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To Build Back Better, pay attention to program design, incentives, and risk allocation

"Building Back Better" isn't just about what we fund; it is also about how we fund it.  This holds true even for very important objectives such as decarbonizing our economy to address climate change risks.  The slides below provide a concise overview of better ways to structure policies so that the incentives are more effectively aligned; limits of knowledge and power are properly reflected in the new programs being put into place; and progress or lack thereof can be detected more quickly to allow for government support and funding to be reprogrammed and redirected.  With irreversible changes from problems such as climate change, it's not just wasted money that is a problem; it is also blowing our very limited response window.1 

  • 1. As an aside, these slides were developed and then refined for invited presentations at two different conferences: one for left-of-center groups and the other for right-of-center groups. Despite political differences, both sides shared a strong interest in achieving objectives of government in more efficient and more transparent ways. These events were the Oil Solutions Summit hosted by the Rocky Mountain Institute and the Brookings Institution in 2008, and Is Subsidizing Commercial Energy Projects the Best Way for America to Achieve it Energy Goals? hosted by the Heritage Foundation and the Nonproliferation Policy Education Center in 2009.
John Harvard Statue

Decarbonizing a large financial portfolio is a complicated task.  Investment managers and their fiduciaries need to ensure that institutional requirements can continue to be met even with greenhouse gas constraints on investment choices.  Selecting what to cull and what to keep is not always straightforward.  Once beyond the most obvious fossil fuel extraction companies, identifying which firms are acceptable investments in a carbon constrained world becomes more gray.  There are greenhouse gas-intensive firms in other sectors.  There are firms that are efficient producers within their sector, but still more carbon-intensive than alternatives once a slightly longer time frame is incorporated.  Lines of business (such as finance or retailing) that appear to have low direct emissions from the consumer-facing portion of the industry, yet be linked to quite substantial emissions once their supply chains, borrowers, or embedded emissions in products (e.g., with refrigeration or air conditioning) are taken into account. 

Read Earth Track's Analysis:  Investment Disclosures by Asset Class -
Current Practice at Harvard Compared to Large Funds

And measuring climate impacts remains an imperfect process, with sometimes wide disparities in how different tracking organizations evaluate carbon impacts of the companies they monitor.  Further, the depth and breadth of coverage and evaluation drops off sharply as one moves from publicly-traded firms to private; from large firms to smaller; and from highly-analyzed developed market firms to developing and frontier countries.  State-owned enterprises, big players in oil and gas around the world, do not always publish reliable and transparent books of account.

Further, if the world progresses as needed to address the threat of climate change, it is clear that many of the firms and industries deemed acceptable in a 2021 portfolio will no longer be so in 2025, 2030, and beyond.  Indeed, the evaluative process will need to be continuous and dynamic.

True, many of these problems will improve over time.  But that time will measure in decades, not years; and each step will be a potential battle.  The Financial Accounting Standards Board, set up to establish standardized rules for corporate financial reporting, is nearly 50 years old.  And yet it continues to grapple with new challenges year-in and year-out.  ESG standards are more wide ranging and often more difficult to quantify.  Further, at least at present, there is less pressure on firms to adopt and apply them.  Consider that with financial reporting, even a small privately-owned firm in a sector with no public-facing reputational risk needs to take on bank loans, and the banks will require audited and accurate financial statements.  The insurers will want reliable financial information, as will many customers.  A similarly-situated firm in an environmentally-problematic industry will not see the same pressure to rigorously adopt standardized environmental reporting. 

Because decarbonizing a multi-billion dollar endowment is a process rather than a statement or an event, one needs to pay careful attention to the checks and balances, the disclosures, and the oversight of actions and procedures that the investment managers and their overseers put into place.  End goals are important, but not without interim milestones that are both concrete and verifiable.  Public commitments are commendable, but not without public disclosure that allows others to see, evaluate, and critique the progress, or lack thereof.  

The good news is that while it is very hard to cost-efficiently pull CO2 out of the air, it is much less hard to establish a robust set of checks and balances on endowments.  These oversight mechanisms can both protect the core (and real) needs of investment managers to move quickly and strategically on their investment strategy, while also ensuring detailed disclosure of those investments over time such that key stakeholders are able to see regular and systematic progress in the endowment's transition to net zero and beyond.

A key element in this oversight is much more extensive disclosure of investment holdings than what Harvard currently does.  Earth Track's review assesses Harvard's endowment asset-class by asset-class.  How big is each category in terms of total holdings?  What has the university committed to do in terms of disclosure and decarbonization?  What should disclosure look like for each asset class, and where are other large investment funds already disclosing much more detail than Harvard does, and yet surviving just fine?

