As we know, climate change, as a global systemic risk, is one that is increasingly integral to asset owners' risk management. However, in approaching, and ultimately implementing, a climate change risk management policy, asset owners must first ask themselves some fundamental questions, while taking on board a number of key considerations. These include:
- Determining at which point of the portfolio construction process climate change risk management considerations should be implemented and whether they should be a primary or secondary consideration. For most, climate change risk management will be integral to manager selection but perhaps secondary to considerations such as the portfolio's required rate of return, risk parameters, diversification and liquidity when determining the Strategic Asset Allocation, given the potential to significantly alter the risk/return, diversification and liquidity characteristics of the portfolio.
- Whether to align portfolios with the objectives of the Paris Agreement,1 as many asset owners are already starting to do, some in anticipation of regulation potentially moving in that direction. However, this is no easy task, given that there is no single validated approach for measuring and evaluating the temperature alignment and, indeed, the carbon intensity of a portfolio. Not to mention the transition pathways of a portfolio's holdings, with data availability being largely limited to equities, credit and sovereign bonds. Thankfully, the publication of the IIGCC Paris Aligned Investment Initiative will assist asset managers and asset owners in implementing investment policies in line with the Paris Agreement's goals.2
- Establishing what ‘good' looks like. Although the Paris Agreement sets a very long-term target to aim at, asset owners will invariably look to their peer group for an initial baseline comparison and ongoing monitoring of their chosen climate metrics. To do so successfully will require greater levels of transparency from all and each setting realistic interim milestones.
THREE KEY OBSTACLES TO ASSESSING CARBON AND GHG EMISSIONS EXPOSURES
With the above in mind, asset owners (assisted by their investment consultant and asset managers) must navigate their way around three key obstacles to assessing the carbon and GHG emissions exposure of their portfolios. These are: the paucity of quality Scope 1, 2 and particularly Scope 3 GHG emissions data analytics; the inconsistency of ESG data, of which climate risk is a key "E" risk factor; and inadequate disclosures by companies of their GHG emissions. The latter severely compromises the accuracy of ESG data and the GHG emissions data compiled by data vendors and analysed by asset managers.
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1.The Paris Agreement's central aim is to keep a global temperature rise this century well below 2°C above pre-industrial levels and to pursue efforts to limit the temperature increase even further to 1.5°C by 2100.
2. The Institutional Investors Group on Climate Change (IIGCC) is the European membership body for investor collaboration on climate change, whose mission is to mobilise capital for a low carbon transition. The Paris Aligned Investment Initiative is led and coordinated by IIGCC with a steering group of leading asset owners.
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