Climate-aligned  investing: what, why and how

Sophie Lawrence, Senior Ethical, Sustainable and Impact Researcher at Rathbone Greenbank Investments, tells us how investors can better achieve climate-aligned investing. 

“Carbon emissions have to decline by 45% from 2010 levels over the next decade in order to reach net zero by 2050. This requires a massive reallocation of capital. If some companies and industries fail to adjust to this new world, they will fail to exist… climate change is a global problem, which requires global solutions, in which the whole financial sector has a crucial role to play.”

Open letter from the Governor of Bank of England Mark Carney, Governor of Banque de France François Villeroy de Galhau and Chair of the Network for Greening the Financial Services, Frank Elderson

Climate change is an existential threat to humanity, the global economy and our planet’s entire environmental system. At the United Nations Framework Convention on Climate Change’s (UNFCCC) Paris Climate Change Conference in December 2015 (COP 21), 195 countries adopted a global, legally binding agreement on climate change. 

The Paris Agreement commits signatories to a number of goals, including holding the increase in the global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit this to 1.5°C. The Intergovernmental Panel on Climate Change (IPCC) is the UN body dedicated to providing the world with an objective, scientific view of climate change. Its 2018 report highlighted the need to remain below 1.5°C of warming in order to avoid significant environmental and economic costs. Yet current global policies and company targets are projected to result in over 3°C of warming. This year’s ‘State of Transition’ report, which is published annually by the Transition Pathway Initiative (TPI), found that, of a total 238 of the highest-emitting listed companies assessed, more than 80% remain off track for a 2°C world. The ambition gap needs to close, and fast. 

Achieving the Paris goals requires both the public and private sector to take action to limit greenhouse gases. The necessary transition to a low-carbon economy will create disruption across a range of industries. There will be winners and losers. The physical risks of climate change, such as sea level rise and extreme weather, will also result in widespread economic impacts. These risks are not homogenous and will materialise at different times and at different levels of severity. However, it is clear that delaying action will only increase the likelihood of severe economic shocks and irreversible environmental damage. Despite a series of stark warnings, the market has not yet fully integrated the risks and opportunities associated with a changing climate. In fact, the 2020 ‘Banking on Climate Change’ report, which assesses the fossil fuel financing activities of banks, found that 35 private sector banks have not only been sustaining but expanding their financing of the fossil fuel sector by more than $2.7 trillion in the four years since the Paris Agreement.

In order to limit warming to 1.5°C, global carbon emissions will need to fall dramatically by 2030 and achieve net zero by 2050. Investors have an important role in directing capital in a way that can support these outcomes. Aligning a portfolio to both support and benefit from this transition may also help to insulate it from medium and long-term risks and position it to capitalise on long-term opportunities. 

There are a number of steps investors can take to align their portfolios to this pathway: 

• Reduce exposure to industries whose activities are misaligned to a low-carbon pathway – for example companies involved in coal or oil extraction or those operating coal-fired power plants. Exposure to other high-carbon industries should also be considered, such as non-electric automobiles, airlines, etc. Reducing exposure may involve full, partial or targeted divestment and decisions should give consideration to an organisation’s current climate impacts and whether it has a credible transition strategy.

• Increase exposure to industries and companies that are either directly or indirectly contributing to climate change mitigation and adaptation. Direct contributors include renewable energy and energy efficiency. Indirect contributors include companies that are reducing their greenhouse gas emissions year on year or providing technology, products and services that facilitate the low-carbon transition. 

• Assess the exposure of investment portfolios and holdings to climate risk. This can be done through collecting data on the greenhouse gas emissions of underlying holdings to produce a carbon footprint or by measuring their exposure to carbon-related assets. 

• Engage with companies and policy-makers to encourage actions consistent with a low-carbon transition (see case study box). This engagement can range from informal dialogue through to more formal measures such as meetings with company boards and voting on AGM resolutions.

In summary, investors can act by decarbonising their investment portfolios and increasing their investment in climate solutions. And, with time running out to achieve meaningful action, collaboration and co-ordination among global investors is key. 

Case study The Paris Aligned Investment Initiative This initiative is led by the Institutional Investors Group on Climate Change (IIGCC), a forum for collaboration among European investors, including Rathbone Greenbank Investments. The aim is to develop a commonly accepted definition of Paris alignment for investors and establish consensus on the potential methodologies and approaches that investors can use to track alignment and the transition of a portfolio over time. The draft framework is expected to launch in June 2020.

If you want to find out more about our work at Greenbank, please visit our website or you can get in touch with Sophie directly.

The Luminous view

The impacts of climate change constitute a risk for asset owners and asset managers, and the financial community at large. Climate risks are long-term risks which short-sighted markets fail to price because there are no incentives to fix them for current financial actors driven by short-term indicators. The role of investors in solving the challenge cannot be underestimated. They have a key role to play in providing capital to companies that are focused on creating long-term value for all stakeholders. They also must act as good active stewards of those companies.