Climate action and investing: connecting data with real outcomes

An increasing amount of labels, aspirational targets and a diversity of reporting metrics make it difficult for investors to know how their investments impact the climate. So how do we measure the climate impact of our funds?

August 2021.

In late 2020 The CFA Institute, a global organisation that provides investment professionals with finance education, released a report¹: “The future of sustainability in investment management: from ideas to reality”. It highlighted one of the main factors that can undermine trust in the fast-growing responsible investment sector is greenwashing.

Greenwashing refers to conveying a false impression or providing misleading information or a misleading narrative about how a company and its products are environmentally sound or positive in an ESG context .

The report revealed that 78% of investment practitioners surveyed believe there is a need for improved standards in ESG (Environmental, Social and Governance) investment products to mitigate greenwashing. What does the need for improved standards mean when evaluating climate risk exposures in your investment portfolio or strategy?

According to U Ethical’s Head of Ethics and Impact, Désirée Lucchese, robust and transparent disclosures are critical for investors to help mitigate downside risks and enable a forward outlook. However these disclosures need to be relevant, comparable and verifiable , not misleading.

“We’re committed to using industry-leading external third party ESG data and estimation assumptions to ensure we remain objective in our investment evaluations and reporting,” Lucchese said.

“Carbon and climate risk data are not perfect and are fast evolving but we cannot let perfection be the enemy of the good. The key message here is that robust estimation tools are available and I would be hesitant about fund managers who claim they can do this analysis internally.”

One such area of measurement for ethical and ESG funds relates to carbon emissions to determine what is called a ‘carbon footprint’³. This examines the pollution from sources owned or controlled by a company (typically direct combustion of fuel) and those caused by the generation of electricity (purchased by a company).

Despite improvements in corporate reporting, carbon data is still sparse and non-standardised. Estimation is therefore critical in ensuring that carbon data suitably reflect energy loads, industrial processes or company-specific processes and their ensuing total emissions and energy intensities⁴. We have seen some significant variation of assumptions when carrying out provider due diligence⁴.

Combating greenwashing in practice

An increasing amount of labels, aspirational targets and a diversity of reporting metrics make it difficult for investors to ascertain what best practice looks like and where to find the source of truth on this issue. So what is an investor to do? We hope that by shedding light on our climate action processes, investors can make informed decisions in the face of greenwashing concerns.

What exactly do we measure?

Primary ethical considerations

Using MSCI ESG Research’s tool, we conduct a minimum assessment of Environmental, Social and Corporate Governance (ESG) ratings and controversies screening. At this point we also target companies with products and services that align to the United Nations Sustainable Development Goals.

Climate change metrics

The next step in our screening process is to look at the carbon footprint of a company. This helps us to see how the company has been trending over the last decade, its management awareness, capabilities and overall commitments to lower emissions and transition the business.

We measure Scope 1 emissions (those from sources owned or controlled by the company, typically direct combustion of fuel as in a furnace or vehicle) and Scope 2 emissions (those caused by the generation of electricity purchased by the company).

GHG


Image source: Greenhouse Gas Protocol.

Some key questions for companies as part of these analyses are:

- Have the companies been reporting a reduction of their operational emissions both under operational control and their supply chain (upstream and downstream)?

- What is the entity’s ability to manage a low carbon transition⁵?

- Has the company released, or in the process of releasing, a Task Force on Climate-Related Financial Disclosures (TCFD) report, which aims to improve risk management and reporting around climate-related financial risks? Alternatively, does the company have a science-based decarbonisation roadmap?

- Most importantly, if it does, has the company set short- and medium-term targets to track performance and transparently report on it?

Once we have answered these questions and looked at the above-mentioned climate metrics, our investment team determines whether a company is suitable to invest in. We continuously monitor these considerations even after a company is included in our portfolio.

Looking forward – investing in a climate safe future

Whilst having proudly completed a divestment from fossil fuels in late 2019, we acknowledge that carbon foot-printing alone is not sufficient to align investment with a climate safe-world. Reporting is not a “proxy for progress”. The measurement of carbon footprints is a point-in-time lens of analysis and, alongside the trend in historical emissions, it helps us determine the status of a company’s understanding and management of operational risk. However, it only tells us a fraction of what to expect from management and the way a company is hedged against future risks. How do we manage this?

Evaluate the climate scenario of our portfolio

In other words, how prepared our holdings are to transition into a lower carbon economy or manage unexpected, and increasingly more frequent and costly, future risks.

We are addressing this in our climate risk report⁶. Here we recently disclosed a preliminary mapping of our listed equities exposures to climate transition⁷ and physical risks⁸ , or climate value-at-risk (CVaR)⁹ . The findings revealed that greater risks are concentrated in a few sectors: materials, transportation, telecommunication services, health care and equipment.

This gave our investment team an indication of priority areas for on-going analysis and discussion with portfolio companies. Is the company aware of these risks? Does the board have oversight of these risks? Most importantly, what is the company doing to mitigate and bolster its critical operational exposures and core products? Climate risk is a material financial risk with emerging liability risks for company directors¹⁰.

Active engagement with existing holdings

By signing up to The Investor Group on Climate Change’s Climate League 2030 we committed to engaging with the top ten companies that represent the largest emissions contributors in our portfolio carbon footprint. We seek accountability from the companies in which we invest, or look to invest in, through evidence of robust climate scenarios, science-based disclosures and related decarbonisation initiatives.

Whilst we are pleased with our current reporting on the carbon footprint of our funds, we believe our greatest impact will come with climate scenario commitments, given they focus on the long-term trajectories to keep the world within climate safe limits.

Does U Ethical connect data with impact? Let our funds do the talking.

The outcome of this aforementioned work means that we can transparently and accurately provide investors with the carbon footprints of our funds, outlined in our quarterly performance reviews. Since fully divesting from fossil fuels in late 2019, we have been tracking at about 60% lower carbon emissions that the benchmark¹¹ for our International Equities Trust and about 77% lower emissions than the benchmark¹² for our Australian Equities Trust, as at 30 June 2021.

In the mid-to-long term, we track all the ESG themes covered in our engagement discussions on the Institutional Shareholder Services (ISS) governance portal. The team also meets with our external Ethical Advisory Panel seeking objective guidance on matters of concern that may arise.

Notwithstanding, we do not think that this is sufficient climate action and may indeed lead to greenwashing risk. Moving forward, we are focussing our efforts on climate scenario mapping and continuous engagement with the holdings in our portfolios to encourage progress. You can learn more about how we engage with companies here: When it's time to engage or time to divest: our stewardship explained.

If you have any questions on how our team is measuring and reporting on carbon emissions and climate action outcomes more broadly, please get in touch today.

¹The Future of Sustainability, CFA Institute, 2020:https://www.cfainstitute.org/-...
²https://www.cdsb.net/sites/def...
³Total carbon emissions emitted by an organization, business, product, event or individual
⁴Energy intensity is a measure of energy inefficiency
⁵We apply a Low Carbon Transition Score and Category assessment that measures a company’s absolute exposure to and management of economically relevant risks and opportunities linked to a low carbon transition
https://www.uethical.com/uploa...
⁷transition risks from regulation, damage to assets, and business interruption
physical risks (chronic or acute) due to numerous extreme weather events, such as extreme heat, cold, wind, precipitation, snowfall and tropical cyclones
⁹Compliments of MSCI ESG Research-Carbon Data
¹⁰Liability Risk and Adaptation Finance – United Nations Environment – Finance Initiative (unepfi.org)
¹¹Benchmark is: ASX300
¹²Benchmark is: MSCI WorldexAU

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