Divided opinions and progress amongst global members is limiting ambition on sovereign debt.
The Net Zero Asset Owner Alliance’s (NZAOA) latest draft guidance – focusing on debt markets including private, real estate and residential mortgages, and sovereign debt – represents an “inevitable compromise” due to differing member perspectives.
The fourth edition of the Target Setting Protocol (TSP), which is open to feedback until 29 September, is the latest update to the Alliance’s blueprint for members to align their portfolios with net zero pathways via its recommended methodologies and approaches.
Guidance on the Alliance’s accounting approach to sovereign debt was outlined in TSP 2, and an emissions reporting framework was introduced in TSP 3. The latest consultation builds on this by proposing a performance assessment of sovereign debt holdings through qualitative indicators.
“Just as asset owners have to accept that they earn a lower yield on the sovereigns they hold for liquidity, they also have to accept that they’re ceding some control over the greenhouse gas (GHG) emissions associated with their sovereign debt portfolio,” said David Land, Head of Investment Strategy at UK-based pensions insurance specialist Rothesay, speaking at a webinar launching the consultation on 5 September.
“That has led to a huge range of opinions from NZAOA members, with some arguing that it seems like a pointless exercise to pay much attention to sovereign debt, while others noted it makes up a large part of their portfolios and so they want to take as comprehensive and holistic an approach as possible.
“What is outlined in this consultation is an inevitable compromise between the various points of view Alliance members hold,” he said.
To formulate qualitative indicators, the NZAOA will draw on the work of the Assessing Sovereign Climate-related Opportunities and Risks (ASCOR) project, which was established to create a database on sovereign exposure to climate risks and opportunities.
“ASCOR’s work is not complete but having consulted with the project, the Alliance believes that to avoid a proliferation of standards and to make the data gathering requirements on members as unburdensome as possible, it is sensible to base the assessment on data that will be available in the ASCOR database,” the consultation said.
Alongside disclosure of carbon intensities and financed emissions, the updated protocol has noted that the ASCOR database will gather additional information that will lend itself to the creation of a scorecard, “which will be useful for assessing features not represented on a continuum”, the draft noted.
The proposed qualitative indicators the NZAOA will adopt in its scorecard include consideration of a country’s absolute GHG emissions over the past five years and whether the country has set a 2030 decarbonisation target. Other indicators are still under consideration by ASCOR, including the question of whether a country’s net zero target is enshrined in national climate law.
The scorecard will better promote avenues for engagement with governments on their climate commitments and progress, according to Land.
ASCOR is set to publish updates to its framework in the next few months, followed by the release of assessments of 25 countries, which collectively account for almost 70% of GHG emissions, against revised indicators.
Last year, sovereign bonds represented almost 40% of the US$100 trillion global bond market, according to the World Bank.
The TSP outlines how the 86 alliance members, with a collective US$11 trillion in assets, can align their sub-portfolio decarbonisation targets with net zero. Members are expected to target a 22-32% reduction in sub-portfolio emissions by 2025 and a 40-60% reduction by 2030.
Real estate and mortgages
The TSP 4 consultation further outlines proposed target-setting guidance for private debt funds, real estate debt funds and residential mortgages.
The guidance defines private debt funds as vehicles within which asset allocation is done by an external asset manager and the investment is not consolidated on the asset owner’s balance sheet, as well as instances when the asset owner commits a certain amount of capital into a ‘blind pool’ – when the asset owner isn’t aware of the individual investments within an investment strategy at the time of the commitment.
For existing funds, the draft protocol asks Alliance members to phase in a systematic engagement approach with their external asset managers on carbon reporting and net zero targets throughout 2025, reporting on these engagement actions in 2026 and disclosing their full coverage of carbon data, explaining any gaps.
Members should further begin phasing in decarbonisation targets for their new private debt funds where possible from the start of 2025, to report by 2027.
“We are talking about private debt funds in which there is usually a general partner or fund manager between the asset owner and the investment,” said Udo Riese, Global Head of Sustainable Investing at Allianz Investment Management (AIM).
“This guidance should therefore be seen in context with our previous Call to Action to private asset managers,” Riese said, adding that members should also utilise the IIGCC’s NZIF guidance for private equity.
“We believe the NZIF’s private equity guidance can be applied nearly one-to-one for private debt funds,” he noted, adding that other new frameworks can be used if deemed credible.
During the webinar, Thomas Van Rompeay, Responsible Investment Officer at AXA Investment Managers Alts, provided an overview of the guidance for real estate debt funds and residential mortgages.
Across both, the draft asked members to disclose building emissions intensity or absolute building emissions on an annual basis.
While real estate debt funds have a target-setting start date of year-end 2024 onwards, reporting on progress from 2026, the draft said target-setting for residential mortgages will not be included in TSP 4, but “this might evolve in future updates in line with key developments in the market”.
Members should report carbon data from residential mortgages from 2026, the consultation added.
“We’re aware that some signatories of market participants want us to be more ambitious, but please note that the current draft is reflective of the level of confidence of signatories across different backgrounds and different geographies, who might be less advanced on certain topics,” Van Rompeay added.