Net-Zero plans, decarbonisation and how organisations can best manage investments
Alasdair Maclay (Chief funds officer, Global Steering Group for Impact Investment (GSG))
Sarika Goel (Global head of sustainable investment research, Mercer)
Joshua Perez (Senior research analyst, Breckinridge Capital Advisors)
Ian Burger (Head of responsible investment, Newton Investment Management)
Sindhu Krishna (Head of sustainable investments, Phoenix Group)
Mark Irish (Deputy head of ESG consulting, Isio)
The CAMRADATA Net-Zero roundtable 2022 began by asking how many organisations represented, had a Net-Zero plan in place. The Phoenix Group, the UK’s largest long-term savings business with £300bn assets under management, does have such a plan. Sindhu Krishna, head of responsible investments at Phoenix, said: “We believe Climate Change is a present and material risk. We have used Bank of England stress tests to evaluate what it means for our investments. I don’t think there is a company which doesn’t have a negative emissions number, according to the Task Force on Climate-Related Finance Disclosures (TCFD). As fiduciaries we have a responsibility to respond to that risk in the interests of our clients.”
But Krishna emphasised that this is a new risk, so how investors act will change as the journey progresses. The interim targets for Phoenix Group for 2025 and 2030 are in the public domain. “Over time, everyone will have a legal obligation to produce a Net Zero commitment,” said Krishna.
For Breckinridge, senior credit analyst, Joshua Perez, said it had signed up to the Net-Zero Asset Managers Initiative. He agreed with Krishna that as fiduciaries, it was an asset manager’s responsibility to address climate change.
“Bondholders’ bottom-line is the preservation of principal,” he said. “We seek to mitigate risks day in, day out.” But Perez also stressed the upside to Net-Zero in terms of opportunities to generate green revenues and to identify companies that are going to benefit from providing solutions targeted towards addressing climate change.
This side of analysis looked at various criteria, including where issuers are spending their Research & Development budgets. Perez and colleagues are looking for companies providing solutions to reduce emissions globally, while also focusing on identifying companies in high-impact sectors that are leaders or laggards relative to sector peers.
At the portfolio level, which is always a snapshot in time, Perez said that carbon budgets and overall emission profiles are changing. He sounded a warning: “The threshold for abatement is getting harder and harder to attain. Will we be able to get emissions down to where they need to be at a feasible rate?” Perez mooted a proper carbon price as one means of effective reduction.
For Newton Investment Management, Ian Burger, head of responsible investment, said its NZC goal was published in June 2022. He characterised the process behind such plans for all organisations as “internalising the externalities… bringing that risk onto the balance-sheet.”
“The threshold for abatement is getting harder and harder to attain. Will we be able to get emissions down to where they need to be at a feasible rate?”
Burger noted that we have all gone up the learning curve in recent years. He recalled the chair of a mining group in 2010 struggling to understand what was meant by the phrase ‘stranded assets’.
Sarika Goel, global head of sustainable investment research at Mercer, said that the firm did have a Net-Zero commitment for the Asia and Europe investments in its discretionary business, but not yet on the advisory side. “We are working through the principles of the commitment in alignment with our corporate governance,” she said. As well as the research Mercer has published over the last ten years on Climate Change, Goel said it was incorporated into its core investment principles.
As a researcher, she noted issues with some managers’ approach to portfolio decarbonisation, notably hasty offloading of the heaviest emitters.
Mark Irish, deputy head of ESG research at pension fund consultancy, Isio, said there was still uncertainty in the market and whilst a large proportion of clients had already embarked on understanding their Net Zero (NZ) journey, only a handful of Isio clients had formed a NZ target. “Our advice to clients is to understand the current position and potential journey before you make a commitment,” he said. Irish pointed out that size was a major explanatory factor: some clients with relatively small portfolios of £10-£100m struggle to find the governance budget.
Isio as a business itself has not yet made a commitment, having only launched in 2020, however is currently developing its NZ strategy which it is aiming to publish by the end of the year. Irish noted, however, that Isio’s Research Team is working closely with clients on achieving their Net Zero Commitment (NZC) objectives and has recently written an 80-page investment case justifying integrating a climate tilt into an equity portfolio for one of the UK’s largest schemes.
Alasdair Maclay, chief funds officer at the Global Steering Group for Impact Investments (GSG), completed the opening exchanges at the CAMRADATA roundtable by examining one global brand’s NZC commitment. The company is Coca-Cola, which aims to be Net-Zero by 2040. First, Maclay praised Coca-Cola because its NZC measures include Scope 3, which puts it in a minority among all companies, listed or unlisted.
But emissions capture only a few important by-products of a drinks business. Versus its biggest rival, Pepsi, Coca Cola’s overall environmental impact is far less sustainable according to the data published by Impact-Weighted Accounts Initiative. Maclay suggested that for enterprises wanting to be best-in-class, there had to be awareness of more than just emissions data among internal and external stakeholders.
