Your Target: Net Zero

The debate around engagement and divestment is nuanced and it should be clear that it is not an either/or matter. There is room for both approaches, depending on an investor’s objectives. When evaluating the two approaches to address climate change, it is important to differentiate between immediate improvement in portfolio climate metrics and creating long-term environmental and societal investor impact. Divestment can be an immediate solution to reduce specific ESG and climate risks. However, it fails to address the systemic, long-term impacts of climate change.

Divestment also abrogates responsibility for tackling climate change to another party. Therefore, an investment approach purely founded on divestment is not desirable in our view. To sell companies within the fossil fuel value chain with immediate effect would forego the opportunity to engage with these companies, to help them adapt and ultimately be a part of the climate solution. However, we expect divestment to remain an option for certain activities (like thermal coal) whose ESG thesis will remain unconvincing.

In terms of a forward-looking metric this is typically associated with the transition path of greenhouse gas emissions between now and a net zero value targeted in the second half of this century. The choice of transition paths is endless, generated by many models. Initiatives, like the sectorial TPI or the SBTi, provide the investor with transparency and support for the evaluation of the company’s proposed transition pathway. In addition there are models that allow for a forward looking assessment at the aggregate level such as Implied Temperature Rise model or the Climate VAR model.

For sovereign bonds a country’s current planned policies and its NDC would all be part of a forward looking evaluation. In its implementation guide the Paris Aligned Investment Initiative [7] suggests a country scoring methodology as developed by the CCPI index [10].

For green bonds we assume zero carbon emissions, even if issued by a high emitter. This is to encourage green bond issuance, however a very rigorous framework should be applied for a strategy to be categorised as a green bond. In this context we can mention the Climate Bond Initiative, of which State Street Global Advisors is a partner.

Ultimately the investor may wish to align the portfolio to a transition path according to its Climate change policy. This can be done for example by favouring companies that have a transition plan. If the allocation is well chosen then the portfolio will have minimal exposure to potential stranded assets while at the same time decarbonizatio occurs automatically.

Simply allocating the portfolio to low carbon emitters defeats the purpose of a smooth transition from a fossil fuel energy derived economy towards a clean energy economy.

There have been a number of Net Zero Initiatives and Net Zero Frameworks released in recent years, including a variety of EU regulations, the Paris Aligned Investment Initiative (PAII) by the IIGCC, the Net Zero Asset Manager Initiative (NZAMI) and the Net Zero Asset Owner Alliance (NZAOA). 

The focus of these initiatives are broadly the same. They tend to focus on decarbonization, increasing investment in climate solutions and green technologies, and achieving better reporting. 

The IIGGCC along with four regional investor networks has proposed a framework for asset owners. The Paris Aligned Investment Initiative (PAII) from the Institutional Investors Group on Climate Change (IIGCC) is an initiative involving over 110 investors and $33 trillion in assets. The IIGCC released their Net Zero Investment Framework in March 2021.

The Framework is intended to be adopted by asset owners or asset managers following a formal commitment. Initially, the framework covers four major asset classes — sovereign bonds, listed equities, corporate fixed income and real estate, with others to follow.

All net-zero frameworks pull on the same levers to varying extents to drive change in portfolio companies, but the IIGCC Framework is highly regarded and vetted by industry participants. It provides somewhat flexible guidelines to investors, along with recommended actions, metrics and methodologies to achieve the goal of net zero global emissions by 2050 or sooner.