate reality, I think that is the pressure valve that's necessary. Because any fixed target is going to run into problems, partly because what is politically feasible and supported clearly varies from region to region. And I think the energy transition is a great example of this. So, I can kind of understand why, from a US perspective, [inaudible 00:20:16] focus on renewables is unattractive when you have plentiful cheap domestic gas and their energy is self-sufficient. But if you're an energy importer, like Europe or China, things look very different. And so, I think it's quite reasonable that different political contexts are going to have different levels of ambition perhaps along different dimensions of the transition. So, I think that rather than attempting to have a one size fits all temperature target, I think investors need to have a stance of strong support for the most rapid possible decarbonization.

For example, if you're a UK investor in a UK company, then given the government stance on net-zero, on 1.5 C line transition plans, it's reasonable to take a more assertive engagement stance, than it is if you're a US investor in a US company. And I think the reason for this contextualising climate ambition within the political backdrop... I think there are two reasons for this. The first is that if investors try to move too far ahead of the government policy trajectory, it's just simply not going to work, as we've seen. The value incentives, the profit incentives just overwhelm any attempts to impose voluntary action on companies. But the second is that they will very quickly be brought to heel by politicians, as we've seen the US. There is no real political legitimacy for investors to go way ahead of the government policy trajectory on climate change.

And I think that the reason why there is this difference in stance of investors between the US and Europe is that in Europe there remains a stronger political consensus about the importance of addressing climate change. Hopefully, that will persist despite the worrying signs. So, I think the headline here is that the commitments do need to be reframed, not just by picking a different target that we may end up catching up with in a few years down the road, but actually a little bit more fundamentally to say that actually investor action needs to be supportive of the most rapid possible decarbonization. And then, investor actions need to be viewed through the lens, not of achieving net-zero one company at a time, but of how investors can best influence the environment in which system change can happen.

Jason Mitchell:

Interesting. I want to qualify something for just a second. You talk about climate concerned investors in the abstract. But do you think that organisations, like the Paris Align Investment Initiative, GFANZ and IGCC jumble up asset managers and asset owners when their respective roles and agency is really quite different? I mean, the net-zero asset managers initiative may feel increasingly tenuous given some of the high profile exits. But maybe the net-zero asset owners alliance isn't given the differential in investment horizon.

Dr. Tom Gosling:

Well, it's certainly the case that the agency objectives and, if you like, legitimacy in this discussion of asset managers and asset owners is very, very different. And I think that is why, actually, different groupings were set up for these different actors in the system. And it is logical that they should have quite different approaches to target setting. I mean, if we start with asset owners, these are the actors in the system that can legitimately have long term... They have the longest time horizons. I think it's very credible for a pension fund asset owner with a 70, 80 year time horizon to be really concerned about the financial impacts of climate change on their ability to fulfil their obligations to deliver pension payments to beneficiaries. And so, they have a real long-term financial stake in climate change is an issue.

Asset managers really do what they're told by their asset owners. I mean, they don't have... Their time horizon depends on the mandate that they're set by the asset owner. And it's less clear that they have the individual incentives, the specific incentives to address climate change as an issue beyond the extent to which their clients want them to. And I think that one of the problems that the asset management industry has got into is that it spent a long time trying to be all things to all people and asset management firms have developed product suites differentiated to different market segments. And now, this new issue of climate change has come in and cut across all of that. And these asset management firms are finding that different clients have very different perspectives on what is quite a foundational issue for how you approach an important sustainability topic. And we haven't had a lot of market sorting going on that issue.

I think a lot of firms have tried to hold the ring between these very different perspectives, but have been standing with one foot on two separating logs in a fast flowing river. I think asset managers are now having to start to jump. And I think that, in a way, a better outcome would be for us to see a little bit more market sorting on this issue where those asset owners, who view climate change as an issue where they want to see proactive action from the investment industry to accelerate mitigation, they will have to choose asset managers that are equally committed to that as part of their service offering. Because I think it makes less and less sense for asset managers to be saying, well, one of our funds is trying to achieve systemic change on climate, but the rest of our funds aren't.

Because actually, I think that the way that asset managers can influence systemic change on climate is not one fund, one company at a time, but more how they act in the market as a whole. I mean, I guess, fundamentally, that's quite a long way of saying I do agree with you that we need to think about the agency in these different segments of the market very differently. But I do think we, therefore, already see some differences in the assertiveness of these different entities. And certainly, organisations like NZAOA, the Net-Zero Asset Owners Alliance, remain much more assertive on the issue of decarbonization than some of the other initiatives.

