The environmental focus for investors in 2020 was heavily dominated by climate risk, a trend that is set to continue in the countdown to COP26.
Responding to the ever-increasing sense of climate urgency, 2020 saw a plethora of net-zero greenhouse gas emissions pledges from countries, investors and corporates, with deadlines ranging from 2030 to 2060.
The investment industry is alert to the growing threat of climate change, with global industry leaders coming together last year through the emergence of the Net Zero Asset Managers Initiative and the Net Zero Asset Owner Alliance, both of which commit to net-zero by 2050.
However, with research from the United Nations Environmental Programme highlighting that G20 countries currently account for 78% of greenhouse gas emissions, these long-term emissions pledges need to inspire drastic action in the shorter-term.
“Climate change is affecting companies and sectors right now, so it has to be something that we all build strategies around as we disclose climate-related risks and opportunities,” says Melanie Adams, Head of Corporate Governance and Responsible Investing at RBC Global Asset Management.
Net-zero pledges are the first step, allowing corporates, policymakers and investors to begin working towards a common goal, so 2021 needs to be a year of active engagement with climate change risks and opportunities, she emphasises.
Later this year, countries will be expected to report their progress and future plans at the COP26 climate talks, which will be hosted by the UK in Glasgow this November. Governments from around the world will submit revised domestic emissions targets, or nationally determined contributions (NDCs), for the next decade.
“It’s a good thing to have a net-zero goal in place, but we now need to know what the plan is to achieve that goal,” Adams tells ESG Investor.
In a recent blog post, Impax Asset Management called for countries that attend COP26 to “elaborate [with] credible sectoral roadmaps that demonstrate how their net-zero goals and shorter-term targets will actually be delivered.” Unless countries are able to provide more clarity, Impax Asset Management warned that “the private sector will struggle to invest in decarbonisation”.
The UK Climate Change Committee’s (CCC) Advisory Group of Finance (AGF) echoed these sentiments on the need for certainty from the public sector, suggesting that, beyond policy and regulatory reforms, the potential introduction of carbon pricing next year could more rapidly reduce climate risk.
“As investors focus on the sustainability transition, we expect this process to identify further opportunities from ‘creative destruction’ on the road to a decarbonised economy […] some incumbent companies and existing sectors will wither; new technologies, business models and industry sectors will emerge,” the firm added.
To identify winners and losers, investors may need new types of data. Emily Kreps, Global Director of Capital Markets for CDP, says that emissions data and environmental standards data is “inherently backward looking” and that investors want to “understand the forward component” of environmental factors. “In 2021, I would like to see a focus on more forward-looking metrics,” she says.
Efforts are building to provide asset owners with the information they need for climate-aware future investment decisions. For example, the Transition Pathway Initiative (TPI) is focused on evaluating the “time path for economy-wide carbon emissions” across sectors against benchmark paths, in order to generate forward-looking metrics for use by investors.
Climate-risk disclosures remain inconsistent
But there remains work to be done on core data. According to the Task Force on Climate-related Financial Disclosures (TCFD) 2020 report, “there is an urgent demand for consistency and comparability in sustainability reporting, especially for climate-related information”.
More than 1,500 organisations around the world have rallied behind the TCFD’s climate-related disclosure guidelines, which cover four pillars: governance, strategy, risk management, and metrics and targets. However, climate-related standards and targets are likely to remain an essential priority and focus for investors in 2021.
Last year, 80% of FTSE 100 firms disclosed climate-related metrics and targets, according to the Investment Association (IA). But corporates are not yet providing consistent transparency across each area. As further outlined by the IA, only 53% of the FTSE 100 firms that disclosed climate-related metrics and targets last year did so to a level that meets TCFD requirements.
Starting this year, TCFD-aligned reporting will become mandatory in the UK. From Q1 2021, commercial companies with a UK premium listing will need to include a statement in their annual financial report which should include acknowledgement that their disclosures are consistent to TCFD recommendations. Occupational pension schemes with assets under ownership of more than £5 billion, insurance companies and building societies also must report from as early as March.
To soften the transition, the Financial Conduct Authority (FCA) recently inserted an interim step for asset managers and corporates to “comply or explain” with TCFD reporting guidelines.
In Europe, 68% of large firms are “partially compliant”, according to a Climate Disclosure Standards Board (CDSB) report. As a result, CDSB has called for TCFD recommendations to be more “explicitly” embedded into the EU’s updated Non-Financial Reporting Directive (NFRD), which shall be published in Q1 2021.
With the US re-joining the Paris Agreement and carbon-intensive China committing to net-zero emissions by 2060, it is likely we shall see regulators working to iron out the most glaring inconsistencies in sustainability reporting this year, Kreps predicts.
“Climate-related reporting is very complex because there are different sectors with differing operating practices and they all have an interlinking impact on different areas of the environment,” she acknowledges. “It really isn’t a checkbox exercise. It’s about enabling the transition.”
Time for a global sustainability standard?
