U.S. companies regardless of any tax or other regulatory measures which may or may not be forthcoming in the United States.

DOMESTIC POLITICAL MOMENTUM

In response to both domestic and international pressure for a robust response to Kyoto, President Bush announced his new climate change policy on February 14, 2002. The administration's Clear Skies Initiative commits the United States to reduce it greenhouse gas intensity by 18 percent over the next 10 years, and includes substantial financial incentives for renewables and clean technologies. The President's proposed budget for fiscal year 2003 increases spending on climate change mitigation to $4.5 billion per year.

On February 20, 2002, EPA Administrator Christine Whitman launched one of the key components of the Bush Administration's new climate policy, the Climate Leaders protocol. That initiative encourages companies to report on their emissions of the six major GHG's, using a reporting framework developed by the World Resources Initiative and the World Business Council for Sustainable Development. In concert with similar initiatives elsewhere, this should make a significant contribution to increasing the level of transparency of carbon risk exposures and, as a result, increase accountability for both corporate directors and investment fiduciaries.

In the United States, there are a number of bipartisan bills, resolutions and legislative proposals currently before the 107th Congress, several of which, among other things, propose significantly increased company disclosure of carbon risks, measurement of emissions, and increased research and development.

NEW INSIGHTS INTO THE ECONOMICS OF CLIMATE CHANGE MITIGATION MEASURES

The economics of climate change has been a source of considerable uncertainty and controversy. Several high-profile studies have estimated the costs of mitigation to be extraordinarily high, particularly in the United States. However, these estimates have invariably used worst-case assumptions that necessarily imply high costs, for example, highly limited or none existent emissions trading activity, a need to meet short term targets, or limited use of non-carbon fuels.

Recent studies give grounds for optimism that the right blend of policies, if skillfully introduced, can substantially reduce the direct and indirect costs of mitigation and perhaps even produce a net economic benefit9.

THE NEED TO LOOK BEYOND THE KYOTO PROTOCOL

Effectively addressing climate change can only be achieved via the adoption of more sustainable development pathways that simultaneously attend to interdependent social, economic and environmental challenges. While the Kyoto Protocol is a crucial first step in managing the problem, focusing entirely on the agreement would encompass too narrow a set of interests and divert attention away from some of the more fundamental social, environmental, technological and economic issues at stake. The broader sustainability context of climate change simply must be appreciated if the issue is to be effectively managed.

Taken separately, few of these trends are sudden or radically new. What is new, however, is their confluence at a single point in time. Taken together, they form a kind of "perfect storm" which has already begun to redefine the responsibilities of fiduciaries in the early 21st century. Together, Innovest believes that they are rapidly moving climate change to a position of growing prominence on both corporate and institutional investor's agendas.

Providing the right blend of regulatory pressure and market mechanisms to allow institutions to incorporate climate-related factors into future underwriting, lending and asset management activities is a critical step. Directing institutional capital toward supporting organic development of new clean energy technologies in their investees is also crucial. The renewables and clean power technology markets are becoming increasingly compelling in the search for 'win-win' outcomes; the nascent GHG, CAT bonds, weather derivatives and microfinance/microinsurance markets also hold substantial promise for strategic finance and insurance companies.

Ultimately, It is Innovest's belief that unleashing the creative instincts of the private sector is by far the most effective way of dealing with environmental pressures. Our research shows that businesses that practice sound environmental management also enjoy enhanced stakeholder and customer capital, operate with reduced costs and less risk, are faster to innovate and generally foster a higher level of manage

9 For example, 'Scenarios for a Clean Energy Future', Oak Ridge; Argonne; Pacific North West; Lawrence Berkeley; National Renewable Energy Labs, for U.S. Department of Energy, 2001

ment quality. More importantly, our research also shows that these benefits translate into sustainable competitive advantage and superior share price performance. This linkage between environmental and financial performance therefore creates a virtuous circle, in which proactive firms are rewarded by investors and encouraged to continue in their endeavors. Less proactive firms are also provided with a powerful incentive to adopt more positive responses. In the ensuing battle for best-in-sector leadership, the only surefire winner is the American public, who benefit from a more competitive private sector whose interests are better aligned with the broader tenets of sustainable development, with all the quality-of-life benefits this brings.

INNOVEST STRATEGIC VALUE ADVISORS, INC.

Innovest Strategic Value Advisors is an internationally recognized investment research firm specializing in environmental finance and investment opportunities. Founded in 1995 with the mission of delivering superior investment appreciation by unlocking hidden shareholder value, the firm currently has over US$1-billion under direct sub-advisement and provides custom research and portfolio analysis to leading institutional investors and fund managers throughout the world. Innovest's current and alumni principals include senior executives from several of the world's foremost financial institutions, as well as a former G7 finance minister. The company's flagship product is the Eco Value 21 platform, which was developed in conjunction with strategic partners including PricewaterhouseCoopers and Morgan Stanley Asset Management. Innovest is headquartered in New York, with offices in London and Toronto.