Jason Mitchell:

I totally agree. Just given the limitations around investment mandates, it does feel like the more interesting discussion is about what asset owners should be asking their managers rather than why managers aren't doing more, in a sense.

Dr. Tom Gosling:

There is a problem with that, though, Jason, as well. Which is that... I mean, asset owners, on the whole... I mean, this is a little bit of a grotesque generalisation. But asset owners tend to be a little bit under-resourced compared to asset managers. So, there is a question in my mind about, how does this actually happen? And I think asset owners aren't really geared up with the expertise, resources or capabilities to really delve deep into this climate issue. And I think you look at some of these alliances as well, they're not terribly well-resourced themselves centrally. So, there's a resource misallocation problem if asset owners are really going to fulfil that role as climate stewards. I don't think they're really set up to do it.

Jason Mitchell:

Interesting. When you think about the actors within this system, do you think the prominent role that data vendors have had in investor climate initiatives, like GFANZ, does it raise conflict of interest questions? I'm wondering if it's resulted in, to some degree, an overemphasis on targeting what can be profitably measured? I mean, namely public company emissions rather than forward-looking alignment efforts like transition plans?

Dr. Tom Gosling:

Yeah, I do. I think, in general, providers, whether it's data vendors, or auditors, or whoever have had too much influence over what we're doing in the climate arena and also, not just over target-setting, but also over reporting regulation. I do remember thinking something was up. I think it was five or six years ago when my old firm PwC announced that they were recruiting, I think, 30,000 people worldwide to address the coming boom in ESG assurance services. And you think, blimey, there's really something a bit strange going on here. And the reason I'm a bit frustrated about it is that I think we've known, for some time, about what these 10 key things are that we need to do to address climate change. I think we kind of know where the major sources of emissions are. We know what the technologies and policies are required to address them.

And I've never really understood what all of this very detailed development of more and more data and more and more complex portfolio footprinting methodologies actually does to our actionable knowledge on what it is that we really need to do. And for me, I think that when investors are thinking about their climate targets, I don't really care about their portfolio emissions reduction target. I think that's largely a nonsense and it's something that is broadly unconnected with what's happening to climate change and the real economy. I think investors need to be thinking about the specific areas where they have expertise, influence and leverage and set targets relating to meaningful activities they can undertake in those areas that deliver real-world. And those will be very different for different investors.

And the problem with that is that if it feels less accountable, it feels less comparable. I think that initiatives have liked to have the higher level, more generic targets around portfolio emissions and financing of solutions because they enable benchmarking and tracking. But I think that comparability and that accountability is a little bit illusory when actually delivery of those targets doesn't have a lot of real world impact. I think we just need to recognise that each investor is going to have specific areas of influence. The targets need to be more bespoke. We need to accept that we're not going to be able to put them all in some kind of spreadsheet that enables share action to rank them from top to bottom. But that is the reality of what it takes to deliver real world impact on climate.

Jason Mitchell:

That's interesting. To this end, recent language from organisations like the IGCC seem to be trying to correct for the historic emphasis on portfolio emissions, even using language like financing reduced emissions rather than reducing financed emissions. Do you see any signs of improvement, I guess, in the reasonableness and deliverability of what climate initiatives are promoting? I guess, by extension, I'm also wondering... I mean, do we see an extension of what we've seen in the EU around this omnibus legislation, this mandate for simplification? Do we see a wave of that come across the language among these initiatives?

Dr. Tom Gosling:

I think it's definitely the case that the initiatives are, as well as recognising this tension between reality and the underlying targets that we discussed already, are also recognising that there needs to be a greater emphasis on real world reduction in emissions. Because we know that the vast majority of the reduction in financed emissions in institutional investor portfolios to date has occurred from asset reallocation rather than underlying emissions reductions. I think that's a positive thing. The bit I still don't feel is addressed enough is this idea that it's not so easy to understand how financing of reduced emissions is actually going to come about when it's not profitable to do that. I think this idea that there are vast pools of capital available that are prepared to accept subpar returns in order to drive lower carbon industrial processes. I don't think there's lot of evidence that those exist.