Going into 2021, many investors are hoping for greater consistency in climate-related disclosures.
“We have too many different climate-related disclosure frameworks to grapple with,” Adams says. “Having some kind of cohesive framework in place will be helpful for investee companies and their investors.”
As well as TCFD guidelines, the International Financial Reporting Standards (IFRS) Foundation published a consultation paper, which closed on December 31 2020. Most notably, IFRS suggested the implementation of a Sustainability Standards Board (SSB) which would oversee the implementation and management of any global sustainability standard that may be introduced by regulators.
In early 2021, IFRS will address feedback and identify “whether and to what extent the Foundation might contribute to the development of [sustainability reporting] standards”.
Five international sustainability reporting bodies, known as ‘the group of five’, penned a statement of intent last year, which outlined their support for a global sustainability standard that builds on the reporting guidelines proposed by the TCFD.
CDP, CDSB, SASB, Global Reporting Initiative (GRI) and International Integrated Reporting Council (IIRC) published a prototype global standard for sustainability-related financial disclosures, which supported the implementation of the SSB and inclusion of TCFD standards.
“This year, our objective is to push the bar higher for climate-related disclosures for companies in order to ensure investors are getting the most relevant information in a uniform and comparable manner,” Kreps says.
A future global sustainability standard will need to account for regional legislative differences, Adams points out. “We need local regulations for regional companies within any global framework that is introduced,” she says.
Kreps says a global sustainability standard would take this into consideration. “We absolutely recognise that a global sustainability standard would have to contend with regional, sectoral and governance differences. The EU’s Taxonomy is not appropriate for somewhere like Canada – which is why there is the transition taxonomy,” she says.
In a webinar last year, industry leaders argued that a global sustainability standard should perhaps be more about promoting “cohesion” between regions as opposed to simply operating as a blanket standard.
“Once we have more cohesion around sustainability reporting, it will be easier for corporates and will be more helpful for investors, too,” Adams adds.
Measuring environmental risks and opportunities
RBC Global Asset Management’s Adams notes that obtaining reliable and consistent environmental metrics remains challenging. Third-party vendors use different methods to measure and collate data, which can make it difficult for asset managers and owners to secure comparable data from investee companies.
“We need consistent data in order to effectively compare companies against their peers, so we can make better investment decisions,” Adams says.
“We subscribe to a number of data sources and have noticed that the quality of all the data we are seeing is improving, but it is very much an ongoing process,” she adds.
Kreps notes that quality data is far more important than quantity. “No matter how you phrase a standard or a framework, quality data is what will really drive the adoption and usage of ‘E’ metrics.”
Aside from quantitative data, the most effective way for investors and asset managers to combat any data discrepancies is to have a more “active dialogue” with investee companies regarding their commitment to sustainability and their targets, Adams advises.
Kreps agrees, emphasising that companies need to “start somewhere” and remain flexible. “Generating a consistent feedback loop is incredibly important to finalising any kind of global standard, but also ensuring investors and investee companies are on the same page,” she says.
Taking a “climate-first approach”
Going forward, investors want to see a “climate-first” approach to non-financial reporting standards, said Clara Barby, CEO of Impact Management Project (IMP), at the Qatar Centre for Global Banking and Finance Policy Forum last year.
She noted that investors “recognise the urgency of climate risk” and that investee companies need to reflect this prioritisation in their future climate-related reporting.
However, Barby added that a climate-first approach means “an initial focus on climate change in non-financial disclosures”. Ultimately, it is important to “broaden the topic scope of sustainability reporting reasonably swiftly”. Investors should aim to maintain an “ESG-diverse” portfolio to better increase their societal impact, she said.
CDSB noted in its report that solely focusing on climate change can be to the detriment of issues surrounding biodiversity, water and forests.
Through its research, the body observed “inconsistent disclosure formats” across environmental policy issues. “For example, quantitative targets and performance indicators were provided on climate change, but updates on biodiversity policies were often far less tangible,” CDSB said.
The disclosure standards group called for corporates to “better specify that policies disclosures should inform other content categories, and be connected to material risks and opportunities, timebound targets and actions, due diligence, outcomes and KPIs”.
“There are other pillars of the environmental focus that need our attention this year, beyond climate change,” agrees Sudhir Roc-Sennett, Head of ESG at Vontobel Asset Management. In particular, he notes that water security is an environmental issue that he hopes investors pay more attention to this year.
“In the future, there will likely be migrations in certain geographies away from areas where water security is poor. Populations are going to move to more stressed areas and there will be huge knock-on effects from that alone,” he explains. “This year, I hope that investors really think through the long-term trajectories of all environmental risks.”
Impax Asset Management argues that environmental risk factors beyond climate change, such as biodiversity, currently present more of a risk than an opportunity to investors.
“However, we are already starting to see potential opportunities in technology solutions to improve the monitoring of threatened biodiverse ecosystems, and to improve the traceability of commodities associated with deforestation, which are likely to pave the way for other opportunities across supply chains,” the firm said.