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With a Pinch of Salt

Metrics used by investors to track climate- and nature-related risks should be treated with caution.  

“Investors’ awareness behind the why of assessing nature- and climate-related risks in their portfolios is rising, but their understanding of how to interpret and incorporate [this data] into their portfolio decision-making is still evolving.” 

This is according to Elizabeth Clark, Lead for the Cambridge Institute for Sustainability Leadership’s (CISL) Investment Leaders Group, reflecting on the challenges and pitfalls of some of the most widely-used climate and nature metrics available to investors today.  

Of course, identifying, measuring and mitigating risks associated with climate change and species extinction is no easy feat; the metrics needed can vary vastly according to sector, geography, time horizons, and the size of portfolio companies.  

But it becomes even more complicated as the data landscape becomes increasingly crowded with innovative metrics and solutions that promise to help investors fulfil growing disclosure requirements and ultimately ensure their portfolios support the transition to a more sustainable economy.  

Despite the need for granularity, there is a degree of safety in widely-used approaches. Standardisation has therefore become increasingly important.  

The most straightforward reason for why an investor would want standardised metrics is to make it easier to compare and contrast companies,” says Rebecca White, Global ESG Integration Lead at Newton Investment Management.  

“If you don’t have those standardised metrics, investors may end up comparing two different things and it would then be difficult to understand what relative performance looks like.” 

This is also true for asset owners that want to compare and contrast the climate- and nature-related performance of their external asset managers, White adds.  

But are there limits to the value of standardisation? There is mounting concern that some popular climate and nature metrics have oversimplified the underlying reality. While they can be applied more easily across different sectors, portfolios, asset classes and investment strategies, they may not sufficiently account for the depth and nuance many climate- and nature-related themes demand.  

“There is a balance to be found between the complex but meaningful, compared to the simple but partly irrelevant,” says Sylvain Vanston, MSCI’s Executive Director of Climate Investment Research. 

Navigating the negative 

No one can predict the future, but it’s vital that investors have some idea of how an investee company’s performance is projected to change in the medium- to long-term. This is especially true when it comes to navigating the negative impacts of a rapidly warming planet.  

The Implied Temperature Rise (ITR), offered by data providers such as MSCI, is a forward-looking metric that has been designed to show the alignment of companies, portfolios, funds and indexes – in terms of the greenhouse gas emissions they generate – with global climate targets.  

In theory, this means an investor can apply the metric to their portfolio and produce a temperature of, say, 2.4°C, effectively extrapolating its emissions to the global level. The investor will then have a clearer idea of the extent of decarbonisation needed across their portfolio to be aligned with 1.5°C by the mid-century.  

“In a short period of time, ITR metrics have come to a great deal of prominence in the market,” says Steven Bullock, Global Head of Research and Methodology at S&P Global Sustainable1, noting that there has been a “groundswell of investor demand”.   

The ITR features in the Taskforce on Climate-related Financial Disclosures (TCFD), a framework which has been mandated in several countries, meaning that many entities utilise the ITR in their regulatory disclosures.  

“The great advantage of ITR metrics is that they provide an easy to communicate measure of alignment,” Dr Rory Sullivan, CEO at global advisory firm Chronos Sustainability, tells ESG Investor. 

“However, ITR metrics suffer from fundamental technical weaknesses,” he acknowledges, noting that there are “major gaps” in the emissions data underpinning these metrics. These include a lack of consensus around the relationship between the companies in a particular portfolio and the portfolio’s climate impacts, and the contribution of an investment in a company to its contribution to temperature rise.  

“Multiple calculation methodologies and approaches have been developed which vary in terms of the data used, the scope of the metric, the treatment of climate solutions, and the assumptions made about the relationship between emissions and temperature impact,” says Sullivan, adding that “none explicitly discuss or quantify the implications of these assumptions and uncertainties”. 

The consequences may give investors pause for thought. “It is not clear whether these metrics even provide an order of magnitude assessment of a portfolio; depending on the assumptions and methodologies used, a portfolio could be assessed as being 1.5°C aligned or it could be aligned with 3°C,” Sullivan notes.  

In June, academics from the University of Augsburg in Germany published research analysing the ITR values assigned by six different data providers. They found a “notable lack of agreement” in how ITR is calculated and the subsequent results, particularly for energy-intensive industries 

Using tech giant Alphabet as an example, the paper noted that one provider claimed the company has a 1.45°C ITR whereas another scored the firm at 3.61°C.  