I still think that whole concept is based a little bit too much on the idea that it's the investment industry that is going to be delivering the decarbonization. I would prefer to see a shift in thinking more towards this idea that the investment industry can create more fruitful conditions for decarbonization to happen. So, what does that mean in practise? I think, at the company level, it certainly means creating space for boards who want to innovate more around lower carbon processes within their business model. I mean, we do know that engagement from investors can provide hooks and triggers for non-executive directors to challenge executive management on what they're doing from a strategic perspective. And boards have a zone of discretion within which they can either lean into the decarbonization trend or seek to resist it. So, I think investors can play that role still through engagement. I think that's really important.

I think investors can play a role in putting in work themselves to develop investment opportunities for those pools of capital that are prepared to use their risk capacity or maybe tolerance for concessionary return to deliver real decarbonization solutions. But I think there's a big role also for government policy influence. And I mean, maybe we'll come onto this as a slightly separate topic, but I think a really, really critical role that investors play is to provide a constituency of support for assertive climate mitigation policy from governments. Every time a government tries to do something that accelerates decarbonization, there is an incumbent that is disadvantaged by that who tries to resist it. And they're very effective, they're very well organised, it's very salient. And I think investors are one of the few constituencies that play a role looking across the economy who can say, yeah, there might be some disruption in that industry, but we can adjust, we can deal with that. Overall, this is economically beneficial. We can make this work.

And I think this is where, in the past, in a run-up to the Paris Accords, for example, and it's where organisations like IIGCC really cut their teeth was around a policy support role for investors. I think investors have been important in encouraging governments to be more ambitious in what they do from a policy perspective. So I guess I feel that, yeah, there is a change in thinking, but I think that role of investors is still... If you look at things like the net-zero investment framework, there are pages and pages and pages on asset by asset alignment methodologies, which I think inherently limited as a concept when you're fighting against profitability incentives. And there's very little in there on the role that investors can play from a policy influence or more system-wide perspective.

Jason Mitchell:

It seems pretty clear that investor climate initiatives both collectively and within firms are losing momentum as a result of burnout, excess complexity, maybe bureaucracy and clearly political pushback. Given that, does additional picking at them, basically throwing stones, do more harm than good. It seems increasingly easy, or too easy sometimes, to sit on the sidelines and dwell on whataboutisms. And I'm talking generally, not about you specifically, Tom. The reality is that climate action is hard. At the same time, investors are paid huge compensation to address the complex job of capital allocation. Where do you see progress on this front?

Dr. Tom Gosling:

Yeah. This is a really valid concern. And it's one that, actually, on a very personal level, I do agonise about from time to time. Because I mean, as I've mentioned previously in this conversation, I think that we're taking far too much risk on climate change as a society. And so, I'm very supportive of more rapid mitigation policy than we're seeing today. And so, I am aware of this danger that criticism of what's being done just leads to people withdraw. And I suspect that we are seeing a little bit of that. But the flip side is that the focus that investors have had, the approach that's been taken has been part of the cause of the problems that we're now facing. Because, despite the fact that I think most of what's happening in the US is pretty crude politicking, there has been a grain of truth in it that has been capable of exploitation by people wanting to use it for their political advantage.

And so, I do think that investors would really be much more effective if there was much greater clarity about this fact that they are fundamentally followers rather than creators of the climate trajectory. And at best, investors can influence progress at the margins. And I think, by setting up infrastructure that suggests the role is much bigger than that, I think investors have actually undermined what they are able to do. So I actually do, in the end, believe that it's really critically important to focus on undertaking the right activities in a way that's efficient and effective. And so, I think that what we need to strike a balance between is saying, as I do believe investors play a really important role... Because the other thing I also reject is this idea that we've got to leave it all to governments. We've got to leave it all to governments and wait until the policy arrives.

Because the reality is that policy doesn't happen in a vacuum. To some degree, voluntary action is the only thing we've got, because government action is a voluntary decision by electorates that we are going to impose constraints on ourselves collectively. I think that businesses and investors play a role, a really important and critical role, in creating circumstances of support for that appropriate government policy. So, I really don't want to see investors exiting stage left on this debate. But I think, unless we focus collectively on the right things and the right activities, actually not only will we not be effective, we will actually end up undermining our own cause.

Jason Mitchell:

I was going to say it feels like the right time to be a little bit more positive on this. What's the silver lining in all of this, if one even exists?

