Managing climate change: A portfolio approach

The landmark 2015 Paris Agreement created a seismic shift in attitudes to climate action - irreversibly changing government policy and corporate strategies to prioritise sustainable and ethical standards. The need to reduce rising global temperatures now lies firmly in the zeitgeist of Millennials and Generation Z, driving their consumer spending towards brands that reflect those values and are taking action on climate change. The most forward-thinking companies are those that are seeking to embrace the opportunities of environment and social governance in the board room and assessing it as a risk in equal measure.

It should follow, and not before time, that the institutional investor community should similarly recognise that climate change is as much a financial risk as an environmental issue and encourage behavioural change on the part of the companies they invest in. Already, regulators are encouraging this behaviour change. The establishment of the Task Force on Climate Related Financial Disclosures (TCFD) in 2015 is a case in point - its mission is to develop voluntary, consistent climate-related financial risk disclosures for use by companies to provide information to investors, lenders, insurers, and other stakeholders. Its high-profile endorsers include Bank of America, HSBC, Barclays, AXA group and Aviva Plc, representing over $3tr in market capitalisations.

The support of over 100 business leaders and their companies to the TCFD's recommendations in 2017 underlined both the growing trend for businesses to consider the impact of climate change on their operations, and for institutional investors to demand better information from them. The financial scale of the sums involved back this up. In the TCFD final report and recommendations, the estimated value at risk as a result of climate change to the global stock of manageable assets ranged from $4.2tr to $43tr between now and the end of the century. The role of global asset managers to help reverse this capital risk presents a huge opportunity for all activities that reduce carbon emissions, including those that are often overlooked by the investment community, namely natural climate solutions (NCS).

Forest conservation, along with other greenhouse gas sequestering landscapes such as agricultural lands, grasslands and wetlands, are absolutely critical to keeping global temperatures ‘well below' 2C. The opportunities to sequester greenhouse gas emissions from land-use sectors, presented as 20 natural climate solutions, provide an opportunity to sequester 5.2-7 gigatons of carbon dioxide equivalent (GtCO2e) annually by 2030. Stabilising the climate in line with the Paris Agreement goals will be impossible without ending emissions from the land use sector and investing in natural climate solutions projects.

Figure 1: Sectoral mitigation potential to 2020 (Source UNFCCC)

Figure 2: Natural climate solutions share of emissions reduction transitional pathway (Source PNAS)

Managing climate risk

In light of the recommendations of the TCFD and the increased regulation that is likely to ensue, asset managers and asset owners will come under increased pressure to disclose and manage the climate related financial risks they are exposed to through their investments. For example, French law on the ]energy transition for green growth' through Article 173 now mandates climate change related reporting for institutional investors. Article 173 is a legal manifestation of the TCFD's final recommendations and it is expected that other European countries, including the United Kingdom, will implement similar laws or financial regulations demanding disclosures, and actions. The UK government has instituted a public-private Green Finance Taskforce to explore regulatory options in line with the TCFD recommendations. The European Commission's High-Level Group for Sustainable Finance has taken a step further to recommend an EU wide label for green investment funds.

Sitting at the top of the investment value chain, large asset managers and owners have a significant opportunity to drive corporate action, using the established voluntary carbon market as a powerful tool for the dual purpose of economic decarbonisation and the capitalising of natural climate solution projects that are essential to achieving the < 2C carbon budget, net zero deforestation and sustainable development goals.

There are two ways in which the asset management industry could make a tangible impact. The first is to voluntarily ensure compliance with the Paris Agreement targets as an ex ante requirement of investment in listed companies. The second is to make carbon asset contributions in the meantime that represent the variance from Paris goals of the underlying companies their portfolios hold, as the following estimates of the variance from the Paris goals key model indices demonstrate:

Figure 1: Index evaluation against < 2C from Stephens et al (2017), Estimating portfolio coherence with climate scenarios, Mirova, Responsible Investment Research

It therefore follows that whole portfolios can be evaluated to determine the value of carbon offsets required to fully offset the variance from Paris targets of their underlying investee companies, as part of a transition strategy to a fully decarbonised portfolio, allowing asset managers to make appropriate offsetting contributions which could have an immediate impact on the emissions curve.

Crucially, many asset managers may not realise that the financial cost of offsets is far less onerous than they might otherwise assume. At an average cost of < $10/t CO2, forest sequestration is the cheapest form of carbon capture and storage (CCS) and should be viewed positively by asset managers as a demonstration by investees of capital expenditure prudence, as well as an ambition to achieve < 2C compliance in the long term.

To date the onus on fostering conservation and the sustainable management of forests to reduce emissions from deforestation and forest degradation (REDD+) has mainly sat with governments and countries at a collective level, through development finance. There is now, however, a growing recognition of the urgent need to mobilise private sector capital to finance REDD+ projects and the carbon markets have a role to play in making these projects financially viable in the short to medium term. The opportunity for the asset management industry is significant - by grasping the nettle and taking an industry led approach they could truly enact change; empowering companies to set net emissions reductions targets across all emissions scopes, drive capital and reduce global carbon emissions, before they are forced to by regulators.

At Ecosphere+ our mission is to do exactly that - we support companies and individuals to reduce global carbon emissions by protecting natural ecosystems and supporting sustainable economic development. We supply high quality forest carbon credits, verified to two of the most widely used and well respected independent standards to enable innovative, market-driven business solutions to help our partners take action on climate change. Our projects deliver not only permanent carbon emissions reductions but a range of measurable environmental and social benefits for local communities. We would welcome the opportunity to work with far-sighted asset managers to help ensure that the vision of a climate-positive institutional investment industry is realised.

Ecosphere+ is part of the €100m Althelia Climate Fund, the largest portfolio of forest carbon projects in the world. Althelia's investors are the world leaders in climate and development finance, including the European Investment Bank, the Dutch Development Bank FMO, Credit Suisse and AXA.

Lisa Walker is CEO at Ecosphere+

Ecosphere+ is a sponsor of this week's BusinessGreen Leaders Briefing: Navigating the TCFD Maze

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