Sustainable Investment in China | Why Environmental Externalities Matter to Institutional Investors

By James Gifford, Executive Director, PRI Initiative

Many indicators regarding the health of the world’s environment remain firmly in the red. Trends such as climate change, water scarcity, air pollution, biodiversity loss and ecosystem degradation all continue to threaten our finite stock of natural capital and the ability of our economy to provide sustainable growth and prosperity for all.

A great deal of this environmental damage is caused by the way we do business. If we are to create a truly sustainable economy, then we must change our economic models so that business can become part of the solution, not part of the problem. An increasing number of investors have begun to factor environmental, social and governance (ESG) issues into their decision-making, recognising the unique role they have to play in driving the transition to a more sustainable global financial system.

A study by the Principles for Responsible Investment (PRI) Initiative and the United Nations Environment Programme’s (UNEP’s) Green Economy Initiative, using data from environmental research provider Trucost, helps investors measure the unaccounted costs of business activities by putting a price on natural resources that power business but rarely show up on corporate balance sheets. It calculates the estimated cost of global environmental damage between now and 2050, discusses why this is important for companies and investors, and outlines some possible actions that investors can take.

In China, the economic, environmental and social costs association with environmental degradation are well known. Greenhouse gas emissions are estimated to be the largest and most rapidly rising environmental cost up to 2050, and hundreds of millions of people could suffer hunger, water shortages and coastal flooding as changes in climate regulation affect access to food production, water, health and the environment. The Stern Review noted that almost two-thirds of economic losses caused by natural disasters in China, equivalent to 3.5% of GDP, were from climate-related events. Sea level rise in the economically developed Pearl River Delta, Yangtze River Delta and Yellow River Delta areas could cause over US$ 65 billion in economic losses by 2030.

Growth in the human population, industry and irrigated agriculture will make it difficult to meet rising water demand and manage water services in the next two decades.

Elsewhere, identifying and managing local and global threats is essential to protect freshwater resources and avoid costly remediation of water-related problems. Water crises are developing in several regions, with water shortages and droughts, floods or both, now aggravated by climate change impacts. Water shortages in China due to over-use and pollution cost an estimated US$ 39 billion a year in lost crops, lower industrial production and hampered economic output. Glaciers in the Himalayas that are crucial to water supplies in China and India are melting at an accelerated pace due to rising temperatures over the past 20 years. The “Water Towers of Asia” feed seven of the world’s greatest rivers, including the Ganges and the Yangtze, and supply water to more than 1.3 billion people. These water shortages, along with other climate change impacts, could destabilise political systems and lower economic activity in Asia in the future.

These calculations support the case for action by large institutional investors that have a financial interest in the wellbeing of the economy as a whole. By exercising ownership rights and through constructive dialogue with companies and public policy makers, these “Universal Owners” can encourage the protection of natural capital needed to maintain the economy and investment returns over the long term. Many Universal Owners are signatories to the Principles for Responsible Investment (PRI), and we hope they continue to exercise leadership and responsible ownership by acting on the ideas and recommendations in this report. It is our shared responsibility to safeguard our natural assets for the benefit of our generation and future generations – both in China and throughout the world.

A full copy of the Universal Owner report is available for download in English and Mandarin from the PRI website.