World’s largest sovereign wealth fund details its frameworks for managing climate change; highlights carbon footprint and climate scenario analyses.
As investors respond to the first installment of International Panel on Climate Change’s 6th Climate Assessment Report, Norges Bank Investment Management (NBIM), which manages Norway’s sovereign wealth fund the Government Pension Fund Global (GPFG), has issued a comprehensive guide to how it addresses climate change as a financial risk.
Understanding when, where and how the effects of climate change will materialise is a complex exercise, but investors can both address both risks and opportunities through their investment and ownership decisions, said NBIM. With approximately US$1.1 trillion in assets under management, GPFG is the world’s largest sovereign wealth fund.
Describing itself as an “early mover” among investors on climate change (having published its first expectations on how companies should address the issue in 2009), NBIM’s responsible investment strategy is based on establishing principles, exercising ownership and investing sustainably.
The asset owner and manager addresses climate risk within the framework set by Norway’s Ministry of Finance, which includes requirements on responsible investment. A benchmark is based on indices from FTSE Russell and Bloomberg Barclays but differs “somewhat” from a broad market index, said NBIM, as it has regional distribution adjustment factors, and excludes certain coal companies and upstream oil and gas companies as per Ministry of Finance stipulations to reduce the total oil price risk for the Norwegian economy.
These factors, said NBIM, mean that its starting point is a benchmark that has “a significantly lower carbon footprint than the investable universe it is based on”.
Investing across equities, corporate and sovereign bonds, and unlisted real assets including renewable infrastructure, NBIM discloses climate information for the fund in regular reporting, including some of the climate metrics recommended by the Task Force on Climate-related Financial Disclosures, such as the carbon footprint of its portfolio. Metrics related to company dialogues, outcomes of assessments of investee companies’ climate disclosures, and the number of companies subject to climate-related divestments and ethical exclusions are also reported, as are the return on environmental investments and the return impact of exclusions and divestments.
Tools to address climate change in portfolios
NBIM identifies four tools it uses to address climate change: establishing principles and setting standards, climate change assessment, ownership, and investments. Its action on standards includes engagement with standards setters and climate initiatives. Climate change assessments of portfolio companies include scenario analysis. On ownership, NBIM engages in dialogue with companies, including thematic dialogues, follow-up of risk incidents, disclosure assessments and ad-hoc company interaction, and exercises its voting rights, which “allows us to hold boards accountable and influence companies”, it said. Finally, when investing, climate change factors are considered.
The tools NBIM uses are tailored to its mandate and the risk to which investments are exposed.
“Over the last decade we have scaled up our risk assessments and dialogues with companies, in both depth and breadth. We have reduced our exposure to climate risk through our 170 climate-related divestments, and 77 ethical exclusions in line with guidelines set by the Ministry of Finance. In 2020, we estimate the fund’s carbon footprint was 12% lower than the benchmark’s,” said NBIM.
Approaches to measuring climate risk
In an accompanying paper, NBIM described two approaches to measuring climate risk in investment portfolios: carbon footprint analysis and climate scenario analysis.
Carbon footprint analysis has provided NBIM with “valuable insights” into changes in the carbon intensity of its equity investments and corresponding benchmark index. “Since 2015, the carbon intensity of the equity portfolio has decreased by 50%,” the report said. Climate scenario analysis can illustrate how emissions trajectories and corresponding financial outcomes affect the portfolio over time.
The firm outlined in a letter to the Ministry of Finance that financed emissions from its equities portfolio had halved in the past seven years, but acknowledged that rising tech stock prices had played a leading role in the shift.
The robustness of the two approaches is “challenged” by incomplete data and “methodological limitations”, said NBIM. A carbon footprint is based on historical data that may have limited relevance to future risk, while climate scenarios designed to test the sensitivity of investment portfolios typically exclude second- and third-order effects of climate change and climate regulation that are difficult to quantify.
However, as climate change is a financial risk to the fund, NBIM said it would continue to engage with researchers and practitioners and support the further development of approaches to measuring climate risk in the fund.