Rickard Nilsson, Director of Strategy and Growth at Esgaia, highlights evolving best practice aimed at reducing climate impacts across investment and lending portfolios.
“Despite growing pledges of climate action, global emissions are at an all-time high. They continue to rise. The latest science shows that climate disruption is causing havoc in every region – right now. We are in a race against time to limit global heating to 1.5 degrees. And we are losing.” – Antonio Guterres, Secretary-General of the United Nations.
Compiled by 278 scientists and 195 countries, the latest IPCC report released on 4 April finds that without immediate action the world is on track for a 3.2°C rise in temperatures by the end of the century.
As if the evidence of certain countries’ negotiation of specific terms and disclosure in these reports to reduce accountability or urgency was not enough, progress is lacking in business and finance as well. In September, a research study by the Science-Based Targets initiative found that out of the more than 4,200 companies in G20 countries that have set climate targets, only 20% are science-based. Similarly, Accenture has found – as exemplified by assessing the 1,000+ largest listed European companies – that the vast majority are not on track to hit their net zero climate goals. Furthermore, recent analysis shows that just 9% of the companies targeted by Climate Action 100+ have aligned their direct climate policy lobbying activities with the Paris Agreement (and even fewer, 2%, have broad alignment between the Paris Agreement and the lobbying activities of their industry associations), casting a shadow over the otherwise significant progress achieved through the initiative since launch.
Reaching net zero
Through the Glasgow Financial Alliance for Net Zero (GFANZ), financial sector net-zero commitments now exceed US$130 trillion. Still however, there is no standardisation on how to evaluate and validate forthcoming targets. Variations in boundaries, time frames and mitigation strategies make it difficult to compare goals, assess progress, and evaluate the credibility of financial institutions efforts to achieve net zero.
To drive alignment in portfolios – including achieving economy-wide decarbonization and a just transition – an investment strategy should prioritise engagement and stewardship and direct management (where relevant), particularly for existing assets. However, as we highlight in this article, given the urgency and based on historical evidence, this requires evolving practices from investors to make it more powerful and effective.
It’s time to evolve
Most investor guidance supports a joint view on the importance of accounting for the transition dynamic of assets, meaning that while we need to incentivise capital allocation to climate solutions and assets already on the right trajectory, maximising real world impacts will come from using active ownership and engagement to drive reductions in assets that need to transition. We need to understand however that ESG sometimes pays and sometimes doesn’t for companies.
Per a recent report from the UN-convened Net-Zero Asset Owner Alliance (NZAOA), corporate engagement becomes increasingly less effective when the business case for the requested action is impractical, uneconomic, or uncertain. When the decarbonisation needed is not technologically feasible, lacks sufficient economic incentives, or lacks stable, predictable, and reliable policy frameworks to build a business case, it will not materialise at scale through corporate engagement alone. Therefore, investors need to expand the breadth of their efforts and move from novel forms of engagement to increase efforts in sector/value chain engagement, policy engagement, and asset manager engagement.
Engagement best practices
Progressive investors truly serious about their intent will ensure that their stewardship activities are adequately resourced in terms of the investment in people and expertise, research, processes and systems. As noted in this ESG Explainer article, we need to focus on quality and not quantity, with more honesty and realism about the deployed resources and communications of progress, which includes addressing the why, how, and what of engagement practice.
Rooted in these evolving expectations, to further collectively address some of the structural barriers to effective stewardship such as short-termism, information asymmetry, and corporate access, we should encourage better transparency and accountability across the investment value chain. This would have asset owners aligning stewardship expectations with that of their beneficiaries, using contractual levers and engagement to – together with consultants and regulators – drive quality supply from investment managers.
Available guidance
On net-zero, there are several relevant initiatives that support financial institutions’ actions to reduce climate impacts across investment and lending portfolios. With criteria in these resources representing minimum requirements for target design, and given the lack of progress in the real world, we all need to contribute more resources and provide best practice examples to drive broad sector implementation. Below I highlight four of these resources.
First, the Science Based Targets initiative (SBTi) has issued near-term guidance for financial institutions and newly launched a net-zero for financial institutions foundations paper, which provides complimentary net-zero targets and will work in parallel. Both include dedicated information and recommendations around how to use engagement as a mitigation strategy. The foundations paper will be followed by an open stakeholder process to develop actionable criteria, detailed guidance, and technical resources to support financial institutions in the formulation and implementation of their science-based net-zero targets. Importantly, to reach broad alignment and usability, SBTi collaborates with both GFANZ and NZAOA around the latter’s Target Setting Protocol to ensure the frameworks account for potential differences in philosophies.
