With net zero commitments coming thick and fast, ESG Investor‘s first Countdown to COP26 webinar discussed how asset owners and managers can best monitor and support investee firms’ low-carbon transition plans.
There are no cast iron rules on how to get to net zero. Many asset owners rely on asset managers, both to assess the net zero plans of investee firms and to guide their own journeys. But, within the investment industry, there are varied approaches, skill sets and capabilities. Asset managers are facing new challenges at a time when there is still a lack of transparency on performance and planning.
“It’s a complex question since climate risks and opportunities are wide ranging across different regions and sectors,” said Eva Cairns, Head of Climate Change Strategy at abrdn, at ESG Investor’s first Countdown to COP26 webinar last week, titled ‘Scrutinising Net Zero’.
The panel began by looking at how to identify those climate risks and opportunities and the importance of undertaking climate scenario analysis.
“Climate scenario analysis lets us look at how asset values are impacted in a range of different scenarios. We complement this with more active research and engagement to understand how companies are managing their transition plans and question whether their net zero 2050 commitments are credible and ambitious,” said Cairns.
Supporting active engagement
Several existing tools give a starting point in scrutinising a company’s net zero commitments and performance. Data sources include the Transition Pathway Initiative (TPI), the asset-owner-led initiative that assesses companies’ preparedness for transition to a low-carbon economy, the Science Based Targets initiative (SBTi), which drives ambitious climate action in the private sector by enabling companies to set science-based emissions reduction targets, and the Climate Action 100+ Net Zero Benchmark, an initiative that encourages the world’s largest corporate greenhouse gas emitters to take necessary action on climate change.
“The Net Zero Benchmark is very comprehensive and a really good guide that can be used in active engagement with the company,” said Cairns.
To help clients align portfolios with net zero 2050 objectives, abrdn also looks to the Net Zero Investment Framework developed by the Institutional Investors Group on Climate Change, with input from stakeholders including abrdn.
The framework is built on decarbonisation, engagement, and climate solutions, with the former implying not just eliminating carbon-intensive companies, but investing in transition companies so that assets in the portfolio achieve decarbonisation.
Active ownership is key to influencing transition, said Cairns, noting divestment should only be considered when very clear milestones are not being met.
“Through engagement, you can give the company a chance to evolve its transition strategy,” she said. “As a large active investor, active ownership can be very impactful.”
The third pillar, climate solutions, looks not just at the carbon intensity of a company, but at its products and services to help the energy transition by enabling decarbonisation in other sectors.
There are still challenges around data gaps and assumptions, panellists noted, but the industry is trying hard to improve portfolio alignment frameworks and measures. For now, investors are hampered by inconsistencies which lead to different temperature metrics for the same portfolio depending on the data provider, leading to a lack of comparability across assets and managers.
Looking into the future is vitally important for asset owners and managers since any analysis of ‘readiness for transition’ must include real-world decarbonisation, not just the carbon footprint of the portfolio today.
To assess whether an investee firm is likely to reach net zero, it’s necessary to gauge whether transition plans are sufficiently ambitious and credible in terms of short-, medium- and long-term impact.
“We want to see whether companies are putting plans into practice,” said Cairns. “Is the plan reflected in remuneration, in capex and investment plans, for instance? And also, what’s the scope of the target? Does it include Scope 3 emissions? Does it include all regions? And, finally, what role does off-setting play?”
Pascal Zbinden, Co-Head of Strategic Asset Allocation and Markets at Swiss Re, outlined three pillars on which the world’s largest re-insurer bases its programme to manage climate transition: enhancement, by engaging with companies to manage its portfolios’ path towards net zero; inclusion, by financing low-carbon investments, e.g. via lending to renewable energy projects or buying green bonds; and exclusion, by limiting the risk of stranded assets in the portfolio.
Asset owners need to make efforts across all three to achieve their net zero ambitions, said Zbinden, and asset managers need to help them building suitable portfolios. Data remains an issue, but that should not stop the transition process.
“The data is clearly not perfect,” he said. “But there’s enough to make a start. The key is to have intermediate targets, and to constantly get better data, including through engagement.”
Swiss Re aims to engage with its investee companies on two dimensions. One is increased transparency, and better data around emissions, and the other is risk, where scenario analysis and forward-looking metrics play an important role. There are clearly risks on the pathway to net zero.
“If you look at how a business model evolves over time, in any given scenario, it requires a lot of assumptions,” said Zbinden. “We would benefit from standardisation and a common view on these pathways. Until then, we want the companies themselves to make better risk assessments – both positive and negative.”
