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We need new ways to measure finance’s contribution to Net Zero

To shift the cost of capital for big emitters, investors and regulators need to look at primary market lending activity, say Ben Caldecott and Christian Wilson. And there’s a new metric that could help

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Financial institutions with more than $70tn in assets have pledged to achieve Net Zero portfolios and loan books by 2050, including meeting ambitious interim 2030 targets. These targets are an opportunity to mobilise capital for the Net Zero carbon transition. However, many metrics and methodologies used to track alignment with climate goals only focus on portfolio holdings, for example, the percentage of companies held with Net Zero targets or defined as green under a given taxonomy. Simpler metrics such as portfolio carbon-intensity are also used.  

These metrics can provide important insights, particularly for measuring and managing climate-related transition risk. But they are poor at measuring the actual contribution of a financial institution to the transition to Net Zero. Simply holding a green company in a portfolio doesn’t necessarily make the real economy greener. 

In bond markets in particular, a change in demand within primary markets can alter the cost of capital obtained by firms, providing a greater opportunity for investors to deliver real-economy impact

Part of the solution is climate conscious financial institutions becoming much better at tracking transactions in primary markets. This is where capital actually flows from the financial system to the real economy, via the issuance of new shares or bonds. Have financial institutions contributed to these capital flows and if so, to what extent, and is this compatible with their Net Zero targets?

Focusing on primary market transactions brings into stark contrast the difference between the equity  and bond markets, with the former the main focus of sustainable investing. For example, while the US corporate bond market is 80% smaller than the US equity market in terms of outstanding value, primary market issuance is seven times larger. Therefore, in bond markets in particular, a change in demand within primary markets can alter the cost of capital obtained by firms, providing a greater opportunity for investors to deliver real-economy impact.

To track primary market transactions that are channeling capital into fossil fuels, we define a simple new metric: Primary Market Carbon Exposure (PMCE). This measures the proportion of securities bought in primary market transactions - for example, shares at IPO or new bond issuance - from fossil fuel companies. We initially define fossil fuel companies as those in oil & gas production, coal mining and fossil fuel power generation.

The development of climate-related financial disclosure regimes in a number of jurisdictions presents an opportunity to integrate primary market metrics. This would enable asset owners to compare funds

To test this version of PMCE in bond markets, we calculate the metric for 35 of the largest US corporate bond Exchange Traded Funds (ETFs), representing nearly half the market in terms of assets under management. We find that from 2015 to 2020, 14% of the value of new bond issues bought by these funds was channeled into fossil fuel companies. The largest bond ETF, the iShares Core U.S. Aggregate Bond ETF with $88bn in assets, also had a PMCE of 14% in corporate bonds, while the iShares iBoxx USD High Yield ETF, with $22bn in assets, had a PMCE of 20%. We also apply this metric to ETFs bought by the US Federal Reserve in 2020, resulting in a PMCE of 13%. As central banks explore integrating climate change into their operations, in line with the recent G7 communique, they should also consider the impact of these ETF purchases. 

To replicate index performance, passive funds such as ETFs may need to hold carbon-intensive assets. However, ETFs have flexibility regarding which bonds are bought in primary markets and selected to replicate an index. 

The development of climate-related financial disclosure regimes in a number of jurisdictions presents an opportunity to integrate primary market metrics. This would enable asset owners to compare funds and for asset managers to compete on the greenness of portfolio flows, even when tracking the same index. Given the sharp growth in passive assets under management, this could help prevent passive funds becoming the financiers of last resort for carbon-intensive companies. 

Firms are increasingly concerned that the growth of sustainable investing could restrict their access to capital, making it harder for them to transition. Greater integration of climate considerations in primary markets, by active and passive investors, could add to these concerns. Firms must therefore develop and implement robust transition plans in line with the Paris Agreement, clearly demonstrating to investors that if they provide capital, it will not contribute to carbon lock-in and stranded assets. 



Dr Ben Caldecott is the Director of the Oxford Sustainable Finance Programme and the Lombard Odier Associate Professor of Sustainable Finance at the University of Oxford. He is also Director of the UK Centre for Greening Finance and Investment 


Christian Wilson is a Researcher for the Oxford Sustainable Finance Programme at the University of Oxford  

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