Transition frameworks need to account for nuances in strategies, asset managers say.
The rising tide of net-zero greenhouse gas (GHG) emission pledges from countries, financial institutions and corporates has been a welcome, albeit necessary, next step in the mitigation of climate risk ahead of COP26 later this year.
Reducing emissions to net-zero by 2050 is seen as a prerequisite for limiting climate change to 1.5°C above pre-industrial temperature levels, an ambition laid out by the UN’s Intergovernmental Panel on Climate Change.
But recent research by NGO Energy and Climate Intelligence Unit (ECIU) and the University of Oxford found that just 20% of existing net-zero targets meet a set of “basic robustness criteria”.
Surveying more than 4,000 significant entities spanning nations, states, cities and companies on the Forbes Global 2000 list, the report noted that a strong net-zero pledge should include interim targets, clear reporting mechanisms, published plans and clarity on use of carbon offsets.
Making a promise without taking action isn’t good enough, with academics warning that net-zero pledges should be treated with a degree of scepticism.
From an overreliance on carbon offsetting (rather than absolute emissions reductions) to backing carbon capture technologies not tested on a large scale, academics wrote that current approaches to net-zero have “perpetuated a belief in technological salvation [while diminishing] the sense of urgency surrounding the need to curb emissions now”.
“Whether it’s bioenergy with carbon capture and storage (BECCS), afforestation, direct air capture or carbon absorbing unicorns, the assumption is that net-zero will work because it has to work. But beyond fine words and glossy brochures there is nothing there. The emperor has no clothes,” said James Dyke, Senior Lecturer in Global Systems at the University of Exeter.
Many major banks, insurers and asset managers have made net-zero commitments in recent months individually and collectively. But the funding and risk management services they have provided to carbon-intensive sectors historically makes for a complex transition.
Last week, PGIM Real Estate – the US$1.5 trillion global investment management business of Prudential Financial – committed to reducing the operational carbon emissions of its global portfolio of managed properties to net-zero by 2050, aligning with the Urban Land Institute’s (ULI) Greenprint Center for Building Performance Net Zero Carbon goal.
Aviva became the first major insurer worldwide to target net-zero emissions by 2040, while, in April, 43 global banks came together to form the Net Zero Banking Alliance.
But prior practices cast a long shadow. A recent report published by NGO Reclaim Finance highlighted that UK banks provided US$56 billion in support to coal companies over two years.
Furthermore, only 20% of asset managers in the Powering Past Coal Alliance (PPCA) have excluded companies from their portfolios that have coal expansion plans, the non-profit noted. This is despite the fact members such as Vanguard, PIMCO and Schroders have all made commitments to net-zero targets.
Asset manager reluctance to take action on climate is clearly seen in their voting records. Last year, major investors voted against a shareholder-led resolution which asked the bank to phase out its financing of fossil fuel and utility companies that don’t demonstrate alignment with the Paris climate goals.
Instances like this fuel asset owner scepticism, with their own pledges under threat if asset managers can’t be relied upon to meet targets.
The United Nations-convened Net Zero Asset Owner Alliance has committed to setting decarbonisation targets every five years. The group of 34 asset owners, with US$5.5 trillion in assets under management (AUM), will be reducing their portfolio emissions by between 16-29% by 2025, according to the Alliance’s ‘Inaugural 2025 Target Setting Protocol’ report.
Alliance members are relying on their asset managers to engage with investee companies and ensure Scope 3 emissions are being addressed.
“The investment industry needs to come together to form standardised frameworks, which are critical to ensuring carbon reduction in the real economy,” says Jihan Diolosa, Head of Responsible Investing at Russell Investments (US$300 billion AUM).
But existing net-zero pledges all look different under the hood, making it difficult to compare one net-zero transition plan to another, let alone identify whether a strategy is credible.
“Net-zero can be ambiguous: nuances in target implementation approaches can determine the real ambition and impact of actors’ net-zero pledges,” according to a report by the NewClimate Institute last year.
Race to Zero gets steeper
The United Nation’s Race to Zero Campaign is a global campaign representing 708 cities, 23 regions, 2,162 businesses, 571 higher education institutions and 127 of the world’s biggest investors. It aims to provide clear guidance on what a high-quality and actionable net-zero pledge should look like.
As net-zero scepticism grew, the Race to Zero’s Expert Peer Review Group (EPRG) oversaw the inaugural three-month review of the campaign’s criteria, requiring more drastic action in the near-term. Originally launched in June 2020, the campaign’s first set of changes will come into force from June 1 2021.
The EPRG will be updating the campaign’s criteria annually, increasingly turning up the pressure on members to accelerate – and provide evidence on – their transition to a low-carbon economy.
This yearly tightening reflects the fact that net-zero frameworks should not be set in stone. They should be reactive to shifts in policy and expectation that will undoubtedly occur over time, such as the changes in energy mix outlined this week by the International Energy Agency.
One of the key changes made by the EPRG is that, alongside a commitment to be net-zero by the 2040s or sooner, Race to Zero members must pledge to achieve a 50% or more reduction in their current emission levels by 2030. Previously, campaign members only had to say they would “plan” to set this interim target.