The underlying science for accurately measuring future temperature change globally is also “uncertain”, points out Jakob Thomae, Project Director at the Inevitable Policy Response (IPR), noting that this makes the idea of assigning a specific temperature to a portfolio “currently absurd”. 

In response to the TCFD’s consultation on forward-looking financial sector metrics back in 2021, asset owner members of the Transition Pathway Initiative (TPI) disagreed with the TCFD’s positioning of the ITR as a “more sophisticated”, and therefore more relevant, metric. 

In May 2021, the Bank of England also said the ITR is “very sensitive to assumptions”.

At least some vendors are known to be refining their approach to calculating ITR.  

Underlying assumptions 

Sustainable1’s Trucost Paris Alignment dataset, which aims to assess how closely companies are aligned with the Paris Agreement’s goal of keeping global warming ‘well below 2°C’, “has made a rigorous attempt to consider the pros and cons of possible design choices in delivering [the dataset] to the market”, according to Bullock. 

This includes incorporating a range of underlying datasets – like historical decarbonisation performance and asset-level data – rather than relying on a single source, such as corporate emissions targets, Bullock explains.  

“The most important thing is that data providers are clear on the underlying assumptions and data sources that are used in ITR metrics so that investors can report with confidence and the insights remain decision-useful,” he says. 

“At the same time, we would welcome more debate and market feedback in this area as the need for more transparency on corporate climate commitments and alignment continues to grow.” 

Of course, calculating the temperature of a portfolio doesn’t tell the full story of real-world decarbonisation efforts.  

“An investor could construct a portfolio which has particularly low emissions intensity, but that doesn’t necessarily mean that the investor is contributing to decarbonisation,” says White from Newton IM. 

“It’s equivalent to cleaning up your garden but chucking everything over the fence.” 

To ensure climate-related assessments of investee companies are suitably robust and in-depth, IPR’s Thomae says that “sector-specific metrics are the way forward”, such as CO2 per megawatt/hour for companies in the energy sector. “That isn’t a metric that companies can hide behind,” he says. 

Cumulative impacts 

“Metrics are five to ten times more complicated when it comes to biodiversity,” notes White.  

In short, impact on biodiversity cannot be quantified in the same way as CO2 emissions, due to the sheer scope of possible risks and themes.  

Biodiversity- and nature-related risks can be the result of direct impacts, as well as an accumulation of impacts by companies and external factors, adds Gemma James, Chronos Sustainability’s Head of Biodiversity and Nature.  

“There could also be a time lag on these cumulative impacts – unless it is an incident such as a [chemical/oil] spill – but the risks of a slow decline in biodiversity may not be picked up in the early years of a dataset,” she says, warning that a lack of visibility of these details may mean that longer-term risks are overlooked.  

“Nature is multi-dimensional and complex. Oversimplifying doesn’t provide a clear reflection of the actual situation and a real understanding of the risks and opportunities is diluted,” James says.  

The World Economic Forum’s 2023 Global Risks Report identified biodiversity loss and ecosystem collapse as one of the most pressing global risks of the next decade, with around US$58 trillion of global GDP dependent on nature.  

As the implications of biodiversity loss and nature degradation become even more stark, there has been growing investor demand for a standardised set of metrics that will detail the extent of a portfolio’s exposure to impacts such as species loss.  

The mean species abundance (MSA) metric seeks to quantify the mean abundance of original species relative to their abundance in undisturbed ecosystems.  

It is a commonly used metric in biodiversity impact assessments which Bullock from Sustainable1 says is “relatively easy to interpret and apply to risk assessments”. 

“It can also help an investor to locate risks to biodiversity when a project – say a new mine – is located in or near a pristine ecosystem that has significant environmental value,” adds William Attwell, Director of Climate Research at Sustainable Fitch.  

However, while the MSA is a useful way of thinking about biodiversity, “it doesn’t capture the complexity or the specificity”, according to Simon Zadek, Chair of think tank NatureFinance, formerly known as the Finance for Biodiversity Initiative.  

James from Chronos agrees, noting that the MSA measures just one aspect where a “dashboard of indicators is required […] to have a holistic view of impacts, dependencies, risks and opportunities”.  

The MSA is “often patchy” – especially in emerging markets, Attwell adds. “While MSA can give an overall picture of the state of an ecosystem, it can be difficult to causally link different types of nature impact to specific pressures a company is having through its operations.” 

So Yeun Lim, Global Head of Infrastructure Research at investment consultancy firm WTW, says that MSA works best in “pristine” areas that have never been touched by man. A country like the UK doesn’t really have any areas like this, she says. 