Dr. Tom Gosling:

I think the silver lining is this period of reflection for investors on what their role should be going forward. I think what the initiatives have done successfully is that they've brought investors around the table discussing this issue. They've given it much greater prominence. There's been good work done in trying to understand where investors can have influence in relation to climate change. It has given rise to lots of activities within investment firms, including your own firm, on actually, how can we get a better handle on what the risks arising from climate change are and how they should feed into our investment and portfolio allocation decisions?

I think the level of understanding of climate change as an issue is immeasurably higher in the investment community than it was five or six years ago. And so, that's incredibly positive. And I also think that this challenge that has been placed at the door of the industry could accelerate the industry refocusing activities on areas that are ultimately going to be more effective in supporting governments in addressing climate change effectively. So, if I want to be positive about where we are, I think that this reappraisal has been really necessary, and the fact that it happened hopefully means that we can move forward in a way where investors can actually do more to support decarbonization even than they have been doing to date.

Jason Mitchell:

I want to come back to a point you made around real world decarbonization. You highlighted in an article you co-wrote with Harald Walkate titled, What GFANZ Should Have Said. I think this was a few years ago. You talked about the distinction between real world decarbonization efforts and portfolio, I.E. paper decarbonization. What's changed since then? And that was in, I recall, 2022. We've seen new decarbonization frameworks emerge, debates around carbon offsets, and even short selling with regard to real world impact, and the emergence of more serious approaches to investing in the energy transition. Do investors, judging from your most recent article evidence from the field survey, do they really understand the distinction?

Dr. Tom Gosling:

Yeah. I mean, what's changed since 2022 when we wrote that? I mean, it was interesting because, I mean, I've recently reread that article. And actually, I still stand by most of it, actually. And I think, in some respects, it reflects the way in which some of these initiatives are shifting their focus. I mean, for example, GFANZ recently announced that it was going to put much more focus on working on facilitating mechanisms for capital to flow to decarbonization, particularly the energy sector, in emerging markets. And that's clearly something where investors figuring out the mechanics have actually had a crowd in private capital. That's a really useful role for them to play. I think it's definitely still timely to reset some of these initiatives. I mean, I think they're useful, right? It's got to be useful to have Fora where investors can come together and share best practises, develop frameworks, think about the most effective locus for their actions. So, I definitely don't want for these initiatives to be disbanded.

And do investors understand the distinction between these different areas? I mean, I would say that, actually, if we look at people actually doing investing, the portfolio managers, I mean, I think the awareness of climate change has risen rapidly. I think there are different views in different markets about how significant and immediate an issue it is. But actually, I think that we're seeing more and more investors look at how they should really be thinking about the impacts of the physical outcome of climate change on their portfolio holdings. And I think this is something where we maybe need to see a little bit of a shift. A lot of the emphasis around climate risk and investment to date has been based on the presumption that there's going to be some massive policy response to deal with climate change. I think there probably needs to be a little bit more of a shift towards understanding the physical implications and risks of climate change because it does seem that the overwhelming policy response is probably not coming.

Jason Mitchell:

That brings to mind, how do you think about the shifts in, call it, three buckets, decarbonization, transition risk, and adaptation, a physical risk, vis-a-vis global climate policy? Does the cooling in decarbonization, potentially, spill over into investment in the energy transition? Does climate adaptation become a necessary refuge in politically uncertain times, like you said, the Los Angeles Flyers or other weather related disasters over the past several years?

Dr. Tom Gosling:

I do think that there needs to be an element of a shift, actually. First of all, I mean, the decarbonization trend is still happening and is still really important. And I think it's important not to get distracted by what's happening at a federal level in the US. The decarbonization trend is still happening partly because in areas that economic momentum is such that these cleaner technologies just make sense. But also, in large parts of the world outside the US, from a geopolitical and strategic sense, they are absolutely critical. So, I think understanding how to invest in the energy transition is still a really important part of what investors should be doing. But I think we shouldn't be assuming that there is going to be an overwhelming government policy acceleration that is going to render fossil fuels unprofitable and a brave new world for renewables. I mean, I think there needs to be some hardheaded analysis, but let's not forget the fact that this decarbonization trend is relentlessly happening.

But at the same time, the one thing that we can be really certain of is that physical risks are going to continue to increase. Even if we hit net-zero today, there would still be an element of accumulation of risks that we have already baked into the system. And this is something where... You don't speak to an insurance executive, for example, who's sanguine about climate change because they're already seeing the effects in how they're pricing insurance policies. And so, I would like to see a greater emphasis within the investment community on really digging down into some of these physical risks and when and how they would emerge. Because, whilst I think that there is evidence that markets are pricing physical risks, it also probably seems to be the case that we haven't fully gone on top of this as an issue yet. And I think when we see physical risks being properly priced, that also supports this kind of feedback loop into government action on... Policy action on climate change as well.