“Our revision of ‘plan’ to ‘pledge’ is underscoring that this campaign is not just about an endpoint in 2050, but a rapid drawdown of emissions to reach that endpoint,” says EPRG Chair Dr Thomas Hale, Associate Professor in Global Public Policy at the University of Oxford’s Blavatnik School of Government.
Members and partners of the campaign are now expected to publicly report progress against interim and long-term targets via platforms that feed into the United Nations Framework Convention on Climate Change (UNFCCC) Global Climate Action Portal.
Progress must account for emissions reductions across Scopes 1, 2 and 3, including “all territorial emissions for cities and regions, […] cumulative emissions and consumption emissions”, the EPRG said.
Members and partners must clearly specify the extent to which they are relying on sinks or credits to achieve carbon neutralisation. This ensures that pledges transition to absolute and immediate emissions reductions as quickly as possible, with neutralisation being reserved for residual emissions, Hale explains.
“Any neutralisation of residual emissions must transition to permanent removals by the time net-zero is achieved,” the working group noted. “[Members must] ensure that any [carbon] credits achieve robust outcomes for additionality, permanence and accounting, and do not undermine social justice or harm biodiversity.”
Ultimately, these changes have provided more clarity for investors, ensuring that requirements are “less complicated and more transparent”, says Zelda Bentham, Head of Sustainability at Aviva Investors, which manages £334 billion in AUM.
Asset managers fall into line
The fact that the Net Zero Asset Managers initiative has joined the Race to Zero means that 73 of the world’s largest asset managers are subject to its recently updated criteria.
Launched in December 2020, the Net Zero Asset Managers initiative is made up of 87 asset managers with US$37 trillion in AUM. Members have committed to reaching net-zero emissions by 2050 or sooner, annually reporting against the Task Force for Climate-related Financial Disclosures (TCFD) recommendations and aligning with the Race to Zero criteria.
“The rapid uptake of net-zero targets in the asset management industry is a very welcome first step, and it’s fantastic to see leaders in the industry commit to the Race to Zero, which comes with rigorous targets and a level of transparency that can ensure accountability,” says Hale.
Asset owners working with these asset managers can be more confident that they are meeting a more rigorous set of requirements to reach net-zero, Hale says.
“The [Net Zero Asset Managers initiative] was formed only recently, so I imagine the asset managers within it will have more work to do to make sure they’re fully in alignment with its goals and therefore with Race to Zero. But that’s what they’ve committed to do,” he adds.
With the Race to Zero Campaign’s recent review only being published in April, many asset managers’ existing net-zero strategies are in need of review to ensure continued compliance. But progress is being made on this front.
Asset management firm Arisaig Partners has committed to transitioning all of its funds to net-zero by 2050, says Lillian Wang, Impact Assessment and Engagement Director at Arisaig. This action plan includes seven consecutive five-year targets and an interim net-zero portfolio target, she notes.
Meanwhile, Macquarie Asset Management aims to identify and publish plans for reducing emissions produced by all new investments within 24 months of acquisition, according to Mary Nicholson, Head of Responsible Investment for Macquarie’s Real Assets team (AU$500.9 billion in AUM).
“Macquarie’s net-zero pledge aligns to the core elements of the Race to Zero guidance, including a commitment to an interim target for our private markets portfolio companies to meet their emissions reduction pathways by 2030, specific immediate actions to be taken and a commitment to report publicly on progress,” Nicholson adds.
Compliance is a compulsory part of membership. Hale explains that the campaign is an ‘umbrella’ initiative, meaning that the Net Zero Asset Managers initiative will be responsible for ensuring its members are complying with the Race to Zero criteria as and when it’s updated.
“As part of that annual review, the EPRG will do spot checks on individual asset managers to confirm that they are in alignment. If initiatives are unable to get into alignment with the criteria, they will no longer be included in the campaign,” Hale warns.
Accounting for nuance
Requirements for increasingly detailed net-zero commitments should only improve in clarity, transparency and efficiency over time as the UN’s Race to Zero campaign finetunes sector-specific frameworks that better standardise the journey.
But standardisation can only go so far. While allowing for more alignment, Bentham says it’s simply too early in the transition to have a single view on the best strategy to meet climate-related targets.
Although asset managers are working hard to ensure that their strategies align with both the Net Zero Asset Manager initiative and the Race to Zero campaign, asset owners can’t expect a “one-size-fits-all approach to achieving a net-zero outcome”, Macquarie’s Nicholson emphasises.
Asset managers have a wide range of underlying investments across sectors with differing levels of carbon emissions, making their individual journeys to net-zero unique, she explains.
Aviva Investors is working on methodologies for measuring the carbon intensity of sovereign bonds, but will need to look separately at how to measure carbon intensity across other asset classes like infrastructure debt and equity, Bentham says, meaning the firm’s strategy will need to be tailored accordingly.
“Inevitably there will be some nuances in [our] interpretations, but we ultimately expect the industry will coalesce around best practice frameworks,” Diolosa agrees.
Going forward, investors want to see clear guidelines for how to best demonstrate ‘alignment’ with the Paris Agreement’s 1.5°C target and deciding how to constitute “a fair share of emission reduction, given differences in geographies and industries,” says Wang.
“There needs to be a consistent view on what net-zero means in principle,” Bentham agrees.