Marianne Haahr, Director of Nature-Related Finance at Global Canopy, says high-level aggregate metrics for nature can help steer the direction of investment strategies, target-setting and capital allocation, but, if used in isolation, “they could fail to provide financial markets with vital insight into the capability of the companies in which they invest to transition away from activities that damage nature within set timeframes”. 

LEAP forward 

Despite the widespread use of MSA in regions like France, due to the need to comply with Article 29, it is not currently listed as a core metric by the Taskforce on Nature-related Financial Disclosures (TNFD). 

The final version of the TNFD framework, published in September, outlines how entities can report on nature-related risks across themes such as governance, stakeholder rights and engagement, and upstream/downstream value chain risks and impact management. 

TNFD also produced additional guidance through LEAP: locating interfaces with nature, evaluating dependencies, assessing nature-related risks and opportunities, and preparing to respond to those risks and opportunities.  

The TNFD’s core global metrics suggests the direction of travel is away from aggregated indicators and towards specific, individual line items that link to the main drivers of nature change, such as the actual volumes of pollutants discharged or water consumed,” Attwell tells ESG Investor. 

“MSA is not listed as a core metric, although various aggregated nature indicators are referenced in the TNFD’s LEAP approach.” 

More broadly, there are a widening range of metrics investors could consider.  

One identified by a number of experts speaking to ESG Investor is the SEED Biocomplexity Index, which Clark from CISL says is an effective and “holistic” measure.  

It uses machine-learning, geospatial satellite monitoring, and localised datasets to condense three scales of diversity – genetic, species and ecosystem – into a measure of biocomplexity. 

“It is currently one of the most sophisticated ways of measuring the state of biodiversity anywhere on the planet,” says Zadek from NatureFinance, which is one of the partners of SEED.  

However, beyond identifying the right metrics to use, it’s pivotal that investors work with biodiversity and nature experts to better inform their contextual and qualitative assessments of portfolio companies, says Monique Mathys-Graaff, Head of Sustainability Solutions at WTW.  

“The finance industry needs to lean on external specialists to ensure they have overlaid different checks and balances to support the metrics they use,” she notes.  

“Healthy” questions 

As Vanston from MSCI outlined, a balance needs to be struck between simplification for the sake of standardisation and more meaningful but complex metrics. 

A degree of standardisation is imperative to scaling the adoption of nature and climate data and tools. 

Clark from CISL adds that standardisation can “provide organisations with the clarity and confidence needed to move beyond target-setting, and to mainstream nature and climate across their wider investment strategies”.  

“On the other hand, if the insights are too high level, the risks to portfolios can be understated or indication of dependencies can be missed.” 

White from Newton IM agrees, noting that while more granular metrics may introduce new levels of complexity, they can be more “additive” in terms of understanding risk within the investment process, because an investor can select the indicators they think are most material in a particular instance. 

“A challenge with metrics like the ITR and MSA is their insights cannot be viewed in isolation,” Clark continues. 

“A robust assessment that drives real impact and power comes from when findings are layered together, integrating both climate and nature, providing a more accurate and comprehensive view.” 

A recent example of this is the collaboration between the UK’s Natural History Museum and Bloomberg to deliver the Biodiversity Intactness Index, which combines the museum’s geospatial data with Bloomberg’s information on the physical assets of over 50,000 companies. 

Ultimately, investors’ questioning the implications of oversimplification is “very healthy” and will contribute to “raising the floor” of quality, standardised metrics going forward, notes Zadek from NatureFinance.  

“The risk is that we standardise around sub-quality, either because the existing data flows are inadequate and claims are wrong, or simply because they’re cheap to buy and easily integrated into risk management processes,” he says. 

Zadek argues that the largest data providers should “come together and agree that they’re not going to compete on different approaches for analysing the state of nature [and climate]”. 

“The science community should also come together to ensure there is a common way that the market can assess different approaches or provide a basis for understanding the differences between approaches,” he adds.  

Such collective processes could help to push the agenda for high-quality climate and nature-related metrics forward more quickly, “without standardising too early and too low”, Zadek theorises.  

Despite inadequacies with current climate and nature data and metrics, this shouldn’t be used as a reason for investors to delay action.  

Investors can already seek out the best data available, take the findings with a pinch of salt, and apply their own insights and/or the expertise of external experts to fill in information gaps and continue to drive progress forward. 

“The worse climate change becomes, the more dynamic the relationship between climate and nature is – so it’s crucial that investors seek to understand the impact climate change has on nature in order to analyse nature-related risks,” Zadek adds. 

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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