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FOSSIL FUELTO DIVEST OR NOT TO DIVEST IS NOT THE RIGHT QUESTIONJUNE 2013

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INTRODUCTION

Student groups at approximately 325 university campuses1 across North America are demanding that university endowments be divested of their holdings in the fossil fuel (oil, coal and gas) industry in an effort to address the issue of climate change. As well, the campaign has signaled that it will extend its focus to include city and state governments, religious institutions and other public institutions.2 For the investors struggling to address these concerns and those of other stakeholders, there are often no easy answers.

Like their counterparts in the U.S., the “Fossil Free Canada” campaign led by the Canadian Youth Climate Coalition has its roots in the activities of 350.org, a grassroots organization whose “Do The Math” campaign has served as the basis for calls to divest.

WHAT bEGAN AS THE U.S. STUDENT-LED CAmPAIGN “GO FOSSIL FREE” HAS APPEARED NORTH OF THE bORDER ON SEVERAL CANADIAN UNIVERSITy CAmPUSES.

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1 http://gofossilfree.ca/campaigns

2 The Canadian Association of Physicians for the Environment (CAPE) have also weighed in on the debate, co-releasing a study with the Pembina Institute on the health impacts of the burning of coal and other fossil fuels. (Available at: http://www.ab.lung.ca/sitewyze/files/costly-diagnosis.pdf) CAPE has since urged Canadian healthcare providers, the Canadian Medical Association and other professional associations to make no new investments in fossil fuel-related companies and to divest from direct ownership and commingled funds that include fossil-fuel public equities and corporate bonds within five years.

The “math” according to website 350.org is as follows:

•The London-based Carbon Tracker Initiative estimates that that the consumption of the earth’s proven fossil-fuel reserves would yield five times the level of emissions recommended by climate scientists to stay below a 2 degree Celsius rise in temperature.

• If governments act to keep the temperature rise below 2 degrees C by putting a higher price on carbon (which arguably becomes more likely as we get closer to that threshold), then the value of those “stranded assets,” and companies and sectors which hold those assets, will decrease sharply.

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IS CLImATE CHANGE A RISk WORTH ADDRESSING?

Mercer regularly reviews research on environmental, social and governance factors including climate change and investment performance. Our research has identified a substantial body of evidence that suggests that climate change risk could have the potential to impact a Fund’s investments over the long-term. Further, Mercer’s own research on the potential impact of climate change for asset allocation found that climate risk could potentially represent 10 percent of portfolio risk for a hypothetical investor.3

With regards to published legal perspectives on whether a consideration of these types of issues is consistent with fiduciary duty, some argue that fiduciary obligations do exist:

FROm OUR PERSPECTIVE, THE kEy QUESTIONS FOR TRUSTEES IN THIS CASE ARE:

3 Climate Change Scenarios – Implications for Strategic Asset Allocation Public Report (2011), Mercer LLC Carbon Trust and International Finance Corporation, February 2011. Available at: www.mercer.com/climatechange

4 Freshfields Bruckhaus Deringer, A Legal Framework for the Integration of Environmental, Social and Governance Issues into Institutional Investment (2005), UNEP FI Asset Management Working Group. http://www.unepfi.org/fileadmin/documents/freshfields_legal_resp_20051123.pdf

5 Baker & McKenzie. 2012. Superannuation Trustees and Climate Change Report. http://www.bakermckenzie.com/files/Uploads/Documents/Superannuation%20Trustees%20and%20Climate%20Change%20Report%20-%20reduced%20file%20size.pdf

•Is a consideration of these types of issues consistent with fiduciary duty?

•Can the issue of climate change be addressed in a manner which maintains (or enhances) long-term investment objectives and responds to stakeholder concerns?

1. The 2005 report A legal framework for the integration of environmental, social and governance issues into institutional investment authored by Freshfields Bruckhaus Deringer concluded that “integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions.”4

2. Australian law firm, Baker & McKenzie’s report “Pension and Superannuation Trustees and Climate Change” argued that “most surveys have shown that the majority of Australian trustees now believe that addressing climate change risk is part of their fiduciary duty.” The authors concluded that “Given the risks and opportunities presented by climate change and the rapid introduction of carbon pricing regimes across multiple jurisdictions, trustees have a clear duty to consider climate change risks and relevant laws and policies in making investment decisions when such matters prove to be material.”5

Step one in our mind is a discussion with investment staff and board members about the nature of the risk (and opportunity) presented by climate change. More broadly, we believe that investors should review the potential impacts of environmental, social and governance issues, where material, on future fund performance. From here, each organization can determine the most appropriate way to address the risks/opportunities.

