Why should investors consider rethinking their approach to aligning to net zero? Because in our view many current solutions, which focus on today’s low-carbon companies, have real flaws.
Without a genuine forward-looking focus, they fail to identify companies across the economy - even in high-carbon sectors - whose credible, Paris Agreement-aligned progress on decarbonisation might not be recognised by the market. In addition, some purportedly low-carbon strategies do not assess scope 3 emissions, which are especially material for sectors like financial services and real estate. By not recognising the full scope of companies' emissions while withholding capital from transitioning firms, they slow progress towards achieving net zero.
Highlights
With policy, corporate and financial-market action on decarbonisation increasing, we provide 5 reasons to rethink portfolio alignment to net zero:
- Accelerating policy momentum
- A carbon footprint is only the first step
- High-carbon exclusions are flawed
- To manage climate risk to 2050, look forward
- Invest in ice, not fire
Accelerating policy momentum
Based on robust science, the necessity of achieving net zero has permeated the world's most powerful institutions. In many countries, decarbonisation is now a policy imperative.
From the US, China and Brazil to the European Union, 195 parties have committed to the Paris Agreement, placing 88% of emissions and 92% of GDP under a net-zero target.
Impactful green industrial policy has followed. The US Inflation Reduction Act catalysed USD 110 billion in clean-energy manufacturing projects in its first year, and China is poised to surpass its 2030 target of boosting wind and solar capacity to 1,200 GW in 2025. To boost green technologies, the European Union's (EU's) Green Deal Industrial Plan aims to improve funding, skills, regulatory approvals and the supply of essential minerals.
The TCFD is setting the disclosure standard
Financial regulations are also aligning to net zero. The UK, Switzerland and Brazil are among the six countries requiring specified companies and financial institutions to disclose emissions data in line with TCFD recommendations. Proposals are live in other jurisdictions, chiefly:
- The US, where the SEC is seeking companies to report a range of climate-related information, from emissions volumes to expected risks and transition plans, also in alignment with TCFD recommendations
- The EU, in which both the range of companies captured under the Corporate Sustainability Reporting Directive and the scope of disclosures have been expanded, with frameworks like the TCFD's required to be taken into consideration from 2024 financial year.
Other markets - such as Japan, Hong Kong and Malaysia, are endorsing the TCFD framework as part of ESG reporting. Broadly, 1,539 of the TCFD's roughly 4,000 supporting organisations are from the financial sector, according to the group's latest status report.
Spotlight: the UK
Asset managers overseeing more than GBP 50 billion are already required to report emissions in a way consistent with TCFD recommendations. From mid-2024, those with GBP 5-50 bn must report from 30 June 2024.
Reporting on climate risk is also a growing requirement for asset owners. Under the Climate Change Governance and Reporting Regulations, corporate pension schemes with more than GBP 1 bn must implement climate-change governance measures and publish a TCFD-aligned report every three years, including:
- The impact of various climate scenarios on assets and liabilities
- The resilience of investment and funding strategies
- Data for scope 1, 2 and 3 emissions that are relevant to chosen metrics
- Measure the emissions-reduction performance of the scheme relative to its targets
- Engagement on persistent data gaps
Starting next year, local government pension schemes in England and Wales are likely to be required to produce annual TCFD-aligned climate reports, which include modelling on how different climate scenarios would affect scheme liabilities. However, given the materiality of climate risks and the expectations of scheme members and the public to demonstrate how portfolios are aligning to net zero, many schemes are expected to voluntarily issue reports in advance.
important information
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