The most negative risk in a portfolio comes from exposure to stranded assets. Divesting is not necessarily the responsible option.
“There’s a balance between mitigating stranded asset risks in a portfolio versus achieving real world decarbonisation,” said Zbinden. “When you divest, you’re not at the table anymore to engage as a shareholder. Nevertheless, you may need to divest at some point because you don’t have confidence that the asset will retain its value. It’s a very critical balancing act.”
Investment consultancy Redington has addressed the issue by aligning all its default client advice to net zero objectives.
“We’re having to build net zero portfolios, rethinking strategic asset allocation from the start to include not just risk and return, but risk, return and carbon,” said Alessia Lenders, VP, Responsible Investments, Redington.
Accountability through stewardship
Asset managers have responded to transition with impact strategies, offering asset owners the opportunity to invest in companies or projects providing the solutions needed to make a net zero world possible. They are also enhancing their stewardship capabilities, helping companies set targets, and most importantly, holding them accountable to those targets.
“We think there’s a huge opportunity here when it comes to stewardship,” said Lenders, who oversees Redington’s ESG-focused manager research capabilities. “We’re shining a bright light on it, because we want managers to understand that it’s a very important consideration when we rate a manager.”
Investors want to know who they should partner with to engage on topics that they care about, including net zero, but that there isn’t a ‘one solution fits all’ approach as every asset class and manager is different.
“Across the board, we’ve seen a shift away from ‘what is it that you’re trying to do?’ to ‘what have you achieved?’” said Lenders. “One of the things we ask is, ‘how many companies have you helped set targets?’”
There’s room for asset managers to improve skills, including use of in-house scientific knowledge to set realistic targets and milestones, as well as the ability to hold companies to account and to escalate engagement, leading either to divestment or meaningful action.
“We’re not expecting these skills to be siloed in a separate engagement team. It really needs to be something that’s owned by the investment decision maker,” said Lenders.
Improving the quality of policy engagement is also necessary among managers since regulators and policymakers need to take the needs of the industry into account, she added.
From voluntary to mandatory
The key issue for any climate-conscious investor is to understand, in detail, the net zero trajectory of the companies controlling assets in their portfolios. Insight currently comes from voluntary disclosure, but more might be available soon due to moves to more mandatory reporting regimes in major jurisdictions. In short, we’re not quite there yet.
“There is still a huge gap between what is expected by regulation and what is needed by investors,” said Josina Kamerling, Head of Regulatory Outreach, EMEA, CFA Institute. “There’s a proliferation of data, but we don’t have compatibility. The complexity facing us is huge.”
One of the main issues is that regulation comes out in piecemeal fashion, with jurisdictions moving at different speeds. “All the regulatory changes are important pieces of the puzzle when looking at a company and what it’s trying to do to get to net zero, but they’ve all come into being at different times. That creates complexity. Global standards would help,” she said.
The regulatory environment is evolving, perhaps not fast enough for many, and so the market is left to its own devices, using the tools and frameworks being developed in the private sector and academia. But global standards would be a benefit in efficiently channeling finance into the projects and companies that will lead the transition.
“We know that, at the moment, policies are not net zero 2050-aligned, despite all the pledges. It makes aligning capital allocation really difficult,” said Cairns.
Identifying best practice
With so much diversity in net zero target setting, divining credible strategies and assessing the ambitiousness of targets is not straightforward.
For the last 15 months the SBTi has been working on developing a Net Zero Standard to bring an answer to the question of what makes a net zero strategy credible, from today all the way through to 2050.
“What we have identified as ‘best practice’ around target setting is to make sure that targets cover the most relevant sources of emissions in the value chain of the company,” said Alberto Carrillo Pineda, Managing Director and Co-Founder, SBTi.
And its those most relevant sources of emission that also represent the main sources of risk for a company, he said. Ultimately, from a scientific point of view and from a risk perspective, companies need to switch towards a business model that adds value to stakeholders without accumulating greenhouse gases and this can only happen if the company moves away from adding carbon to the atmosphere.
“It’s really critical that a focus on net zero feeds through into the decarbonisation of the business model of a company,” said Pineda, noting that carbon offsets should play the smallest possible part in firms’ strategies.
Long-term net zero targets are critical in that they set the direction of travel, but – as panellists observed – they need to be matched with interim milestones, with accountability, and with transition plans that bring substance to the ambition.