Investment Disclosures by Asset Class: Current Practice at Harvard Compared to Other Large Funds

Harvard has the largest university endowment in the world.  Its investments are run by the affiliated Harvard Management Company (HMC), which operates under the Treasurer of the University and the Harvard Corporation.  The University has committed that the endowment will be net zero greenhouse gas emissions by 2050.  The stature of both the University and its endowment mean that real innovations in investment tracking, measurement, and selection would have enormous ripple effects across many other large investors.  At present, however, there have been no interim milestones publicly announce

Harvard Shield

Harvard Management Company (HMC), which manages Harvard University’s nearly $42 billion endowment, released its first Climate Report in February 2021.

As the largest university endowment in the world, decisions Harvard makes to tangibly and materially reduce the climate impact of its investments will garner significant attention around the world and provide space for many other institutions to make similar moves.  Further, the school has the scale and the stature to coordinate with other institutional investors and accelerate the pace of financial innovation across asset classes to more effectively integrate climate-related criteria.  The reverse is also true:  when Harvard does little or nothing, it provides an excuse for other institutions to delay restructuring as well.  

Read Earth Track's detailed review of HMC's Climate Report here

The issue of decarbonizing the endowment has been discussed for years, though with very little real change in investments.  Perhaps as a result, Harvard Faculty of Arts and Sciences (FAS) formally voted 179 to 20 to support divesting the portfolio of fossil fuel assets at their February 2020 meeting.  The vote included an amendment to decarbonize the entire endowment in accord with IPCC climate projections.  Thus, the FAS faculty also voted to decarbonize the endowment. 

At the time, Harvard President Larry Bacow committed to bringing the faculty motion to the Harvard Corporation for consideration.  Bacow summarized the Corporation’s response in a June 2020 written communication.  It read, in part:

Harvard’s endowment should be a leader in shaping pathways to a sustainable future. With this in mind, the Corporation has directed the Harvard Management Company (HMC) to set itself on a path to decarbonize the overall endowment portfolio—a move in step with the final element of the resolution adopted by the Faculty in February. In particular, the Corporation has instructed HMC to develop a strategy for the endowment to achieve net-zero greenhouse gas emissions from the portfolio by 2050. This will require developing sophisticated new methods for measuring emissions associated with the investment portfolio and then for systematically reducing them across the full breadth of the portfolio. We believe that this approach, which considers the investment portfolio as a whole, rather than simply targeting the suppliers and producers of fossil fuels, is the right one for the University to pursue.

The first public step along that strategic process was to be the creation of a public climate report by HMC.  There were some positive elements to, and disclosures in, the report.  However, its scope and depth were underwhelming; so too were the framing and reporting choices made by HMC.  Key changes needed include:

  • Convert the Climate Report from an ad hoc policy summary to a rigorous presentation of progress and challenges.  HMC should formalize that the Climate Report will be an annual publication, with a specific release date.  Additional changes:
    • Like a financial report, the annual Climate Report should include a standardized set of sections, including both qualitative and quantitative.  This will ensure consistent and comparable reporting over time.
    • Report authors and reviewers should be listed individually all future documents.  Any advance approval by parties outside of HMC and its climate team for data included in the report needs to be disclosed.
    • For each third-party organization to which HMC or Harvard has joined to leverage its decarbonization effort, the Report needs to include the data reported to that organization, which data elements are not made public, specifics on why that data has retained confidentiality restrictions, and options to address those constraints going forward.
    • The Report needs to include a section on the available financial and personnel resourced to achieve the net zero targets, an evaluation of its adequacy, and a plan to rectify shortfalls if they exist.
  • Robust interim targets.  Harvard needs to set formal interim targets and reporting milestones during CY2021 that map out its path to net zero by 2050.  Milestones need to include not only emissions, but disclosure transparency on holdings and company-engagements as well.
  • Full transparency on holdings.  Company-level (not fund-level) disclosure of endowment positions across all asset classes should be implemented as soon as possible.  During 2021, HMC should provide a listing of each asset class, what information is already available to others – whether released in financial filings or assembled by third-party data providers like PitchBook and Preqin, and outline a path to present investment-level holdings for all asset classes to the public via the HMC website.  While there may be appropriate guardrails on when something is released or in what form, HMC needs to present a plan to go from no-release to full look-through transparency.
  • Modernize shareholder committees.  Harvard needs to update its oversight shareholder committee structure, first implemented nearly 50 years ago, to reflect the current investment environment, and to summarize its recommendations in a publicly released white paper.


Decarbonizing Harvard’s Endowment : Reviewing Harvard Management Company’s First Climate Report

Harvard Management Company (HMC), which manages Harvard University’s nearly $42 billion endowment, released its first Climate Report in February 2021.  As the largest university endowment in the world, decisions Harvard makes to tangibly and materially reduce the climate impact of its investments will garner significant attention around the world and provide space for many other institutions to make similar moves.  Further, the school has the scale and the stature to coordinate with other institutional investors and accelerate the pace of financial innovation across asset classes t