{"id":42647,"date":"2015-06-09T00:33:22","date_gmt":"2015-06-08T22:33:22","guid":{"rendered":"http:\/\/beta.next-finance.net\/opinion\/portfolio-decarbonisation-making-sure-tomorrow-never-dies\/"},"modified":"2015-06-09T00:33:22","modified_gmt":"2015-06-08T22:33:22","slug":"portfolio-decarbonisation-making-sure-tomorrow-never-dies","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/opinion\/portfolio-decarbonisation-making-sure-tomorrow-never-dies\/","title":{"rendered":"Portfolio decarbonisation: making sure tomorrow never dies"},"content":{"rendered":"

The need to de-carbonise portfolios seems to have been broadly accepted, and many
\ninitiatives have been launched by investors on this topic: the Portfolio
\nDecarbonisation Coalition, the Montreal Pledge, and events such as the Climate
\nFinance Day, to name only a few. However, in order to address portfolio
\ndecarbonisation efficiently, we need to answer the very question that lies behind this
\ngood will: why would financial industry players ever want to do such a thing? What is
\ntheir real motivation? <\/strong> <\/em><\/p>\n

Motivations matter<\/strong><\/p>\n

As part of a partnership concluded in 2012 with the Cambridge Institute for Sustainability
\nLeadership (CISL), Mirova has brought together a group of investors known as the \u201cInvestment
\nLeaders Group\u201d (ILG). Their aim is to develop and promote concrete tools and measures that,
\nonce implemented, can increase the efficacy of responsible investment. Last year, the ILG
\nreleased a report entitled The Value of Responsible Investing, which examined investors\u2019
\nmotivations to invest responsibly. The report looked at three aspects of the argument in favour
\nof Responsible Investment: the economic case, the financial case and the moral case. All three
\ncontribute to a global motivation capable of inducing concrete action.<\/p>\n

In addressing climate change, we need to think along the same lines. As players in the financial
\nindustry, we cannot separate these three elements, we must think of them as an integrated
\nissue. From an economic point of view, climate change will have major consequences that we
\ncannot ignore. From a strictly financial perspective, a potential regulation of carbon threatens
\nthe value of our portfolios. From a moral point of view, we have a responsibility, as economic
\nactors and stakeholders in society, to do our best to meet the challenge of climate change.<\/p>\n

When examining financial players\u2019 motivations, what we find first is that recognition of
\nregulatory risk seems to be on the rise, encouraging players to develop solutions for dealing
\nwith it. This leads to strategies aimed at reducing portfolios\u2019 carbon risk, for example by
\nreducing the weighting of certain carbon-intensive companies or sectors, while overweighting
\nother, less carbon intensive, sectors.<\/p>\n

We believe that this is not enough. Such half-hearted decarbonisation, even if it applies to a
\nsignificant portion of financial assets, meets neither the economic challenges ahead nor,
\nespecially, the challenge of responsibility that is ours.
\nThere are two reasons for this. <\/p>\n

Carbon footprint: a complex matter<\/strong><\/p>\n

Measuring the carbon footprint of a portfolio is a complex issue. The Carbon measurement
\nmethods currently employed generally rely on tools focusing on direct impacts. This means that
\nthe impact of an oil company, for instance, will be reduced to carbon issued during oil
\nextraction. It also means that the carbon impact of a wind turbine manufacturer will simply
\nignore the fact that the company\u2019s product reduces GHG emissions for several decades. Such
\nmethodologies ultimately lead to a situation where the highest carbon risk lies with companies
\nsuch as cement makers, for example, while the least \u201ccarbon intensive\u201d sectors will be Media …
\nand banks! <\/p>\n

A straightforward application of these methods leads to increased weighting of the banking
\nsector at the expense of cement-making companies in portfolios. Can we really say that such an
\naction adequately addresses the energy transition challenge? We don\u2019t think so.<\/p>\n

Other investors apply a \u201cbest in class\u201d methodology, selecting the least emissive companies in
\neach sector rather than focusing on less emissive sectors, and thereby remaining sectorneutral.
\nThis strategy is also open to attack: sector neutrality is by essence a form of nonengagement.
\nApplying it will not support investments in innovation or the energy transition. <\/p>\n

Reducing the direct carbon footprint of a portfolio by erasing highly emissive companies is not
\nenough, and can even be counterproductive. Indeed, sectors responsible for releasing
\nsignificant carbon are where real leverage is possible, and cannot simply be overlooked. Rather
\nthan relying on incomplete methodologies and investing in low emissive companies, we believe
\nthat a strong shift in asset allocation is needed to combat climate change. A shift that would be
\nfavourable to renewable energy and projects promoting energy efficiency. A shift that would
\ndirect savings to companies and projects that enable the energy transition, as well as
\ncompanies which manufacture products or develop services with a measurable positive impact
\non greenhouse gas emissions. To identify these companies, it is essential to understand their
\nreal impacts. This means keeping track, not merely of the carbon released by their activities,
\nbut also the carbon induced by their products and services, in a word, the carbon footprint of
\ntheir business models. <\/p>\n

In order to accelerate a shift to this approach, Mirova and the consulting firm Carbone 4 are
\ncurrently developing a carbon impact methodology that combines direct and indirect GHG
\nemissions, to assess the percentage of investments favourable to the transition. What does this
\nmean? Imagine you want to compare a large producer of hydropower with an integrated oil
\ncompany. The former\u2019s direct carbon emissions are very high, half those of the latter despite its
\nmuch smaller size. However, our methodology also indicates that the producer of electricity
\nsuccessfully avoids 1.4 times more emissions than it releases. The oil company, on the other
\nhand, shows 0 emissions avoided, illustrating that the business model of one firm contributes to
\nthe energy transition, whereas the other\u2019s does not. We believe that a ratio (emissions avoided\/
\nemissions released) is a far better indicator than direct emissions alone. <\/p>\n