I do think I guess there's a final point that there are really a couple of ways the world could play out as physical risks increase. One view of the world is that there's a point of awakening where even Donald Trump recognises that actually climate change is a real issue and there's a pivot to blaming the oil companies as an overwhelming policy response. I think the problem with that view is that mitigation, unfortunately, is always a tricky political proposition. Because any benefits from mitigation really have a 10, 20 year horizon at best. And the costs are immediate, and I think we may even see a pivot towards adaptation if climate physical risks get worse and worse. And so, adaptation is something that's probably been under emphasised in this whole discussion around climate targets in investor action. And it's probably the one thing that everybody should be able to agree on, is that we're going to need more adaptation as we go forward.

Jason Mitchell:

Yeah. I'd absolutely agree. It seems like the one area that resists the politicisation of climate. I mentioned this paper that you co-authored with Alex Edmonds and Dirk Jenter called Sustainable Investing: Evidence from the Field. And I wanted to ask a little bit more about it. In it, you find that most portfolio managers, both those managing traditional as well as those managing sustainable investment strategies, they all consider some degree of socio-environmental factors.

Now, apart from client mandates, what's your sense for how informed investors are broadly in terms of specifically the trade-offs around net-zero investing? From a quant perspective, you can find quant approaches that can pretty easily optimise for carbon constraints relative to a specific tracking error. That doesn't necessarily exist to the same degree within a discretionary approach.

Dr. Tom Gosling:

Yes. I mean, the first thing that was really clear from that research is that the extent to which asset managers are taking... And this was a survey of portfolio managers, asset managers, rather than asset owners. The extent to which they're taking climate considerations into account in investment decision-making is entirely driven by how they see those considerations affecting risk-adjusted returns, unless they face a constraint in their mandates. Asset managers are, essentially, return maximizers subject to the constraints faced in the mandate. So, we don't see asset managers going around voluntarily acting on climate for the good of the world. So then, how are they taking those? How do they see those trade-offs in relation to climate investing? And really, it comes down to different sets of beliefs, I think, underlying beliefs. There are some asset managers who clearly view addressing climate change as a cost in the industries that they operate in.And so, they're viewing this very much through the lens of, is regulation going to come into my industry and impose a cost? And it's very much, therefore, seen as a trade-off.

There are other portfolio managers who are much more inclined to see this as a win-win and who believe that... They are generally ones who believe that there is an inevitable policy response coming and that this trajectory of decarbonization is going to strengthen and that, therefore, there's a win-win zone between addressing decarbonization in your business model, and actually being more successful in future. And in a way, this is as it should be, right? This is a market where people with different perspectives have competing views, and that is how price formation happens. But the thing I'd want to emphasise is that this is just coming down to different views amongst those portfolio managers about what it is that's going to create value, rather than portfolio managers somehow imposing environmental views or constraints voluntarily on their investment decision making.

Jason Mitchell:

I want to ask you one other thing. You've written about how investors can't drive climate outcomes by themselves, but they can have a material effect on policy development through engagements with governments. How do you measure the effectiveness? What's the proxy for progress that you look at? I guess one that I've been looking at over the last several years is the investor agenda, which publishes an annual global investor statement to governments on the climate crisis. And I guess, in my mind, what do you make of the inconsistency in investor participation over the last several years? Support seemed to peak in 2021 with 733 signatories representing more than 52 trillion in AUM, but it fell in 2024, just recently, to 651 signatories with almost 34 trillion in assets. That's an 11% decline in investors and a 35% decline in AUM, which is pretty staggering.

I mean, these aren't declines reflected at all in other membership organisations like the PRI. How do you explain this phenomenon? Is this a collective action problem among the seven organisations and initiatives that coordinate the statement in terms of finding a common baseline of expectations? Some are more normative, some more legalistic. In my own opinion, I think it's interesting that the 2022 statement carried two very different definitions of fiduciary duty, which partly undermined the message. But what do you make of these collective efforts to engage with governments and some of the inconsistency and support we've seen?

