Climate Stability

All investors need to be able to understand the alignment of their fund with the Paris agreement. Doing so would be made possible if there was uniformity in reporting portfolio temperature alignment and the metrics used to report climate performance were simple and understandable to all investors – even non-experts. Research from the University of Cambridge Institute for Sustainability Leadership (CISL) looks at the current approaches used by market leading funds to measure climate performance and makes the case for a universal disclosure of Paris alignment.

While the pandemic has shrunk global economic activity, it has also highlighted the need for a green recovery, and momentum has slowly grown - evident from the increase in the demand for sustainable funds despite the market turmoil. With the US making an official return to the Paris climate accord and the resumption of COP26 in November 2021, the climate crisis will again be at the centre of conversations around the world and it is no surprise that investors are increasingly interested in the impact of their investments on global temperature rise. 

The trend towards incorporating climate evaluation in investment decisions will only rise, driven by regulated reporting frameworks such as the SFDR which mandates adverse impact reporting for green funds, and a surge of individual investors and asset owners who want their money invested with climate in mind. Alongside investors desire to align their portfolios with their values, it is also in the best interests of the investment management industry to build resilience to climate risks and stop further temperature rise. Research conducted by Cornerstone Capital Group for example found that $3-24 trillion or 2-17% of global financial assets are exposed to financial risk and loss stemming from climate change.

To make more sustainable investment decisions, investors need to know whether their holdings help or harm the stability of the climate. Clearly, to be informed, investors need access to accurate data on material climate impacts via fund reporting. Trends such as investor demand and regulation for better sustainability data disclosure are driving better availability and accuracy of corporate climate-related data. However, while year-on-year corporate disclosure of carbon emissions is improving, it is alarming that just under half of the assets in the MSCI World Index fail to report something as basic as carbon footprint (the figure is far lower across many broader global indices). The Sustainable Investment Framework published by CISL in 2019, on which the Navigator is built, acknowledges that at present, reported data availability and accuracy remains patchy. Alongside a suite of five other impact metrics to give a holistic picture of fund sustainability performance, the framework proposes a simple metric for reporting climate stability that considers a company’s Scope 1 and 2 GHG emissions – information which is generally well understood and reported today – expressed in tonnes of carbon dioxide equivalent (CO2e) per US$ mn invested.

Job done? Not quite. Whilst reported emissions intensity communicates a fund’s carbon footprint, investors also need this information presented in a way that’s comparable and easily understood by investors and non-experts. Recent analysis from global investors network the Investment Leaders Group (ILG) shows that present fund disclosure does not allow investors to understand and compare the alignment of funds with the Paris Agreement. The report analyses a series of market leading sustainability funds and finds a plethora of ways are currently used to report climate performance: from reported carbon intensity, to the percentage of assets aligned with the Paris Agreement and exposure to climate risks. While each reporting method has its uses, the diversity of approaches makes comparison difficult. Furthermore, not all reporting approaches give investors a clear picture of their impact on the climate. Whilst benchmarking emissions shows the relative performance of one fund against another, this does not indicate whether asset performance is in line with the Paris ambition. It may well be that both funds have poor climate performance in absolute terms, but investors are not easily able to make that judgment with the tools at hand.

This problem would be addressed if the industry adopted a universal measure to judge alignment of funds with the Paris ambition. In sequence to the Framework’s basic metric which provides a picture of a fund’s carbon footprint, CISL is working with the ILG to develop a simple, transparent and scientifically robust method which converts available emissions data into a ‘temperature score’ that associates a fund with a specific level of global warming in °C. Such a metric offers a meaningful, outcome-based measure that reveals instantly how a portfolio aligns with the Paris ambition – keeping global mean temperature rise well below 2°C between now and 2050. Without such disclosure, investors remain blind to the impact of their holdings on climate stability.

CISL are working with the ILG to develop a proposed temperature scoring methodology to be incorporated into the Navigator and, in doing so, will update the current Climate Stability metric in the Navigator to reflect the latest thinking and research from CISL.

Senior Programme Manager

Investment Leaders Group