Divestment is only one possible response. However, as a response, while divestment is not a new approach, divestment from fossil fuels is relatively untested and potentially difficult for investors for many reasons, such as:

•Fossil fuels represent a significant component of today’s energy mix and they are used in a wide range of commercial and consumer applications beyond the energy sector

•Appropriate substitutes for fossil fuel companies may be fewer compared to other divestment campaigns such as South Africa and Sudan

•Divesting from such a large sector of equities markets might be considered a breach of fiduciary duty

•Divestment eliminates a shareholder’s ability to engage with companies and influence business strategy

•There is active debate over the ability of divestment to impact the value or behavior of companies

•Divestment is likely to have up-front and recurring costs

•Institutions may be wary of setting a precedent where they are subject to more frequent company or issue specific student requests (a.k.a. the “slippery slope” of divestment)

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WHAT SHOULD INVESTORS DO TO bETTER UNDERSTAND CLImATE CHANGE RISkS AND POLICy ISSUES?

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REVIEW EXISTING mANAGER APPROACHESInvestors can review if/how their investment managers consider sustainability issues in the context of managing portfolio risk or improving returns. For example, do they consider future carbon pricing scenarios when assessing investment opportunities?

ACCESS SUSTAINAbLE INVESTmENT THEmESThese strategies offer exposure to long-term growth beyond renewable energy and build in downside protection against future carbon pricing. Such strategies are increasingly available across asset classes, and can be particularly attractive in real assets.

VOTE yOUR SHARESProxy voting guidelines can be amended to actively respond to shareholder votes on climate risk disclosure, political lobbying and sustainability. Surveys suggest that an increasing number of investors globally are establishing policies with regards to voting considerations on shareholder resolutions related to climate change.

ENGAGE WITH COmPANIES AND POLICy mAkERSParticipation in collaborative initiatives like the Investor Network on Climate Risk, Carbon Disclosure Project, The Forum for Sustainable and Responsible Investment, and the UN-backed Principles for Responsible Investment urge companies, investors and governments to consider the benefits of climate change mitigation from an economic perspective. These initiatives allow investors of all types to share resources and maximize impact while providing valuable learning and networking opportunities.

START A COmmITTEE Higher education endowments often have campus sustainability committees with student representation. Expanding the scope or creating a new committee – as some North American universities have - to review sustainability issues related to the endowment can provide the Investment Committee with useful information and serve as a valuable means of engaging key stakeholders, including students and alumni.

The conversation about fossil-fuel divestment and its implications should be an informed and open exchange exploring the relationship between sustainability and long-term investment objectives so that meeting the goals and objectives of the organization remain the primary aim. We believe there are ways in which investors can consider climate change and a broad range of sustainability issues within the context of their current investment structure and objectives.

IN OUR VIEW, THE ISSUE REmAINS COmPLICATED. THE SIzE OR STRUCTURE OF AN INVESTmENT PROGRAm CAN mAkE WHOLESALE DIVESTmENT ImPRACTICAL, EXPENSIVE OR RISky. AmONG THE ALTERNATIVE OR COmPLEmENTARy OPTIONS THAT INVESTORS CAN CONSIDER ARE TO:

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Mercer encourages clients to consider responsible investment approaches and the proactive management of climate risk. Mercer employs a specialist team of 15 professionals that help institutional investors integrated environmental, social and governance factors throughout the investment process.

For more information, contact:

Jane Ambachtsheer Partner +1 416 868 2659jane.ambachtsheer@mercer.com

or visit our website at www.mercer.com/ri

Jean-Pierre Talon Partner+1 514 841 7568jean-pierre.talon@mercer.com

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Copyright 2013 Mercer (Canada) Limited. All rights reserved.Copyright 2013 Mercer (Canada) Limited. All rights reserved. CA-06-25-JB

Argentina

Australia

Austria

Belgium

Brazil

Canada

Chile

China

Colombia

Czech Republic

Denmark

Finland

France

Germany

Hong Kong

India

Indonesia

Ireland

Italy

Japan

Malaysia

Mexico

Netherlands

New Zealand

Norway

Peru

Philippines

Poland

Portugal

Saudi Arabia

Singapore

South Korea

Spain

Sweden

Switzerland

Taiwan

Thailand

Turkey

United Arab Emirates

United Kingdom

United States

Venezuela

For further information, please contact your local Mercer office or visit our website at:www.mercer.com/ri