Published in Institutional Investing in Infrastructure

Drew Campbell, i3 senior editor, spoke with Michael Likosky, a partner at Advantage Infrastructure Advisors, about California Governor, Gavin Newsom, leadership on climate change.

California Governor Gavin Newsom

What is Governor Newsom’s approach to the emergencies faced by California?

Newsom is addressing the dual emergencies of COVID-19 and Climate Change through a battery of actions, which themselves provide short-term safety to the state’s businesses together with an ability to do long-term commercial planning. Both are essential for innovation, quality jobs, and competitiveness. California is a globalizing economy, an extroverted economy, so Newsom’s impact is being felt well beyond the state’s borders. 

How is Governor Newsom handling Climate Change?

The international community faces a high stakes climate emergency. At this pivotal moment, Governor Newsom is leading this community from the emergency’s epicenter. California’s forests have unprecedented climate-induced fires raging, it is horror and distress. Importantly though, the Governor is not playing defensive. 

Instead, Newsom is pursuing a proactive innovative approach covering a number of elements including automobile emissions, forest stewardship, state sovereign fund investing, conservation, among other areas. These distinct focal points are part of a broader holistic approach touching on manifold sectors of the economy. Importantly, California is a globalizing economy, so the reach and impact of the Governor is expansive. The opportunity for prudent global climate investors is sizable. 

That is the environment he is working within—how is he approaching the challenge?

Governor Newsom has a distinctive approach to leadership which carries authority within the state and nationally. It is on display with the dual crises. 

Leading California through these unprecedented crises is no small feat. It is not widely known, but California is one of the most unaccommodating states to govern. California is not a command and control economy. To the contrary, counties, cities, quasi-public entities, a critical mass of citizenry and companies frequently view themselves as having equal decision-making authority over the economy as the state does. This condition is what is referred to as “home rule”.

Newsom thrives in this environment. His approach is authoritative, collaborative, and highly skilled in acting as the lead decision-maker within the interchanges among so many public entities throughout the state.

How does this translate into leading the state?

The Governor is known for establishing audacious goals. Right now, Newsom’s portfolio of goals is evolving into a cohesive forceful vision. His California is both making markets and moving markets nationally and globally.

His way of formulating and executing on these goals has a number of elements. The goals are driven by entrepreneurship and innovation. Several leadership elements are worth highlighting.

Newsom’s focus is always upon respecting the capabilities of Californians to take on seemingly intractable challenges as drivers of decisions rather than being conditioned by circumstances out of everyone’s control. Many of Newsom’s most impactful decisions are taken through unorthodox means such as executive orders, agreements with the federal government, among others. These means are not an end around of the legislature, but rather an art of leadership. Newsom frequently mandates that the execution of his goals happens collaboratively among key stakeholders. Although great latitude is given to them to innovate solutions, mechanisms of accountability are elemental, acceleration of results is required.

Just because Newsom thrives in this environment is no reason not to appreciate the difficult vexed decisions being taken. For instance, the COVID-19 crisis has had tremendous individual and community costs. It has also been enormously expensive, and the state has had to carry much of this cost on its own balance sheet. The federal government and local governments have not covered proportionate costs. Another area is the fires ripping through parts of the state. Although California owns less than five percent of the forests, it has entered into a shared stewardship agreement with the federal government to carry out forest thinning to decrease the likelihood of the magnitude of further climate-induced fires. The federal government owns the majority of these forests. Newsom has decided in both of these cases that stepping up and leading is the only course of action, because others will not lead or pay their share of the costs. Importantly, it is these types of decisions that are among those ones providing safety and business security to private enterprise in the near, medium, and long-term.

Governor Newsom recently signed an Executive Order on automobile emissions and climate, what is his approach?

The majority of California’s carbon emissions come from cars. So, Newsom went to the source and signed an Executive Order mandating zero emission for new cars and passenger trucks within the state by 2035.

In doing so, given the unique position of California in size, innovation and global commodity chains, Newsom established a significant element of decision-making over the production processes for vehicles. This order is in important ways a de facto sector-wide purchasing order. It provides a long-term flatbed of business certainty for zero emissions car manufacturers and the diverse array of businesses involved in the sector to engage in sizable innovation and also research and development. Companies can engage in greater planning exercises.

Because California is an extroverted state rather than an inward-looking protectionist one, businesses involved in the national and international automobile sectors will be beneficiaries of Newsom’s decisions as will individual automobile purchasers.

Given the boldness of the order, automobile facilities and their supply chains will also reorient. This value chain involves the sourcing of primary materials for autos, global commodity chains, site location and expansion of production facilities, worker training and wages, and infrastructure build out. Because firms can count on a burgeoning market leading up to 2035 and beyond, they can also access less expensive financing for business operations.