RESPONSES BY DR. MARTIN WHITTAKER TO ADDITIONAL QUESTIONS FROM

SENATOR JEFFORDS

Question 1. It is clear that, regardless of the remaining uncertainties concerning exactly when and how climate change will impact our world, perceptions of climate risk have grown to such an extent that companies here and abroad are considering changing their practices to improve their long-term financial stability. How have investors in this and other countries begun to reorganize their financial portfolios to favor more climate-friendly businesses?

Response. From a traditional asset management perspective, few investors have taken steps to adjust investment actions due to climate change considerations alone. The only segment of the asset management universe that has adjusted portfolios on account of climate change issues is the socially responsible investment community (which constitutes anywhere between 3–8 percent of total assets under management in the United States). Mainstream asset managers, regardless of location, have not begun to adjust their portfolios, indeed, our research indicates that many fund managers or analysts do not even recognize that climate change is an issue that would prompt them to consider reorganizing their assets. The overriding feeling on climate change within the non-SRI institutional investment community is that the financial implications of climate change (or, more accurately, the manifestations of climate change on the one hand, and exposure to regulations limiting GHG emissions on the other) are not proven. Unfortunately, this belief is not based upon any rigorous financial analysis of potential impacts to equity or debt valuations. Were such analyses to be conducted, our research indicates that the financial community would be a willing listener.

Rather than adjusting portfolios, there is a small but growing number of pension fund trustees and pension policy professionals (including, for example, the State of Connecticut Treasurer's department) that recognizes climate change as an issue of potential concern, and that is preparing to engage companies to urge them to manage the issue more proactively on account of fiduciary concerns. The Carbon Disclosure Project, which now has backing of over $2 trillion in assets under management, and includes Merrill Lynch Investment Management, the Credit Suisse Group, and Walden Asset Management, is an example of this. We expect that the engagement approach, rather than the asset adjustment approach, will be favored by most pension funds, and that this approach has the potential to exert major influence over corporate management strategies on the climate change issue.

Elsewhere within the broader financial services sector, we know of several commercial banks that are examining whether there is a need to adjust credit risk calculation due to climate change factors. For example, in the hotel and leisure sector, there are reports that financing of winter resorts dependent upon snowy conditions has been affected; Fitch and Standard and Poor's, the credit rating agencies, have begun to examine exposure to potential GHG legislation at the company-specific level in the utilities and power sectors; and private equity and project finance spe

cialists have steered more money toward clean, low carbon technologies on account of the market opportunities being created by actions (regulatory and otherwise) to lower GHG emissions. Finally, in the insurance industry, climate change is exacerbating concerns over weak economic conditions within the insurance industry and forcing companies such as Swiss Re to reexamine their business mix. The P&C business in particular continues to experience weak premium pricing power and increased losses, with catastrophic event (CAT) losses contributing to poor results. The P&C industry has also been plagued by excess underwriting capacity, the effect of which has been to depress prices, shift product mixes into banking and other financial services, and force firms into expanding into overseas markets where climaterelated regional impacts may be more acute.

I would be happy to elaborate with specific details on any of the points made above.

Question 2. You work with companies that have started to internalize the risks of emitting greenhouse gases. Why are some companies taking this step, while others hang back? What and why should investors know about a company's carbon risk?

Response. Companies that have taken action to manage climate-change related risks thus far have done so for one or more of the following reasons: (i) to comply with current or anticipated regulations restricting GHG emissions (notably in Europe); (ii) to realize efficiency gains within their operations (notably through energy conservation initiatives); (iii) to reinforce a positive environmental reputation; (iv) to act upon concerns over the effects of future climatic changes on their business; (v) to gain a perceived competitive advantage over peers in technological innovation, particularly in industries with long capital planning cycles (next generation technologies in most industrial settings often confer GHG emissions benefits as a side effect); (vi) in response to concerns expressed by shareholders.

A key determining factor on company stance is its geographic location. For European firms, the primary drivers appear to be reputation (they operate in a marketplace more cognizant of environmental pressures) and regulatory requirements. Companies hang back in this market either because they do not feel exposed to consumer sentiment about climate change or because they do not anticipate being effected by future regulations. In the United States, primary drivers appear to be international competitiveness and operating excellence. U.S.-based multinational companies such as Exxon-Mobil have made it clear that they will act to curtail emissions and internalize risks in those areas of the world where they are required to do so, which may result in different strategies by business units within the same company. In our opinion, U.S. companies hanging back do so primarily because they do not perceive a need to act, either due to lack of regulatory compulsion or because their client base does not require action of them.