Passive management, active failure<\/strong><\/p>\n

The second barrier to decarbonisation is the current weight of passive management. We hear it
\nsaid that it would be possible to reduce the carbon impact while minimizing tracking error
\nrelative to market indices. This combination of passive management and decarbonisation is
\nconsidered a perfectly adequate first step for big institutional investors. We find this somewhat
\ndisturbing.<\/p>\n

Indeed, at the same time, so-called \u00ab smart beta \u00bb or smart indices (minimum variance, for
\nexample) are very successful. These smart indices deviate significantly from traditional market
\nindices. The tracking error of a minimum variance strategy is about 6%. This shows that
\ninvestors are ready to tolerate deviation, when it serves a purpose: here, reducing financial
\nrisk. Why is it assumed that they would not accept the same thing for low-carbon products?<\/p>\n

We believe that investors do have the capacity to support deviations from market indices.<\/p>\n

Meeting the climate-change challenge entails a reallocation of investments. Saying that the
\nenergy transition requires massive investment does not mean massive new investments. It
\nmostly means divesting from companies or sectors whose business models are not sustainable,
\nto invest in companies or sectors offering real solutions. A report issued by The Green Growth
\nAction Alliance, a partnership between the public and private sectors to scale-up private
\ninvestment in \u201cgreen\u201d sectors, claims that 90% of the investments needed are actually
\nreallocations of existing investments. Most of the money is already out there; the challenge now
\nis getting investors to redirect it. In this regard, the financial industry has a central role to play.
\nPlayers have to accept that no real solution can be based on \u201cbusiness as usual,\u201d even a nipped,
\ntucked and adjusted business as usual, and recognize that a substantial change in asset
\nallocation is necessary.<\/p>\n

The infrastructure sector is a striking example: according to the OECD, it occupies only 1% of
\ninstitutional investors\u2019 portfolios, and only 3% of this 1% is invested in renewable energy
\nprojects. Measures need to be taken to encourage investments in these kinds of projects. <\/p>\n

Public help wanted<\/strong><\/p>\n

The efforts of governments to support responsible investment and long-term decarbonisation
\nare crucial. At the level of each State, as well as at an international level, the industry would
\nbenefit from measures to make investments favourable to energy transition more attractive
\nthan others, and from actions to improve standardization and harmonisation.<\/p>\n

Some progress has already been made, such as the creation of EU Long Term Investment
\nFunds (LTIF). These new financing vehicles aimed at institutional investors should increase the
\npool of capital available for companies and infrastructure projects over the long term.
\nNevertheless, insurance companies remain too constrained by solvency rules. To make
\ninvestment in renewable energy projects more attractive, these rules need to be updated.<\/p>\n

On the other hand, we find the EU’s on-going consultation on Capital Markets Union (CMU) quite
\ndepressing. The process treats finance and capital markets as if they were a goal in themselves,
\nindependent from the rest of the economy. The consultation\u2019s objective was to improve how
\ncapital markets function, but it never raises the issue of what they should serve first. We
\nbelieve that the efficiency of capital markets cannot be an objective in and of itself; it matters
\nonly because of what it makes possible, which should include the financing of sustainable
\ncompanies and projects. Looking elsewhere, however, Aviva has proposed a Sustainable CMU
\n(SCMU), and we fully endorse this idea. <\/p>\n

Last, but not least, it is essential for securing and facilitating investment that \u201cpositive\u201d financial
\nproducts be easily identified by investors. Some products already have meaningful names that
\ncan guide potential consumers: Green Bonds, or Green Funds for example. But even these titles
\nare still self-attributed. Sustainable investment would significantly benefit from government
\nhelp in implementing standards, creating restrictive labels and making dedicated indexes
\ncredible.<\/p>\n

Real solutions for decarbonising portfolios and meeting the climate change challenge already
\nexist. Green Bonds, Renewable Energy Funds, Green Equity Funds: the financial industry is
\ndesigning and offering more and more options to investors ready to make real choices. By real
\nchoice, we mean more than marginal alterations to current portfolios intended to limit risks. We
\nmean educated and engaged choices, based on reliable carbon measurement methodologies;
\nchoices that will contribute to a significant asset allocation shift and participate in financing the
\nenergy transition. The actions of governments and regulators, once they are translated into
\nconcrete measures, should help investors make these choices. As responsible investors, deeply
\ninvolved in market organisation, we hope and believe that the current climate of general
\nawareness and the multiple initiatives now emerging will allow the industry to achieve
\nsignificant progress. This is what we work at every day. <\/p>\n","protected":false},"excerpt":{"rendered":"

The need to de-carbonise portfolios seems to have been broadly accepted, and many
\ninitiatives have been launched by investors on this topic: the Portfolio
\nDecarbonisation Coalition, the Montreal Pledge, and events such as the Climate
\nFinance Day, to name only a few. <\/p>\n","protected":false},"author":1,"featured_media":42645,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[1480],"tags":[1655,1826,1682,1651,2159,2087,1650,2068,1685,1680],"_links":{"self":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/posts\/42647"}],"collection":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/comments?post=42647"}],"version-history":[{"count":0,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/posts\/42647\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/media\/42645"}],"wp:attachment":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/media?parent=42647"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/categories?post=42647"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/tags?post=42647"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}