The importance of bold large-scale action right now cannot be underestimated. With the onset of the COVID-19 crisis, substantial businesses are actually making long-term business decisions so long as they have significant operations within sizable safe sovereign environments such as California. Prime among these decisions are ones around production facilities and global commodity chains. Long-term logistics are now being entered into, favoring certain airports and seaports. Certain primary commodities going into vehicles and other products are having advanced purchases made upon them. Medium-sized suppliers are being chosen for long-term favorable agreements. Many of the paths through which global business happens are beginning to harden as these long-term agreements are forged. For this reason, Newsom’s capability to act decisively in the midst of the crisis is itself hardening these businesses processes within the climate area. Here, Newsom has emerged as a major driver of global climate markets.

These types of long-term business decisions are only possible if short term safety exists. Governor Newsom is providing this safety through his handling of the COVID-19 crisis, and also actions such as the 2035 one. Newsom is providing safety, durability and a long-term orientation for California’s businesses in a decidedly non-overbearing way. As a result, the state’s businesses are maintaining and/or expanding additional operations in other states and globally. California is not a zero-sum economy. It makes the global economic pie larger, so is less concerned with fighting over a slice which it perceives as shrinking. Many companies are making long-term commercial commitments. They are doing so often in uncertain political environments. Newsom’s ability to deliver security for businesses with substantial facilities and supply contracts within California allows this to happen. In fact, automobile manufacturers and the large number of suppliers who depend upon them are able to leverage Newsom’s credibility in delivering results to make long-term business planning.

Newsom just followed up on an Executive Order from last year involving California’s pensions and Climate and the follow-up report by his Department of Finance issued recently, what is the approach?

The Governor is viewing the state’s pension plans as sovereign funds. As with other initiatives, Newsom’s approach enmeshes the fact that California is not only a sovereign, but also the fifth largest economy in the world. Most sizable countries have their own sovereign funds. Certain U.S. state sovereign funds are especially important because of their sheer size and global influence. Unlike many countries, the U.S. federal government itself does not have a sovereign fund in this sense, it is invested in Treasury Securities.

The three most sizable funds – the California Public Employees’ Retirement System (CalPERS), the California State Teachers Retirement Fund (CalSTRS), and the University of California Retirement Plan (UCRP) – have $700 billion under management. So, the position is that these funds have enormous investment capabilities which can advance decisions, mitigate climate risks and also drive capital into opportunities to create sustainable inclusive communities. Moreover, if they move together and regularize their investment processes in the climate area, then they will have further impact within the institutional investor market and also among third-party money managers and, in turn, the climate business opportunities into which they invest.

As they devise common and shared processes including investment parameters and disclosure rules, the funds will in certain ways act as a bloc. The result will be greater strength among them as well as beyond as they drive the institutional investor market and set a gold standard among money managers on climate investments. Importantly, these sovereign funds are already among the most sophisticated as regards investing in areas involving Climate, Environment, Social, and Governance.

One important outcome of Newsom’s action is that these sovereign funds will be much more equipped to invest in separately managed accounts and through direct co-investment vehicles. Related, the rigor of diligence involved in choosing third-party managers will increase substantially driving greater clarity in the investment hypotheses of these managers. 

Under the Newsom guidelines, a multi-stakeholder working group will be established which can assist in building on great depth among the sovereign funds to develop common disclosure standards. A working group can also have a great impact upon a core area of Newsom’s mandate: the definition of investment parameters and apparatuses to move capital into projects. These sovereign funds can draw upon California’s unique expertise in this area. The investment approach will extend beyond disclosures to articulations of Climate benefits and their alignment with financial outcomes. As this process matures, it is likely that we will see some reorganizing of the investment decision-making process of each, on their own, and collectively.

For instance, major climate investments in the area of infrastructure must be rethought. Right now, these investments come largely out of the sovereign funds’ allocations for infrastructure. However, a major climate infrastructure is likely to have real estate, transnational corporate, and logistics elements. A truly impactful climate infrastructure investment would need coordination among allocation areas.

If you adopt the hypothesis that an infrastructure project is not standalone, then these sovereign funds are going to, with their disclosure policies and with investing strategy, increasingly integrate the operations of their divisions.

One of the greatest challenges right now within infrastructure is devising an investment vehicle that is a natural fit with the investment opportunity. It is not possible to slice and dice a climate project while still accounting for its benefits and risks.

For instance, a zero-emission company will have a corporate investment, supply chain considerations, facilities to build or expand, infrastructure projects tied to the facility, among other investible opportunities and areas for disclose of risks and articulations of benefits. Another example is a climate transit project which may have an interconnected real estate project which also advances these objectives. Right now, sovereign funds are not set up to invest into infrastructure and real estate at the same time. In fact, many sovereign funds preclude doing so. Related, most third-party money managers who invest on behalf of these sovereigns have similar strict divisions; that is, infrastructure or real estate.

Because of the natural outcome of Newsom’s Executive Order, the California sovereign funds will be able to capitalize on a much larger investment opportunity than now available.

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