He suggested that measuring impact holistically, relevant to each industrial sector but by globally accepted standards, would be the role of the embryonic International Sustainability Standards Board (ISSB). The G7 Impact Taskforce (ITF) was a project created by the UK in its 2021 presidency of the G7 countries to progress impact transparency and trail the way to impact valuation.
“We are hopeful impact valuation captures the consequences not just of emissions,” said Maclay, “but of all elements of a just transition, including diversity of the workforce, social equity, green impact and the broader corporate mission.”
Treading a new path
The CAMRADATA panel then discussed how to better understand the process of decarbonisation and how to manage investments accordingly.
Krishna said that for a small inhouse sustainability team, platforms have been useful to share ideas and questions.
“No one has gone down this path before so the more sharing, the better,” she said, naming IIGCC as a most helpful forum. Phoenix joined IIGCC in 2019 and was one of five members to trial an assessment of carbon intensity of real portfolios against a model, multi-asset portfolio. “This was the how, not the why,” she explained.
As a large asset owner, current teething problems include a lack of standardisation among third-party asset managers. Krishna said the situation was probably worse for smaller firms. She said it was great that managers developed proprietorial methodologies but that left asset owner clients to synthesie the results and relate the data to their own NZC commitment. She hoped that regulators could do more to standardise methodologies and reporting.
Perez said the question was: how you are going to get to the end goal? “NZC changes your approach to investing,” he told the CAMRADATA panel. “Breckinridge continues to incorporate material ESG data but we are now more proactive in terms of driving for improved climate disclosure, goals and ultimately execution against company stated targets. What do we want out of these companies? There is a drive for a collaborative approach with issuers.”
He too praised IIGCC’s guidance: “It makes us more comfortable that there is a reputable framework for managing to Net Zero over the long term.”
In response to Krishna’s comment on the variety of managers’ responses, Perez agreed that there are numerous ways to calculate and report but he felt that that was ultimately a good thing because “best practices will surface over time.”
Breckinridge is an asset manager with its own proprietary framework. Perez also championed the Partnership for Carbon Accounting Financials (PCAF) as the gold standard for accounting for portfolio financed emissions, further adding that Breckinridge uses the 50% Fair Share guide from the Glasgow Financial Alliance for Net Zero (GFANZ), which recognises that some sectors are easier to decarbonise than others and therefore allows managers to invest broadly and engage. “Otherwise, you get portfolio decarbonisation but not real-world decarbonisation,” warned Perez.
Goel agreed on the variability of approaches taken by managers. “Some make commitments first and then think about implementation,” she said. “We have some managers doing both.”
She noted that some have less than 10% of assets under management committed to NZ. Goel said that Mercer’s preference was to assess asset managers not just with regard to particular strategies but at the level of the organisation itself to understand how they undertake climate stewardship.
She said that practices such as selling out of high emitters to achieve very rapid decarbonisation was one that merited further explanation. Conversely, there were strategies with higher-than-average intensity that made a feature of active engagement with companies on their transition targets. She said overall, Mercer was sceptical about blunt mechanistic approaches that do not take a more holistic approach incorporating integration and stewardship.
Elsewhere were to be found managers seeking value by selling out of lower-emitters to locate outperformance elsewhere. What mattered to Goel here was clear policies on engagement and a consistency of philosophy.
Burger endorsed the need for action. “Climate change is a known systematic risk,” he said. “It’s no good in 10 or 20 years complaining to board directors about their policies of 2022.”
He was adamant that engagement has a role to play. “A lot of investors ask what is our explicit engagement policy?” he noted. He said that managers had to be transparent in explaining what they are doing and to what effect. “Hiding behind engagement without substance is dangerous,” he said. And likewise, ardent campaigners can challenge target companies but if their goals for change are not realistic, then it is wasted engagement, according to Burger.
“Hiding behind engagement without substance is dangerous”
Burger cited the efficacy here of the Transition Pathways Initiative to figure out how decarbonisation might in practice occur. Newton also uses a scenario factor of carbon pricing at USD140 a ton to stress how different companies will fare as externalities get properly priced in. But Burger emphasised that USD140 per ton was a measure for understanding company plans, not a stick with which to beat them.
On researching managers’ portfolio decarbonisation plans, Irish said he was cautious about going to an asset manager and telling them to use one set of standards if they are already using another. Instead, the Isio approach is to understand how the manager is using various frameworks to feed into their investment process. Irish said that different users may value different Net Zero initiatives. For example, clients often favour the Science-Based Targets Initiative (SBTi) when analysing corporate investments.
However, he suggested that for consultants, the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) provides a useful tool for understanding Net Zero pathways, i.e an orderly transition versus disorderly transition could have a massive effect on the financial outcomes for clients.
At this point, Burger noted that research by Climate Action Tracker in the midst of the Glasgow COP-26 summit that 73% of Net-Zero plans were inadequate. He asked the consultants and asset owners at the CAMRADATA roundtable how they worked with managers in order to achieve their targets. Krishna said she was more for reporting.
