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The ESG Interview: Coalition of the Willing

Günther Thallinger, Chair of the Net-Zero Asset Owner Alliance, hopes to expand the group’s membership and horizons, and looks forward to the industrialisation of engagement.

Reflecting the urgency and scale of climate-related risks in this pivotal year, 2021 has got off to a flying start for Günther Thallinger.

The 33 members of the UN-convened Net-Zero Asset Owner Alliance, which he chairs, have publicly committed to reducing financed emissions by as much as a quarter by 2025, having spent Q4 2021 consulting on and refining their ‘Inaugural 2025 Target Setting Protocol’.

Member CEOs also held a meeting with UN Secretary-General António Guterres, who reiterated the private sector’s crucial role “in building a more equitable and sustainable world”.

Further, the alliance has issued a call to join a proposed advisory body of scientific and academic institutions “to provide ad-hoc guidance and consultation” to its key workstreams. The advisory body will help to interpret and apply scientific information to the process of decarbonising portfolios, for instance guiding engagement efforts to understand and develop net-zero pathways in high carbon-emitting industries.

“We don’t already have models that can give clear guidance to companies active in different sectors. To support the evolution of individual assets, we need to have scientific pathways,” says Thallinger.

This flurry of activity comes on top of the day job. Thallinger serves as a member of the board of management, with responsibility for investment management and ESG, at Allianz, the Munich-headquartered global financial services provider. He also chairs Allianz’s Group ESG Board, which is responsible for ESG integration across all business lines and core processes dealing with insurance and investment decisions.

For Thallinger, the pace is unlikely to ease any time soon. The alliance has grown rapidly since it was launched, at the UN Secretary General’s Climate Action Summit in September 2019, with 12 founding members. Current members collectively account for just over US$ 5 trillion in assets under management, with Allianz accounting for around half (AUM: US$ 2.73 trillion in 2019).

The group has a stated ambition to recruit a minimum of 200 members or US$25 trillion in AUM in the medium term. Thallinger is hoping growth will bring a more even geographic balance. Despite the participation of CalPERS and Canada’s CDPQ, it is an overwhelmingly European enterprise at present, including AXA, Aviva, Generali, Swiss Re, Nordea Life and Pension and PensionDanmark.

He’s also targeting state-owned funds, including sovereign wealth funds, especially those of countries which have made 2025 net-zero commitments.

“If a government has made the Paris pledge, it is perhaps surprising that state-owned funds are not following through and coming up with their commitments,” says Thallinger. “Some such structures have joined us, but I believe that many could step forward and align with what their governments have stated clearly.”

Setting the pace for change

For Thallinger and other alliance members, much of the year will be taken up with the practical work of decarbonising portfolios in line with a target range of 16-25% by 2025. As outlined in the protocol, this is an interim ambition. New targets will be set every five years on the route to net-zero greenhouse gas emissions by 2050, in parallel with the updates to the Nationally Determined Contributions of signatories to the Paris Agreement.

“We are going to revisit the protocol year by year. Currently, it covers listed equities, corporate bonds and real estate; next will be infrastructure, as well as government and supranational bond issuers,” he says.

The protocol’s quantitative targets are in line with the UN Inter-governmental Panel on Climate Change’s 1.5 degree Celsius scenario for global warming, By setting five-year targets and publishing results every year, the alliance aims to avoid the risk of a disconnect between present actions and policies and long-term goals. This also minimises the temptation to depend on as-yet-unproven innovations and technologies to achieve targets.

The alliance offers members a range of tools and methodologies in order to reduce the carbon emissions of their portfolios. The protocol acknowledges fiduciary or equivalent duties to beneficiaries, recognising the need to act prudently, based on credible information, analysis, scenarios and models. As such, while the protocol recommends use of “science-based ranges, targets and methodologies”, they accept that flexibility is needed as “data and methodological constraints persist”.

This year, each member organisation will publish its own 2025 targets within the agreed range, then work with peers, providers and investee companies to make good on their commitment.

Emissions reduction targets are confined to the asset owners’ own Scope 3 emissions, ie portfolio or financed emissions, although members are also encouraged to set net-zero targets for their Scope 1 and 2 emissions. The alliance recommends also setting targets for the Scope 1 and 2 emissions for underlying holdings and for Scope 3 in priority sectors.

The protocol expects asset owners to achieve net carbon emission reductions via a four-part framework covering engagement targets (focused on the 20 high-emitting companies in their portfolios); sectoral targets (intensity-based reductions focused on specific industries, e.g. oil and gas, utilities, transport, steel); sub-portfolio emission targets (%-based reductions in asset classes with credible methodologies and adequate data coverage, e.g. listed equity, publicly traded corporate debt and real estate holdings); and financing transition targets (requiring members to report in their progress switching allocations to climate-positive investments, e.g. ‘green tech’ and renewable energy).

The rule of engagement

Engagement will be central to emissions reduction efforts by members. “It rests on engagement with companies,” says Thallinger. “That is clearly the key forum for how the evolution of the assets and the portfolios are going to be steered.”