At this stage, knowing what we know about potential climate effects and the impacts of emissions regulation, I think it's prudent for financial market investorsparticularly those with a long-term investment horizon-to require more information and reliable analysis on how these risks might affect equity valuations or debt quality, so that they can then factor such risks into their own preferred investment style. For investment banking and project finance specialists, there is a more immediate need to understand how the costs of reducing GHG emissions might reduce rates of return and influence capital spending decisions (companies such as BG and Shell are already calculating the sensitivity of project returns to carbon price movements, as they would examine sensitivity to oil price fluctuations or interest rate movement). On the flip side, the World Bank's Prototype Carbon Fund experiences has shown that the generation and sale of carbon credits can augment returns to the point by several percentage points.

In view of on-going post-Enron concerns over off-balance sheet risks, the possibility that climate change may well be a market risk capable of inflicting damage to investor returns has taken on a new significance. The essential point is that company competitiveness and profitability in a wide range of industrial sectors-automotive, chemicals, coal, electric power, manufacturing, oil and gas, refining, water, steel, tourism, food and agriculture, cement-could be seriously affected by climate change. Moreover, there will be substantial differentials in company carbon risk exposure within particular industry segments, differentials that are not currently being picked up by traditional securities analytics.

Question 3. As you know, I'm a cosponsor of legislation to cap carbon dioxide emissions from power plants, S. 556. If there is no cap in the near future, what do you think will be the effect on carbon markets and companies' carbon risk management activities in the United States and abroad?

Response. My chief concern is that without a cap, carbon is unlikely to be assigned a value, and without much of a value, the notion of a carbon market is unlikely to have any legs. Markets function on the basis that something of value is being exchanged. Voluntary or uncapped emissions targets, particularly when applied to the highest emitting sector (and the one most likely to act as buyers of emissions credits/offsets), will not create the conditions necessary for a fully functioning marketplace, with the result that emissions trading is unlikely to prosper except for certain multinational and transnational companies.

Of course, from an environmental emissions perspective, the absence of a cap is unlikely to focus the mind of corporate emitters on mitigation activities. Under an uncapped scenario, carbon risk management is less likely to come down to the simple objective of reducing emissions, and more likely to focus on (i) internal efficiency initiatives, where the prospect of economic gain through enhanced efficiency is the chief driving force, and, (ii) in the long term, clean technology development, where economic gain through new product offerings and process innovation is foremost. These are worthy goals for any firm to pursue but they may not produce the emissions reductions required to combat climate change over the time periods identified by the IPCC.

Question 4. What do you think is the greatest risk, in the next 30-50 years, of continuing to increase human-made greenhouse gas emissions? And, what is the most feasible way to reduce or eliminate that risk?

Response. From a global perspective, to my mind the greatest risk is the potential exacerbation and intensification of poverty-inducing conditions within the developing world. Less developed countries (LDCs) stand to bear the brunt of any disruptions to climate shifts and have less capacity to deal with those disruptions as and when they occur. Aside from broader moral humanitarian concerns, this may also carry an economic penalty for OECD countries, in the form of accelerated immigration from poor regions, lower productivity in basic industries situated in LDCs, stresses on the public purse (due to, for example, health costs and disaster relief) in LDCs with attendant currency woes, requirements for more aid and foreign direct investment from rich countries, and sizable opportunity costs relating to a failure to capture inherent entrepreneurial talents and skills of LDC populations struggling to cope with deteriorating domestic infrastructures.

The most feasible way to reduce that risk is the expedited development, commercialization and transfer of clean power production and transportation technologies. Transportation and stationary power production are the two greatest anthropogenic sources of greenhouse gas emissions; they are also the two areas of civic infrastructure most in need of advancement within poorer countries, primarily in view of their catalytic role in general economic development. India and China play an especially important role in global GHG emissions and international trade, and both present clear market opportunities for U.S. business. The Indian electric power sector is the largest consumer of capital in that country, drawing over one-sixth of all Indian investments. The United States is the largest supplier of foreign direct investment in India, much of it in the power sector. As part of efforts to reduce dependency on coal, India has a significant program to support renewable power, exemplified by wind power capacity that rose from 41 megawatts in 1992 to 1,025 megawatts in 1999, which should present U.S. exporters with appreciable opportunities.

