Fog Begins to Lift on Net-Zero Transition

Multiplicity of tools present challenges for investors, exacerbated by lack of consistency on companies’ carbon emissions data.

With little time to waste, the investment community must engage “whole-heartedly” with the data, tools and analytics available today to measure companies’ transition to net-zero greenhouse gas emissions.

Users should work hard to improve their metrics and methodologies, rather than waiting for some “imagined future” where “perfect” information and answers will be delivered, says Adam Gillett, Head of Sustainable Investment at investment consultancy Willis Towers Watson (WTW).

Understanding the just transition to net zero – a systemic and urgent global challenge – is critical to building robust, resilient and high-quality portfolios, he adds, and will be “one of the biggest sources of alpha across all asset classes.”

Having access to the appropriate tools, analysis and data is a key part of institutional investors’ ability to deliver on climate commitments, he says. Emissions might be counted in CO2e, but variations abound and there is no single, definitive metric to adequately measure transition progress. Data and analytics in the climate space are rapidly evolving and will continue to do so.

To support asset owner clients, WTW is investing in analytics, including for company-specific climate transition value-at-risk modelling. Gillett says many current tools are limited in their assessment of the “true financial risk” investors are exposed to, including the extent to which that is reflected in market pricing.

Other tools recently launched include MSCI’s Net Zero Tracker, which provides a quarterly gauge of climate change progress across a global universe of 9,300 publicly listed companies based on the MSCI All Country World Investable Market Index, and Arabesque’s suite of Climate and Regulatory Solutions.

Tools and services specifically aimed at helping investors analyse and quantify the emissions levels and transition strategies of investee companies are part of a widening range of offerings, including portals and hubs provided by firms including asset servicers Brown Brothers Harriman and BNP Paribas Securities Services and exchange group Nasdaq.

Evidence is critical

As proprietary solutions evolve, a level of consistency around underlying data and methodology is important for comparability. During the past two to three years several standards have emerged for the measurement of the current carbon footprint of a portfolio, says Daniel Klier, President of ESG data and analytics provider Arabesque. These are used in tools that help asset managers deliver against investor commitments and regulatory obligations. Arabesque’s Temperature Score, for example, expresses the alignment of investment portfolios with a net zero pathway.

“While there remains a level of uncertainty for investors, the fog around indicators and models is lifting and regulatory bodies must further play their part in setting market standards,” adds Klier.

Klier describes 2021 as a critical year, with increasing numbers of financial institutions making public net zero commitments. “In order to avoid any concerns about the seriousness of such commitments, it is critical to evidence progress and alignment to a net zero scenario,” he says.

Gillett stresses the importance for investors when navigating all the tools, metrics and methodologies to understand “what they tell you, what they don’t, and why”.

Rory Sullivan, CEO of sustainable investment consultancy Chronos Sustainability, says there are too many different models and tools on the market to identify the most credible or most useful, a situation he likens to “the wild west”.

Asset owners and asset managers are using different tools, some in-house developed, others from third parties. “Individually, these are of value and can help decision-making. However, because there are so many and no real consensus, it is almost impossible to compare different investors’ strategies and approaches,” he says.

Call for standardised carbon data framework

To improve the situation, the industry must address the data underlying these tools and models. Sullivan helped to draft the Transition Pathway Initiative’s (TPI) response to a consultation by the Task Force on Climate-related Financial Disclosures (TCFD) on its Proposed Guidance on Climate-related Metrics, Targets, and Transition Plans. Backed by asset owners and supported by asset managers representing US$30 trillion AUM, the TPI assesses the progress that companies are making on the transition to a low-carbon economy, supporting efforts to mitigate climate change.

“Our experience has demonstrated that we urgently need a standardised framework defining how companies present their carbon data, and the supplementary information that needs to accompany these disclosures,” TPI states in its response.

“Without this foundational framework in place, it is extremely difficult to robustly assess and compare company practice and performance. It also means that more sophisticated indicators and metrics simply add confusion and not clarity. The consequence is that, in the absence of such a framework, the core goal of TCFD, namely, to produce climate-related financial data that can be used by market participants, simply will not be delivered.”

