Challenges and opportunities of decarbonizing your portfolio
Marina Severinovsky, Head of Sustainability, North America, Schroders
Below is an insight into what can be expected from Marina’s session at Climate Risk USA 2023.
The views and opinions expressed in this article are those of the thought leader as an individual, and are not attributed to CeFPro or any particular organization.
How can data be leveraged to decarbonize portfolios?
The four approaches institutions can take to decarbonize their portfolios are:
- Investing in positive carbon solutions
- Engaging with issuers
- Using carbon offsets and divestment
- Leveraging data on emissions, carbon pricing and temperature alignment
This can enable institutions to build a fuller picture of their carbon footprint, understand associated risks, set targets, and ultimately build an efficient approach that meets their needs.
For example, at Schroders we utilize a variety of tools to track the net contribution that companies or sovereigns have on the environment. Data collected from public Scope 1, 2 or 3 emissions is used to estimate the implied temperature rise of investment holdings. This helps our portfolio managers determine which assets have the highest negative impact and vice versa. We can then make informed decisions on which assets are worth engaging to create positive change rather than simply re-allocating or divesting.
It is also important to actively monitor whether the engagement is creating a meaningful change towards the entity’s decarbonization efforts. Schroders utilizes and supports frameworks such as Science-Based Targets (SBTi) to validate emissions targets and track progress towards net zero.
Leveraging data is also essential for developing the correct decarbonization trajectory. Decarbonizing too slowly risks higher physical risks from climate change while being overly aggressive will reduce the investment universe drastically. Finding the correct balance would be difficult without the use of high quality data.
Why is adherence to net zero targets when decarbonizing an important objective? What are some of the challenges achieving this?
In order to meet the Paris agreement goal of limiting warming to 1.5°C, global carbon emissions need to be reduced to net zero by mid century. Companies that lag behind global efforts are exposed to greater financial risk and costs, as are their shareholders.
Global decarbonization will be a long process but adhering to net zero targets is critical for building a sustainable future and avoiding the worst impacts of climate change. In this regard, Schroders published a Climate Transition Action Plan in 2021 setting out targets to reduce emissions across our managed assets. The goal of these targets is to follow the decarbonization trajectory to achieve temperature alignment of our client’s portfolios to 1.5°C by 2040.
This process is not easy to achieve and requires a concerted effort from all stakeholders including investors, companies, governments, and civil society. This effort must be sustained over the long term and involves significant changes to both our economy and public policies. Without goals this task can seem monumental, however, following laid out, science-based targets (such as those validated by the SBTi) can make a transition to net zero more achievable for a company.
Schroders is a founding member of the Net Zero Asset Managers Initiative and has developed frameworks that can help our clients create these targets and start their journey to net zero.
What are some of the nature dependencies when offsetting carbon?
There are several technological solutions available for offsetting carbon, but they are still limited in scale and often non cost competitive. This leads us to consider natural carbon off-setting. The main nature dependencies are to forests, soil, and oceans, which absorb a large level of carbon from the atmosphere (with the ocean absorbing 25% of all human carbon emissions alone). It is vital to consider these nature solutions, and also to consider both dependencies and risks in this context.
Any carbon offsetting projects must be managed in a responsible and sustainable way, with respect for land use and ownership, indigenous rights, the needs of local communities, and other similar considerations.
Understanding why just divesting is not a solution to decarbonizing?
Divesting involves screening portfolios and removing assets that don’t meet requirements determined by their net zero targets. While this is a quick solution to decarbonizing a specific portfolio, it is not a silver bullet and does little in the way of actually reducing total emissions globally. For example, high emitters possessing the scale and resources to develop and distribute cleaner energy alternatives have the potential to make significant progress towards decarbonizing the energy sector; whereas divestment may leave them with fewer incentives to do so.
Continued investment and engagement could help lead them towards a net zero future by providing them with the frameworks and the know-how to start their transition. This could provide a larger positive contribution to reducing carbon emissions while also decarbonizing the institution’s portfolio.
Divesting should be limited to companies that repeatedly show no progress towards becoming net zero. However, before making this decision, institutions can work to engage companies in many ways through active ownership. This can involve dialogue with company executives, going public with concerns, submitting resolutions, and voting.
How can institutions drive capital towards a more sustainable business model?
Institutions have a critical role to play in driving capital towards a more sustainable business model. One key way to do this is by incorporating ESG factors into their investment decision-making processes. This allows institutions to capitalize on both growth opportunities and avoid risk while also creating a positive impact on the environment and society.
To drive capital towards more sustainable business models, institutions need to be seen as responsible stewards of their clients’ assets. They cannot lose sight of generating competitive returns while offering decarbonizing solutions. Their financial models/tools would also need to have a long term perspective to understand the sustainability of an asset; in essence, its ability to sustain strong financial returns.
Engagement with companies is an important tool that institutions can use. By engaging with companies and encouraging them to improve their ESG practices, investors can help create further positive change and drive the transition to a more sustainable business model.
Institutions can also support the development of sustainable investment products and solutions. One of the many reasons the world is not at net zero already is because there are not enough sustainable assets to invest in.
Institutions can work together to support new and developing products to mobilize capital and move investee companies towards a more sustainable business model. Some of these new solutions are in the area of impact investing which is investing with the intent to solve a social or climate issue alongside a financial return. Developing solutions like these can help align more capital with net zero targets and more environmentally and socially responsible companies.
Are there any technologies currently available to aid with decarbonization for institutions to take advantage of?
There are several useful databases, tools, and software currently available to aid institutions with decarbonization. They cover a wide range of uses from data tracking to new carbon capture processes.
An important tool that is publicly available is carbon footprint software. This software can calculate the mass of specific emission factors needed to calculate a total carbon footprint. In addition to maintaining a database of scope 3 emissions data from companies, it can help companies identify pain points that need improvement and help to address them.
There are several public resources that can help institutions track progress towards net zero:
- MSCI’s Climate Value-at-Risk (Climate VaR) model provides a forward-looking and return-based valuation assessment to measure climate related risks and opportunities in an investment portfolio.
- CDP is a leading global disclosure platform where over 18,000 companies publicly report their emissions, climate change strategy, scores, annual data and more. CDP also publish research on global climate policy, sector specific decarbonization and recently launched their ‘Corporate Environmental Action Tracker’.
- Race to Zero is a corporate coalition which has developed an interactive tool tracking key climate metrics (such as emissions trends, progress against climate commitments, temperature alignment of their revenues and CapEx, etc.) from the 500 largest companies in the coalition.
- Influence Map offers platforms providing in-depth analysis and scores for companies’ climate policy lobbying and engagement efforts.
We have also developed proprietary tools such as Carbon VaR, Physical Risk, and the Schroders Net Zero Dashboard.
- Carbon VaR captures the effect of higher carbon prices on a company’s cash flows and valuations.
- The Physical Risk model assesses an asset’s exposure to a range of climate-related hazards and related insurance costs. It can be used to create incentives for companies and investors to transition to low-carbon technologies and business models.
- Our Net Zero Dashboard helps track financed emissions, company commitments towards emissions reductions and measures portfolios’ temperature alignment dynamically.
- Our team has also developed tools that track the net benefit/cost of the positive or negative environmental and social externalities of a company or government. This tool enables us to place a dollar price on the impact to either the environment or society. Other tools show which stakeholders are impacted and which SDGs (Sustainable Development Goals) are addressed by the goods/services of individual companies.