Dr. Tom Gosling:

Yeah. Look, I think, clearly, part of the explanation for the reduction in support is I think there has been kind of compliance departments in some institutions that pressed the pause button on signing up to anything collective. I'm sure that's part of the explanation. But I mean, I do think that there are also genuinely different views within asset owners, even those who believe in the seriousness of climate change, about what the right stance is to take on these issues. And so, I think that you can, like me, believe that climate change is a really, really serious issue, whilst, at the same time, having concerns about whether 1.5 C is a credible target to sign up to, and also have concerns about how you combine fiduciary duties as an asset owner with meeting climate commitments. And there are others see no such kind of problems or conflicts in those positions.

I'm sure that part of the problem has been getting agreement as to exactly what it is that we're signing up to. And I think that, as time has gone by, some of the more stringent parts of the statement, and particularly the reference to 1.5 C, probably makes it more and more difficult for some asset owners to sign up. What influence does this have? I mean, I think, obviously, the more that investors can speak with a coherent, strong, and unified voice to governments about what they're wanting, the better. And that's where I think, in a way, we could allow ourselves to become unhelpfully distracted on these kinds of semantics about 1.5 C. Which is, in any event, something that subjected huge uncertainty about whether we'll meet it on a given carbon trajectory and how much it matters, and so on and so forth.

And I think trying to get back to some of these areas that we should be able to agree on, which is that we do need to get to net-zero. We do want to do that as rapidly as we can. We do need that to be politically driven, and to have political legitimacy. I mean, I think it would be great if we could get to some principles which actually a broader group of investors could consistently sign up to and speak with one voice on. On the other hand, I think that where we are now, I mean, global climate policy has kind of... I don't see major advances on the Paris Agreement coming anytime soon. So, the real action is in country-level NDCs. And so, I think what's most important is really not the global piece of paper shared commitments, but actually how investors are working with the opportunities they have in specific territories, as government said, NDCs to encourage ambition, to encourage sensible policy. So, part of me thinks that this probably doesn't actually matter very much and the focus needs to be a little bit more granular.

Jason Mitchell:

Got it. Last question. The latest podcast out is with Andy King at Boston University, which discusses the replication crisis in sustainable investing. Now, as someone who sits literally in the nexus of the academic practitioner community, how do you think about the claims in light of the increased scrutiny around replication studies? And I'm talking about specifically around the notion that decarbonization strategies that seek to limit temperature increases to 1.5 degrees C can also provide excess returns, I.E. a win-win situation.

Dr. Tom Gosling:

I'm very concerned about those sorts of claims. I don't think they have a huge amount of merit. And now, that's not to say that a decarbonization strategy might not produce outperformance depending on the scenario that pans out. But it's far from an obvious win-win. And I think that there's this real confusion. I mean, sometimes even within academia, to be honest, between realised returns and expected returns. And I think that there are some studies that suggest that there has been a period where a variety of sustainability considerations, including climate, who've gained greater salience and have caused some element of relative repricing of assets that may have produced an outperformance period for more sustainable stocks. But I don't think there's anything obvious that suggests that the same should happen in future. In fact, if anything, you might expect there to be a premium for dirtier stocks in future.

I think the idea that any outperformance that there may have been to date inevitably persists into the future, I think, has no basis. And I think, if anything, we might expect there to be lower expected returns in the future for stocks and portfolios that have lower risk. Coming on specifically to the decarbonization portfolios, I do have a concern about these because we do see some pension funds offering these as the sustainability option to beneficiaries. And the language around enhanced returns and reduced risks from these portfolios, I think is quite problematic when what they really are is the operationalization of an investment thesis that there is going to be a strong policy transition towards decarbonization that will result in stranded assets amongst heavy emitters, which will result in underperforming. Now, for me, that's an investment thesis rather than a risk management or an inevitable outcome. So, I think we need to be really cautious about making any linkages about sustainable portfolios and [inaudible 00:58:22].

Jason Mitchell:

Got it. Great. It's been fascinating to talk about how to think about the exits among climate initiatives, what the future of net-zero commitments could look like, and why investors, despite their limitations in driving climate outcomes, are still able to have a material effect on climate policy development. I'd really like to thank you for your time and insights. I'm Jason Mitchell, head of Responsible Investment Research at Man Group. Here today with Dr. Tom Gosling, professor in practise in the financial markets group at The London School of Economics. Many thanks for joining us on a sustainable future, and I hope you'll join us on our next podcast episode. Tom, this has been great. Thank you so much.

Dr. Tom Gosling:

It's been a great pleasure. Thank you, Jason.