Second, the Paris Aligned Investment Initiative (established by IIGCC) published their Net Zero Investment Framework in March 2021, which provides a set of recommended actions, metrics and methodologies for investors to maximise their contribution. It currently covers the asset classes Sovereign bonds, Listed equity, Corporate Fixed Income and Real Estate, with active plans for extension.
Third, the Investor Agenda’s Expectations Ladder, released in May 2021, provides clear expectations and actionable steps for Investor Climate Action Plans (ICAPs). These are aligned with and complementary to the investor net-zero alliances guidance, providing a good stepping stone for investors early on in their net-zero journeys that accounts for differences in progress in investors’ climate journeys.
Fourth, the Institutional Investors Group on Climate Change (IIGCC) has launched a new toolkit, which provides a systematic framework consisting of six key steps that codifies best practice for all investors, aligned with the aforementioned net-zero investor initiatives.
Examples of areas to prioritise and practices to follow:
| Science Based Targets |
• Timebound climate science–based targets built on forward-looking climate scenario analysis, with review commitments
• Mitigation strategies incl. engagement, divestment & exclusions, climate solution financing, and (within) sector reallocation
• Capital management plans in relation to new high-carbon projects, low-carbon projects, and existing high-carbon assets.
• Relevant disclosures (incl. on climate lobbying) aligned with TCFD requirements |
| Paris Aligned Investment Initiative |
• Strategy and practice in terms of using clear milestones and escalation processes with feedback loop to investment, weighting, and divestment decisions,
• Using collaboration (collaborative initiatives) to increase influence,
• Asset owner engagement with asset managers on net zero investment goals,
• Influencing the enabling environment through public policy and market engagement. |
| The Investor Agenda |
• Collective/collaborative engagement,
• Bilateral engagement, and corporate escalation and voting,
• Disclosures of outcomes and impacts achieved from engagement. |
| Net Zero Stewardship Toolkit |
Steps include:
• net zero alignment criteria,
• engagement strategy for priority companies,
• introducing a baseline (minimum level) for engagement and voting across all portfolio companies,
• asset owner and manager alignment and engagement, as well as a framework for disclosures to improve transparency |
The bottom line
We all recognise that the transition to net zero must be just, inclusive, and effectively address social inequality as a systemic risk. Thus, even if this is still uncharted territory for many, with a lot to take on for both investment institutions and companies, the bottom line is that we need more climate awareness both on the issuer and investor side, with transparent plans and robust near-term action to follow.
Rickard Nilsson, Director of Strategy and Growth at Esgaia, highlights evolving best practice aimed at reducing climate impacts across investment and lending portfolios.
“Despite growing pledges of climate action, global emissions are at an all-time high. They continue to rise. The latest science shows that climate disruption is causing havoc in every region – right now. We are in a race against time to limit global heating to 1.5 degrees. And we are losing.” – Antonio Guterres, Secretary-General of the United Nations.
Compiled by 278 scientists and 195 countries, the latest IPCC report released on 4 April finds that without immediate action the world is on track for a 3.2°C rise in temperatures by the end of the century.
As if the evidence of certain countries’ negotiation of specific terms and disclosure in these reports to reduce accountability or urgency was not enough, progress is lacking in business and finance as well. In September, a research study by the Science-Based Targets initiative found that out of the more than 4,200 companies in G20 countries that have set climate targets, only 20% are science-based. Similarly, Accenture has found – as exemplified by assessing the 1,000+ largest listed European companies – that the vast majority are not on track to hit their net zero climate goals. Furthermore, recent analysis shows that just 9% of the companies targeted by Climate Action 100+ have aligned their direct climate policy lobbying activities with the Paris Agreement (and even fewer, 2%, have broad alignment between the Paris Agreement and the lobbying activities of their industry associations), casting a shadow over the otherwise significant progress achieved through the initiative since launch.
Reaching net zero
Through the Glasgow Financial Alliance for Net Zero (GFANZ), financial sector net-zero commitments now exceed US$130 trillion. Still however, there is no standardisation on how to evaluate and validate forthcoming targets. Variations in boundaries, time frames and mitigation strategies make it difficult to compare goals, assess progress, and evaluate the credibility of financial institutions efforts to achieve net zero.
To drive alignment in portfolios – including achieving economy-wide decarbonization and a just transition – an investment strategy should prioritise engagement and stewardship and direct management (where relevant), particularly for existing assets. However, as we highlight in this article, given the urgency and based on historical evidence, this requires evolving practices from investors to make it more powerful and effective.