Similarly, in China, which reportedly ranks second in the world in energy consumption and greenhouse gas emissions, power generating capacity and power consumption are expected to nearly triple by 2015 from their values in 1995, requiring some $449 billion in total costs. The China Daily reports that Chinese and U.S. trade ministers agreed in Beijing in April 2002 to set up a new consultation mechanism under which U.S. Trade and Development Agency (U.S. TDA) will provide funding for projects in China in the areas of e-commerce, renewable energy and solid waste treatment. According to Chinese government officials, wind power, solar energy, hydropower and other renewable and new energy resources will account for 0.7 percent of the total annual commercial energy used in China by the end of 2005, and 2 percent by 2015—again, major opportunities for U.S. clean power developers. All of this is to say that the renewables and clean power technology markets are becoming increasingly attractive for investors and provide a clear possibility for a 'win-win' outcome involving LDCs; the nascent markets for greenhouse gas emissions credits, 'green' power certificates (based on Renewable Portfolio Standards), catastrophic event (CAT) bonds, weather derivatives and microfinance/microinsurance also hold substantial promise for forward-looking finance and insurance companies. Indeed, commercially viable technologies exist today (such as combined heat and power, and cogeneration approaches) whose introduction could go a long way

toward reducing GHG emissions in the short term, while more developmental clean technologies are brought to the market.

RESPONSES BY DR. MARTIN WHITTAKER TO ADDITIONAL QUESTIONS FROM

SENATOR SMITH

Question 1. Dr. Rowland testified that "during the 20th century, the atmospheric concentrations of a number of greenhouse gasses have increased, mostly because of the actions of mankind." Do you agree with that statement? Why or why not?

Response. On matters relating to the science of climate change, including the buildup of GHG concentrations and the potential effects on global climate conditions, I take my lead from the Intergovernmental Panel on Climate Change, which I believe to be an authoritative source on the subject. To the extent that Dr. Rowland's statement reflects the opinion of the IPCC, yes, I agree with his statement. A brief point on the issue of scientific discourse: As a scientist by training I realize that uncertainty and debate are fundamental to the process of scientific and technological advancement. While it is clear that uncertainties remain, and that there are scientists whose opinions differ from those of the IPCC, it appears that the balance of probability has shifted toward the view that anthropogenic influences have accelerated the buildup of GHGs in the atmosphere, and that this buildup is likely to be causing changes in the Earth's climate.

Question 2. Dr. Pielke testified that "the primary cause for . . growth in impact[] is the increasing vulnerability of human and environmental systems to climate variability and change, not changes in climate, per se." Do you agree with this claim? Why or why not?

Response. As I recall, Dr. Pielke was trying to point out that the heightened economic impact of climate variability was due to more to the increased vulnerability of human systems than to climate change per se (in other-words, modern day society was more exposed to climate variability by virtue of the fact that urban centers, coastal developments, etc., were likely to suffer greater economic impacts from extreme weather events). I agree that human and environmental systems are more vulnerable to climate variability than was previously the case; the recent reports from Swiss Re, Munich Re and the Lawrence Berkeley National Laboratory/U.S. DOE strongly support this view. But the same reports also present compelling evidence that the incidence and severity of extreme weather conditions is also rising, implying that it is not just the economic consequences of climate variability that is worrying, but that the variability is also becoming greater.

Ultimately, however, I am not sure that I recognize a huge distinction between the two points of view in terms of what it means for how we go about addressing the problem. If impacts are growing because of increasing vulnerability of human and environmental systems to climate variability (and if anthropogenic GHG emissions are increasing climate variability) then it is still prudent to adapt more effectively to changing climate conditions and deal with anthropogenic GHG emissions. Question 3. Dr. Pielke also stated that "the present research agenda is focused improperly on prediction of the distant climate future" and that "instead of arguing about global warming, yes or no. we might be better served by addressing things like the present drought. . .” Do you agree with that proposition? Why or why not?

Response. I believe that Dr. Pielke is right to stress the importance of dealing with more immediate climate-related problems (such as droughts, famines, etc.), which have tended to become forgotten in terms of the overall global warming debate (although not within broader development circles). However, given the possible causal connections that exist between the short-term problems he alludes to and the longer term issue of global warming, I don't believe that we can afford to dismiss the need to better understand future climate conditions altogether. IPCC data presented in the Third Assessment Report and the Special Report on Emissions Scenarios implies that one cannot successfully deal with one issue without tackling the other, and make plain the links between short- and long-term climate issues, and the critical importance of broader demographic, technological and political trends in determining future emissions scenarios. The integrated, interdependent nature of these broader factors, captured within the image of sustainable development, has been overlooked in my opinion within the climate change debate (which has focused more on Kyoto instead). I would certainly concur that less focus on esoteric matters of perceived scientific relevance and more urgency around action to improve the lives of ordinary people and the world in which we live is desirable.