Perez said Breckinridge’s model has fourteen climate related metrics for prospective issuers. One metric was whether a company has SBTI targets. He said that was indicative of a company that has outlined strong commitments for emissions reductions although he noted that SBTi did not require companies to reapply on a yearly basis and that an SBTi approved target alone is not enough to determine if a company is indeed aligned towards a Net Zero pathway. To avoid a checkbox approach of simply screening companies for SBTi approved targets, Breckinridge scrutinises issuers on their prospective goals, strategy to achieve their decarbonisation agendas and ultimately on their execution against these goals over time.
Krishna was then asked whether Phoenix had studied whether mitigating the risk of Climate Change in its portfolios had had any effect on its cost of capital. She responded that it had not. She did say, however, that it was increasingly seen as an industry standard to incorporate ESG considerations in investment. “If it doesn’t work for Phoenix, it can’t work for others,” she said. “Either way, there will be industry consensus.”
Maclay then returned to the theme of the totality of social impact in a Just Transition. He raised the issue of coalmining in South Africa, an activity red-lined for its carbon emissions but one that employs over 100,000 people and indirectly supports over two million people. “When you consider the role in society of these activities, it makes evaluation more complex,” he said.
Regarding the choice of standards, Maclay believed that GFANZ was bringing people together on more aligned metrics. He wondered, however, where the balance between healthy competition and standardisation lay. “Will standards take away managers’ edge?” he asked.
On the possibility of cost-of-capital reduction for companies, Maclay pointed to the $1trillion issuance last year of Sustainability-Linked Bonds (SLBs). “That is capital based on environmental outcomes,” he said.
Maclay accepted that there were elements of “smoke and mirrors” in some of the terms set “but fundamentally they are results-based.”
Maclay asked the other CAMRADATA panellists whether they saw more opportunities for SLBs and where they saw that market headed? Perez answered that the more specific the KPIs, the better. He reckoned that the criteria were often too easy to achieve and in tandem the step-up criteria, by term and size, were not punitive. However, he saw that as the market for SLBs grew, investors would become more discerning about issuing companies and their terms.
Irish contrasted SLBs with private investments, where he saw more back-to-back negotiations with companies. He agreed with Perez that the terms to SLBs had to be meaningful, both from a sustainable and financial perspective. He urged proper evaluation, including versus non SLB issuance. “Are we fulfilling our fiduciary duty to get a better deal?” asked Irish.
Who’s helping you?
The CAMRADATA panel were asked which organisations or groups helped them formulate and achieve their Net-Zero transition.
Krishna, who had already praised IIGCC, mentioned the Association of British Insurers.
Perez mentioned CERES, Climate Action 100+ and IIGCC. Burger mentioned the Consumer Goods Forum in the UK as well as the Responsible Investment Network, which he co-founded almost two decades ago.
Irish highlighted concerns related to the European Union’s Sustainable Finance Disclosures Regulation (SFDR). He felt that SFDR has potentially gone somewhat against its original purpose – to prevent greenwashing in financial services – by leaving such a wide spectrum of interpretation, notably for Article 8 categorisation. Mark hoped that the incoming UK SDR will help eliminate this uncertainty for UK investors.
This led to a debate about understanding labels and parameters. Perez noted that the first movers in ESG in the US were mission-based organisations that often request customised mandates. But as ESG mainstreams, more pooled products abound. He noted that as in Europe, the regulator in the US (SEC) is beginning to crackdown on greenwashing.
Krishna said that ESG labels were going broadly in the right direction. “At Phoenix, we are going down the pathway of disclosure. If managers make a claim, we want them to evidence it.”
She said the key question for asset managers was whether the ultimate client, the woman in the street, would understand their actions?
Maclay said that he was an investment professional but would score his own personal pension provider “one out of ten” for its information disclosure on ESG, which he described as opaque.
Burger agreed that there was a lot still to be done on reporting. The one observation he did want to make is that there is a danger of managers being scrutinised – and possibly punished – on a line-by-line basis. His fear was that regulators were looking for ‘sin stocks’ rather than evaluating strategies for their holistic character. That could have unintended consequences for managers actively engaging with companies nearer the start than the end of their decarbonisation journey.
Goel agreed with Krishna that the intentions behind labelling are good. She clarified, however, that Mercer doesn’t see categorisation such as Article 8 or 9 under SFDR as necessarily signifying a superior strategy.
Goel responded that managers determine the SFDR classification of their funds but in manager research at Mercer, SFDR classification wasn’t commented on. Instead, Mercer has ratings of 1 to 4 for ESG integration. These are distinct from its traditional manager ratings of A to C.
Irish added that many Isio clients, typically UK based, do not know what SFDR Articles 6-9 means.
The CAMRADATA discussion on the path to NZC concluded with thoughts from Maclay that great progress has been made in the last couple of years. For the near future, he believed that disclosure is the most important and valuable tool at our disposal.
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