The protocol advises asset owners to identify either the 20 highest emitting companies in their portfolios, or those responsible for 65% of their portfolio owned-emissions which do not already have Paris-Aligned transition plans. Although the protocol offers options for how to engage and to monitor progress, individual asset owners are left to set their own targets and KPI frameworks.

Thallinger recognises that the level of engagement presently required to understand and influence the climate-related impacts of investee companies is both unprecedented and unsustainable.

“Only lately, perhaps over the last 5-6 years, have investors been reaching out to companies to have a dialogue about their approach. Now, this is something that many are pushing for,” he observes.

In the short term, Thallinger supports collaboration, both with asset owners and managers. The alliance collaborates with a number of like-minded initiatives, including the COP26 Private Finance Hub launched last February by UN Special Envoy for Climate Action and Finance and Advisor to the UK Prime Minister Mark Carney.

It also works with the Science-Based Targets Initiative on target-setting methodologies for financial institutions and partners with ClimateAction 100+ to collaborate on sector-specific decarbonisation pathways, and support collective investor action. Thallinger cites the activities of ClimateAction 100+ as demonstrating the power of group engagement.

“It’s a great initiative that is bringing together many investors, and covering the largest emitters,” he says, noting in particular an efficient tactical approach in which one signatory leads the engagement with a particular company, with support from others to form the basis for ongoing long-term dialogue. “From today’s perspective, that’s clearly the best approach to develop.”

Dialogue is the preference but, in recognition of urgency, lines being drawn. The alliance has already asserted its strong opposition to investment in thermal coal. Last November, it published a position paper which recommended a cancellation of all new thermal coal projects, phasing-out of unabated coal-powered electricity generation and an end to financing and development of planned or future coal-fuelled power plants, beyond those under active construction.

Although members will aim to support transition pans by firms in which they are invested, they reserve the right to escalate opposition up to and including divestment in firms which prove “irresponsive” to the alliance’s demands.

Reporting required

In the longer term, Thallinger notes the longer-term need to scale up engagement, pointing out that asset owners are not the only organisations requiring more information from corporates.

Banks, insurers and other stakeholders also need to develop a detailed understanding of firms’ strategy and performance with regard to emissions levels. “We investors cannot assume we are alone in needing such engagement. Mandatory reporting needs to cover lots of information that needs to be gathered today in the engagement process. We need to come up with an industrialisation of the process in the form of structured and ideally mandatory reporting.”

Thallinger also calls for reporting to be audited. “If that information is audited, market participants can take this information as a starting place. And the more solid and complete the starting place, the less ongoing engagement dialogue is necessary,” he says, drawing parallels with the standardised and well-understood information flows already available for listed equities.

As moves evolve toward standardised reporting of material ESG risks by corporates, the present emphasis on engagement requires asset owners to work closely with managers. Thallinger welcomes the establishment last quarter of the Net Zero Asset Managers initiative by 30 buy-side firms.

“We need to ensure our asset managers are working our mandate, fully covering the targets we set in terms of climate impact. Here, we really need to work with the asset managers along the entire value chain. This clearly starts with RFPs and how a mandate is defined and how the follow-up dialogues are conducted,” he says.

Climate risk in context

Representing one element of one component (ie the E of ESG), the engagement efforts of the alliance members reducing carbon emissions must fit alongside existing sustainable investment policies and processes.

This applies to Allianz as much as any of its peers. The firm first published its ESG integration policy in 2018, including guidelines in areas from agriculture and animal welfare to human rights and nuclear energy, as well as its approach to selecting asset managers, engaging with investee companies and scoring them across 37 ESG criteria.

Thallinger sees these scores as informing a conversation rather than leading directly to a decision to divest. “We check the reasons for the score and open up a dialogue with the companies behind the scores to discuss their approach,” he says. “In this context, we believe we are tacking all of these areas of E S and G, including aspects that can be viewed in terms of a just transition, which needs to be considered by the asset owner alliance clearly.”

While engagement is crucial to the process of moving away from a carbon-intensive economy, so too is the fourth pillar of the alliance’s targets, financing transition, which covers a wide range of vehicles, structures and projects. “We really need to work together not only the companies, but also governments to have the overall context for these forms of financing,” says Thallinger.

Engagement with governments also includes advocacy efforts by alliance members. From a policy perspective, they are focusing lobbying activity on support of embedding net-zero 2050 ambitions into Covid-19 recovery frameworks, sectoral policies toward accelerated energy transition and mandatory climate reporting.

“Mandatory reporting is something governments should really push,” confirms Thallinger. “But we also believe we need to talk about the price of carbon and adjustment mechanisms, otherwise arbitrage transactions make it extremely difficult for us to manage our portfolios. A further issue is the subsidy of fossil fuels. Bluntly speaking, it simply needs to come to an end, very quickly.”

With a busy agenda like that, Thallinger will need is stamina as well as speed.

 

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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