Key factors for establishing an emission reduction goal

Asset owners are diverse and drivers for action will vary, ranging from financial value to social values, with actions and outcomes flowing from these.

Each asset owner will need to develop a goal appropriate to their particular organisation, starting by considering:

Organisation profile:

Headquarters and operational countries, portfolio size, breakdown of AUM by asset class and market, investment strategy and relevant regulation
Responsible investment beliefs, policy, goals and objectives

Exposure to:

Carbon on a per member basis, as indicated by quantitative measurement (i.e. a portfolio carbon footprint) and qualitative review by portfolio managers
Direction of public policy on climate change that may impact on the portfolio (either globally, domestically or in particular key markets)
Technological and physical impact of climate change on the portfolio

Opportunities to reduce emissions and carbon intensity:

Investor engagement, public policy engagement, investment strategy
Discussion with portfolio managers and investment consultants

Companies are developing emissions reduction techniques and in time these may hold learnings for investors, as well as prove important to include in investor engagement with companies. These techniques include: Science-based targets; The Three Percent Solution (WWF, McKinsey and CDP); We Mean Business; and the EC on Energy Efficiency Finance Opportunities.

Priority areas for emissions reduction

We run out of a carbon budget around 2040 (or sooner) if no substantial changes are implemented versus current levels of ongoing emissions. However, switching to a lower carbon economy could result in lower average carbon emissions over periods of time allowing for a gradual transition to occur successfully, keeping us within this budget by 2050:

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Years	Gt/Yr
Source: IPCC
2011-2015	185 Gt
2016-2020	150 Gt (30/yr)
2021-2030	250 Gt (25/yr
2031-2040	200 Gt (20/yr)
2041-2050	100 Gt (10/yr)
Total	885 Gt

Goals in line with the average decadal global emissions reduction percentages required would be one path forward for investors. Production and use will both need to be addressed for annual emissions reduction to be achieved. Action by category of emissions might include:

electricity generation – changing the energy mix;
energy use in the ongoing functioning and maintenance of buildings – maximizing energy efficiency;
modes of transportation – building infrastructure for electric vehicles along with efficiency policies such as miles per gallon;
industrial processes – industrial symbiosis, sharing economy, closed loop/circular economies;
agriculture and land use – better deforestation standards and growing practices including methane capture.

In 4 Steps to keep us within 2 Degrees, the IEA suggested:

transitioning away from coal use;
removing energy subsidies;
maximising energy efficiency;
capturing methane in natural gas extraction (and perhaps other processes).

Embedded in here are new policies that would be required and which investors need to be advocating for as well as financial opportunities in energy efficiency and methane capture. Examples can be seen in the Value Driver Model work on the UN Global Compact website and in related PRI publications.

Timeframes and reporting

Thought needs to be given to an appropriate timeframe for setting goals, taking into account the IPCC/IEA/Carbon Tracker Initiative consensus on a global carbon budget of about 900-1100 Gt expiring around 2040. Asset owners will need to agree targets and timeframes with portfolio managers.

Corporate examples could be useful guides. The Unilever Sustainable Living Plan, for example, was launched in 2010 and set out a “blueprint for sustainable growth” by 2020 focusing on three main goals (health and well-being, reducing environmental impact and enhanced livelihoods) underpinned by nine commitments. Unilever reports on its website whether the target is achieved, on-plan, off-plan and the percentage of the target achieved, providing strong transparency to customers.

Asset classes

Listed equity

Responsible investment practices including active ownership and ESG incorporation are typically most advanced in listed equity. For actively managed mandates, investment analysis may help identify opportunities in companies wellpositioned for climate change and those offering low-carbon or adaptation solutions. For actively managed and passive mandates, active ownership on climate change is likely to be an important approach, including voting on climate change-related shareholder resolutions and dialogue with companies and public policy makers on climate change. As highlighted below, portfolio carbon footprint measurement is most advanced in equities.

Fixed income

Integrating climate change into issuer analysis is possible and underway to some degree in government issuers, emerging market debt investors, corporate (non-financial) issuers and in covered bonds. Some large fixed income owners find they have increasing influence to engage directly with the issuing company to address future potential credit risk. Climate bonds are designed to lower the footprint of sectors such as energy generation and transportation. More climate bonds being developed and issued could increase appetite for the asset class. Measuring the carbon footprint of new issues is an important shortterm focus. For examples of climate change integration, engagement and green bonds, see PRI’s Fixed Income Investor Guide.

Private equity

Little-to-no useful data is available on either privatelyowned or state-owned companies, although work is underway by at least one provider and asset owner to measure the carbon footprint of a private equity portfolio. CalPERS has called for equity to be considered as a single asset class, regardless of whether privately or publicly held, which would boost investors’ ability to ask for data so that assessments can be made.

Infrastructure

Bespoke analysis on infrastructure is essential. It is an important area of future focus, with calls for replacing trillions of dollars of energy and transportation infrastructure in the years to come including grid, storage, airports/aviation and much more that will have a direct bearing on the carbon footprint of global society. Solutions must also be found to properly fund energy innovation.

Property

Standards such as LEED and BREEAM are somewhat useful, as is the move to benchmark buildings in cities. In general, cities are expected to lead on reducing their carbon emissions with many planning to both mitigate and adapt through direct investment, including forms of energy efficiency financing that can create jobs. There is a clear opportunity for carbon reporting of portfolios to be performed over time, with targets that can be measured and reported.