It’s time to evolve
Most investor guidance supports a joint view on the importance of accounting for the transition dynamic of assets, meaning that while we need to incentivise capital allocation to climate solutions and assets already on the right trajectory, maximising real world impacts will come from using active ownership and engagement to drive reductions in assets that need to transition. We need to understand however that ESG sometimes pays and sometimes doesn’t for companies.
Per a recent report from the UN-convened Net-Zero Asset Owner Alliance (NZAOA), corporate engagement becomes increasingly less effective when the business case for the requested action is impractical, uneconomic, or uncertain. When the decarbonisation needed is not technologically feasible, lacks sufficient economic incentives, or lacks stable, predictable, and reliable policy frameworks to build a business case, it will not materialise at scale through corporate engagement alone. Therefore, investors need to expand the breadth of their efforts and move from novel forms of engagement to increase efforts in sector/value chain engagement, policy engagement, and asset manager engagement.
Engagement best practices
Progressive investors truly serious about their intent will ensure that their stewardship activities are adequately resourced in terms of the investment in people and expertise, research, processes and systems. As noted in this ESG Explainer article, we need to focus on quality and not quantity, with more honesty and realism about the deployed resources and communications of progress, which includes addressing the why, how, and what of engagement practice.
Rooted in these evolving expectations, to further collectively address some of the structural barriers to effective stewardship such as short-termism, information asymmetry, and corporate access, we should encourage better transparency and accountability across the investment value chain. This would have asset owners aligning stewardship expectations with that of their beneficiaries, using contractual levers and engagement to – together with consultants and regulators – drive quality supply from investment managers.
Available guidance
On net-zero, there are several relevant initiatives that support financial institutions’ actions to reduce climate impacts across investment and lending portfolios. With criteria in these resources representing minimum requirements for target design, and given the lack of progress in the real world, we all need to contribute more resources and provide best practice examples to drive broad sector implementation. Below I highlight four of these resources.
First, the Science Based Targets initiative (SBTi) has issued near-term guidance for financial institutions and newly launched a net-zero for financial institutions foundations paper, which provides complimentary net-zero targets and will work in parallel. Both include dedicated information and recommendations around how to use engagement as a mitigation strategy. The foundations paper will be followed by an open stakeholder process to develop actionable criteria, detailed guidance, and technical resources to support financial institutions in the formulation and implementation of their science-based net-zero targets. Importantly, to reach broad alignment and usability, SBTi collaborates with both GFANZ and NZAOA around the latter’s Target Setting Protocol to ensure the frameworks account for potential differences in philosophies.
Second, the Paris Aligned Investment Initiative (established by IIGCC) published their Net Zero Investment Framework in March 2021, which provides a set of recommended actions, metrics and methodologies for investors to maximise their contribution. It currently covers the asset classes Sovereign bonds, Listed equity, Corporate Fixed Income and Real Estate, with active plans for extension.
Third, the Investor Agenda’s Expectations Ladder, released in May 2021, provides clear expectations and actionable steps for Investor Climate Action Plans (ICAPs). These are aligned with and complementary to the investor net-zero alliances guidance, providing a good stepping stone for investors early on in their net-zero journeys that accounts for differences in progress in investors’ climate journeys.
Fourth, the Institutional Investors Group on Climate Change (IIGCC) has launched a new toolkit, which provides a systematic framework consisting of six key steps that codifies best practice for all investors, aligned with the aforementioned net-zero investor initiatives.
Examples of areas to prioritise and practices to follow:
• Mitigation strategies incl. engagement, divestment & exclusions, climate solution financing, and (within) sector reallocation
• Capital management plans in relation to new high-carbon projects, low-carbon projects, and existing high-carbon assets.
• Relevant disclosures (incl. on climate lobbying) aligned with TCFD requirements
• Using collaboration (collaborative initiatives) to increase influence,
• Asset owner engagement with asset managers on net zero investment goals,
• Influencing the enabling environment through public policy and market engagement.
• Bilateral engagement, and corporate escalation and voting,
• Disclosures of outcomes and impacts achieved from engagement.
• net zero alignment criteria,
• engagement strategy for priority companies,
• introducing a baseline (minimum level) for engagement and voting across all portfolio companies,
• asset owner and manager alignment and engagement, as well as a framework for disclosures to improve transparency
The bottom line
We all recognise that the transition to net zero must be just, inclusive, and effectively address social inequality as a systemic risk. Thus, even if this is still uncharted territory for many, with a lot to take on for both investment institutions and companies, the bottom line is that we need more climate awareness both on the issuer and investor side, with transparent plans and robust near-term action to follow.
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