In analysing disclosures across ten high-emitting sectors, TPI found some companies exploiting loopholes in emissions reporting, rarely disclosing the reporting boundaries chosen. ESG investing is hindered by a lack of clarity on target boundaries, preventing investors from assessing the true magnitude of companies’ transition ambitions and dependence on offsets, it said, concluding that it is often difficult, if not impossible, to compare targets on a like-for-like basis.

In the oil and gas sector, for example, TPI assessed one company that had until recently limited its emissions reduction target to CO2, thus excluding non-CO2 GHGs such as methane, despite these emissions being material in the sector in which it operates. Likewise, many companies in the food processing sector report emissions from purchased goods and services (i.e. agricultural products), without being explicit on whether these figures include emissions from land use, land-use change and forestry, which are also highly material.

TPI found that “carbon neutrality” targets often fail to account for non-CO2 GHG emissions. It proposes that under the TCFD framework, companies should disclose the types of greenhouse gases covered by their emissions reduction targets.

More innovative approaches needed?

Gavin Starks, Founder of Icebreaker One, an independent, non-profit net zero advisory company, also calls for a more standardised approach. “While measurement tools are useful, they still have a long way to go before they truly represent the materiality of what they are measuring and give good options as to ‘what next’. Proliferation of analysis is good; however we need to standardise on some of the data elements to ensure cohesion, interoperability and comparability,” he says.

Initiatives such as TCFD will help “move the needle in some areas”, but more innovation is required to create the right institutional incentives for investors to act now and make better investment decisions.

Icebreaker One has developed a market architecture for non-financial data flows, that it hopes will make the wealth of data now available more usable to help firms address climate and environment risks and “to radically improve our investments in, and planning and management of our global infrastructure”. It is based on a federated approach to data sharing, namely that the data is not centrally stored, but is left with the data owner or controller, with consent managed to allow those with permissions to access using conditional rules that have been agreed by the market.

A data governance trust framework addresses three key issues, the firm claims. First, it helps align data discovery and access in a scalable manner to support millions of use cases. Secondly, it aligns participants around a secure and trusted environment from which they have a direct benefit. Third, critically, a trusted framework can reconcile legal, IP, liability and rights issues “in a manner that can unlock data sharing between organisations and across borders”.

Starks says collective efforts are making great progress, but “material change is still too slow. Physics doesn’t care about our economy, and balancing our social responsibilities with environmental facts is going to be increasingly challenging.”

Early days for tracking tools

Net zero tools are becoming more relevant, says Adnan Khan, Head of Data Strategy for Europe, Investor Services at Brown Brothers Harriman. ESG data providers are a “positive first step” in getting the data right and helping organisations understand the impact of their investment decisions from both a social and environmental perspective. Without the correct data, organisations can fall into the trap of “garbage in, garbage out”.

Speaking at the launch of the MSCI Net-Zero Tracker, Henry Fernandez, Chairman and Chief Executive Officer, MSCI, emphasised the role of data in tracking the progress of companies and their investors to a sustainable path in line with the Paris Agreement. “In addition to listed companies taking action to drive the transition to net-zero, there needs to be a reallocation of capital by asset owners and an effective channelling of funds by asset managers and banks,” he said.

Truly understanding the implications of being net zero is at the early stages in many organisations, says Khan. “For example, planting trees has been a common scheme to meet this goal and though it seems like a simple fix, there are many factors to consider when understanding value: are the trees in the right location?  Will planting the trees impact the current natural habitat? How can it be guaranteed that the trees will grow to maturity?  All these considerations matter, otherwise the scheme doesn’t deliver.”

Until the quality and availability of data improves, the task of scrutinising net-zero transition plans will be a tough one. “Ultimately, as investors start to understand the data better it may put pressure on companies that currently have an avoidance approach to carbon emissions rather than an offset approach,” he says.

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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