The shift to low-carbon investment
Earlier this year, Peabody Coal, the largest private sector coal company in the world, filed for bankruptcy amidst falling global coal prices. Peabody Coal is one of five coal companies that have sought bankruptcy since 2011. Financial analysts have attributed what’s happening in the coal sector in part to environmental causes – more stringent legislation and declining demand for coal in favour of lower carbon fuels.
Whilst the reasons for these ailing companies’ bankruptcy claims are complex, what has happened provides an indicator that traditional technologies are increasingly exposed to climate change risk. And when these potential risks are not addressed, devaluation of ‘stranded assets’ occurs, companies fail and investors lose money.
It’s therefore vital for the investment community to measure potential climate change risk as part of an assessment of financial or reputational risk.
Indeed, the sector has a history of engaging with this subject from the almost 850 institutional investors that request companies disclose their carbon emissions to CDP to the development of investor communities focused on considerations of climate risk.
Furthermore, over 120 companies have signed the Montréal pledge, committing them to measuring and publicly disclosing the carbon footprint of their investment portfolios on an annual basis.
Conducting a carbon footprint of the entire investment portfolio allows understanding of the level of investments’ exposure to climate risk from un-emmitable carbon.
Portfolio analysis requires managers to calculate the carbon performance of their investments against climate change scenarios to better understand their contribution, the scale of change required, and therefore the risk their organisation faces.
Managing the footprint of a portfolio follows three steps:
- Assessing the greenhouse gas emissions of the portfolio. The metrics to determine the carbon footprint of a portfolio could be measured against:
- Carbon emissions per amount invested
- Total carbon emissions of the portfolio
- Carbon intensity of the portfolio in terms of emissions per unit of output
- Weighted average carbon intensity examining the exposure of the portfolio to carbon intensive companies
- Setting a benchmark to track improvements over time (e.g. baseline) and compare performance against pre-defined levels (e.g. 2°C target)
- Identifying reduction opportunities and plan how to manage these
France is the first country to make portfolio footprinting mandatory for the financial sector. The legislation introduced in 2015 is now effective and compliance will have to be met for the 2016 reporting period. It requires firms within the financial sector to disclose how they consider environmental issues in decision-making, the physical and policy risks associated with all the assets they own and the opportunities which arise from investments in low-carbon industries or renewable energy. Investors holding or managing more than €500 million of assets are also required to quantify their contribution to climate change (e.g. carbon emissions) and explain how their strategy aligns with international climate objectives. Investors now have to set targets, measure progress and provide justification if the targets are not met.
Other countries are likely to follow in France’s footsteps, especially in light of the Paris Agreement and national commitments to carbon reduction targets. These will require more stringent regulation, carbon taxes and other strategies to achieve the carbon targets set at national level. The European Commission is currently considering requiring retail funds to report on their ESG approach.