High-Carbon Sectors Caught in Sights of LGIM, CBAM

Manufacturers face further pressure from investors and new European carbon pricing mechanism.

Firms in sectors now included in scope of Legal & General Investment Management’s (LGIM) expanded Climate Impact Pledge are under most threat of disruption and higher costs from Europe’s planned carbon tax, according to research from Allianz and credit insurance subsidiary Euler Hermes.

As announced earlier this week, LGIM now includes cement, steel, chemicals, and property among the sectors it is pressurising to address climate change, using proprietary ratings to monitor their progress on reducing emissions. Firms in these sectors will be rated against 40 climate-related indicators, facing sanctions up to and including divestment if they fall short of LGIM’s expectations.

“We are monitoring heavy-emitting sectors that make possible the production of basic materials, the transportation and housing of goods and people. But we are also covering those that have a high indirect impact through their supply chain,” said LGIM in a new document outlining its updated strategy for encouraging firms to transition to net-zero emissions by 2050 through targeted engagement.

The cement, steel and chemicals industries are among those facing further pressure from European Union plans to levy fees on polluting imports under a carbon border adjustment mechanism (CBAM), expected to be proposed formally early next year.

As part of its programme to achieve net zero greenhouse gas emissions by 2050, the European Commission is drafting rules that would charge fees on imports into member states from countries with lower emissions standards. It would also end the practice of providing domestic EU producers with free emissions trading certificates in sectors that cannot pass on costs to customers, thus potentially disrupting existing business models.

The new mechanism is expected to be introduced gradually from 2023. A commission official has said that steel, cement and electricity imports would be the first to affected, but the scope could be extended to aluminium, fertilisers and chemicals.

Under current EU rules, sectors under threat from cheap external competition are on a carbon leakage list, meaning firms receive a free allocation of EU-ETS (emission trading systems) certificates, thus making their emissions-related costs more manageable. The most recent carbon leakage list includes more than 50 sectors, with free allocations amounting to 37% of ETS emissions in 2015, meaning more than a third of relevant emissions are not priced.

Although three models are under consideration, Allianz asserts that the CBAM is almost certain to end the current distribution of free EU-ETS certificates to carbon leakage sectors, if only to comply with World Trade Organisation rules. As such, discussions on transition arrangements for affected sectors “is already in full swing”, with subsidies, test phases and staggered / selective introduction all under consideration.

At current emissions levels, the cost of certificate expenditure for the cement sector under CBAM could exceed 140% of sectoral gross value added under certain emission pricing assumptions, representing “significantly higher carbon costs”. Other highly impacted sectors include manufacturers of industrial gases, steel, fertilisers, aluminium and chemicals.

Allianz points out that anticipation of the costs would lead manufacturers to lower their emissions or otherwise pass on costs rather than suffer the burden represented by the new regulatory framework. But the research is clear on the level of disruption that the EU CBAM would cause.

“These industries (and their customers) are in for a rough ride: adaption costs to a CBAM are challenging, to put it mildly,” the report reads.

According to Allianz, the EU CBAM could set a precedent which encourages other jurisdictions to align with European climate policies, similar to the way that the General Data Protection Regulation influenced standards for data protection beyond European borders. “The planned introduction of a CBAM has the potential to be a game-changer in global climate policy,” the Allianz report reads.

Under LGIM’s renewed Climate Impact Pledge, the number of firms covered by its climate ratings will increase tenfold to more than 1,000. LGIM will publish the ratings on its website using a traffic light system and intends to “ratchet up” both its standards and sanctions over time.

Previously, the engagement programme focused on 80 of the largest firms in the energy, transport, food retail and financial sectors. Indicators on which firms are rated by LGIM include climate-related governance, disclosures in line with the Task Force on Climate-related Financial Disclosures, lobbying activity, and forward-looking carbon performance.

“Investors must be transparent about how they assess companies. By making our climate ratings publicly available, we want to encourage companies to address gaps in their disclosures and strategies, whilst adding a layer of public accountability,” said Meryam Omi, Head of Sustainability and Responsible Investment Strategy at LGIM.

LGIM is a unit of Legal & General, the UK’s largest life insurer, and has more than £1 trillion in assets under management.


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