Commodities

There is no method to measure a carbon footprint for the vast majority of commodities, whether ecosystem-related or resource-related. A spectrum of Sustainability Standards are being developed at the sourcing level, varying in strength and credibility. Palm Oil standards (e.g. RSPO) are a work in progress to mitigate deforestation. Work has been done on sustainable fisheries and sustainable gold, amongst other resources, but these are typically traded by certificate without the ability to discern which are actually sustainable and not. Conservation of critical areas remains an important concern, including wetlands, forests, oceans, fisheries and, from a carbon reduction perspective, preserving, enhancing and restoring carbon sinks. Conservation finance does not provide enough cases to make techniques financially viable for investors at sufficient scale to address the underlying issues.

Investment approaches

Active ownership

Investor engagement with companies on climate change has been underway for some time. As one recent example, Norges Bank Investment Management has published Climate Change Strategy Expectations to Companies which aims to serve as a basis for constructive dialogue between investors and companies. Positive developments for company-investor dialogue include The Aiming for A Coalition’s shareholder resolution, Strategic Resilience for 2035 and Beyond, which received support from company management and over 98% of shareholders at the 2015 Annual General Meetings of BP, Royal Dutch Shell and Statoil.

The Carbon Asset Risk Initiative involves engagement with fossil fuel companies to use shareholder capital prudently. Meanwhile, a recent shareholder resolution filed by As You Sow and Arjuna Capital’s called on Chevron to return dividends in light of spending on high-cost, highcarbon projects; the resolution receive support from 4% of shareholders. There are also calls for forceful Stewardship, whereby investors would press companies to present 2 degree compliant business plans and vote for resolutions to change business models.

Investor collaboration

Institutional investment makes up over 65% of equity ownership in publicly-traded companies – up from 35% over the past few generations. If institutional investment – whether invested actively or passively, directly or through outsourced relationships – were to act collectively and collaboratively on carbon emissions, this may present the largest available opportunity to address the climate challenge at hand. Through Carbon Action, investors have engaged collectively with companies on disclosing an emissions reduction target and the PRI has launched a collaborative engagement programme on corporate climate lobbying. This engagement is aimed at encourage responsible company practices on climate change-related policy activity, focusing on Australia, Canada, Europe and the USA.

Passive investing

There is a move in the market towards lower fee investing, especially passively managed public equity. Passive investment does not mean passive ownership. As large investors with substantial voting rights, passive investors are well-placed to influence companies. As they invest across the whole market, passive investors have an interest in raising standards beyond the individual company level and through engagement with regulators. Passive investment can be done through separate accounts and other low-cost index strategies to ensure that asset owners are able to tilt their portfolios towards lower carbon assets when clients request this within the mandate. Further work is need with some asset managers on how to provide this basic service within pooled, passive mandates.

Portfolio managers and external managers

Dialogue and engagement with portfolio managers is essential. This may include asking for portfolio carbon footprints as well as integrated analysis and active ownership on climate change. Portfolio managers must demonstrate the necessary knowledge of and capacity to address climate change factors in order to meet goals for portfolio measurement, asset allocation and engagement strategy.

Many asset owners work with third-party providers such as external fund managers, hedge funds and consultants. The Global Investor Coalition on Climate Change’s recent Climate Change Investment Solutions guide includes guidance on how asset owners can engage with fund managers, including on:

measuring emissions and carbon intensity;
integrating within investment decision-making;
voting and engagement;
setting targets to reduce portfolio carbon intensity and exposure to fossil fuel reserves;
including climate change in mandate design.

Fossil fuels and divestment

For some asset owners divestment is a way to align investment beliefs with invested dollar. A classic example would be the outright sale of a sector, such as selling of tobacco companies due to health concerns and liability considerations. Another practice would be selling a targeted company after years of engagement failing to achieve a result.

Norges Bank Investment Management has a specific process for, and history of, selling companies they have failed to make engagement progress on.

For other asset owners, divestment will conflict with investment beliefs linked to active ownership and ESG integration. Furthermore, the global use of fossil fuels may be seen as being so embedded in commerce, household consumption and society that it would be unclear where to stop divesting to remove fossil fuel from one’s portfolio.

Asset owners considering their approach towards fossil fuels are encouraged to consider carbon mitigation measures recommended by the IPCC and in The Low Carbon Investment Registry. The range of approaches for reducing or removing exposure to fossil fuel reserves include: placing a percentage cap on exposure to fossil fuel extraction, or excluding fossil fuel industry groups; using a low carbon indices to measure and manage portfolios against a benchmark that integrates climate change into its weighting methodology; and for passively managed funds applying a tilt away from higher carbon assets to lower carbon ones.

Investor approaches include:

In Fossil-fuel investments in the Norwegian Government Pension Fund Global: addressing climate issues through exclusion and active ownership, the expert group of authors recommended active ownership and integration into investment analysis, which led to the fund divesting from 40 coal companies.
Investors with guidelines on coal include KLP, KPA, Storebrand, Nordea Investment Management, Wespath, Local Government Super and HESTA.
The Church of England has committed to divesting from thermal coal and oil sands, while the Church of Sweden has divested from all fossil fuels. Several universities have committed to divestment, with Stanford University divesting from coal.
AXA has committed to divesting internally managed assets from companies most exposed to coal-related activities to de-risk investment portfolios and align with AXA’s corporate responsibility strategy, while tripling green investments to €3 billion by 2020.