If carbon footprinting is the answer, then what is the question?

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There are expectations on institutional investors (asset managers, asset owners, insurance companies) to report on the carbon footprint of their investment portfolios. These expectations have grown following the ratification of the Paris Agreement and the publication of the final recommendations from the FSB Task Force on Climate-Related Financial Disclosures (TCFD). In 2017, a group of European asset owners and their managers met to discuss the use of carbon footprinting as an investment management tool. Those participating included: AP1, AP2, AP3, AP4, the Church Commissioners, the Church of England Pensions Board, EAPF/Brunel Pensions Partnership, MN, PGGM, RPMI RailPen, TPT Retirement Solutions, USS, and West Midlands Pension Fund. Members of this group have, over the years, tracked the evolution of carbon footprinting, and, depending on the organisation, done the following:

• Commissioned carbon footprint studies, although in most cases this has been confined to listed equities;
• Supported the development of carbon footprinting methodologies across a range of asset classes;
• Reviewed the carbon footprint studies prepared by eternal asset managers;
• Used carbon and carbon footprinting data in their investment research and decision-making; and
• Engaged with their stakeholders on carbon footprinting and related issues.

While each organisation had different experiences, we found that our conclusions and perspectives on carbon footprinting were strikingly similar. There was consensus on the value of carbon footprinting as a portfolio management and communications tool, but that its usefulness may be limited because of methodological and data issues.In this short article, we summarise the group’s views on the value of carbon footprinting, we offer practical suggestions to other asset owners, asset managers and other stakeholders on the role that carbon footprinting might play in modern portfolio management, and we highlight some priorities for research and action. A more detailed paper looking across asset classes can be found in the linked paper: “If carbon footprinting is the answer, then what is the question? Asset Owners’ reflections on current practice in carbon reporting” Link to report

Carbon footprinting can provide a range of valuable benefits to investors
These, depending on the details of the carbon footprint, can include:

• Supporting or informing their investment analysis and decision-making, including risk management, engagement/voting and identifying opportunities.
• Delivering on their responsibility commitments (e.g. as set out in investment beliefs and ESG policies).
• Communicating with stakeholders – including beneficiaries, regulators and wider society – about their practices and performance.

Carbon footprinting can also provide other benefits. These include: building knowledge on climate change (both within the organisation and across the investment system); understanding carbon exposure across an investment portfolio; providing a basis for discussions between asset managers and their clients about how climate change-related risks and opportunities are managed in investment portfolios; and encouraging better disclosures across the investment chain and from the underlying companies and other assets.
Methodological challenges and data issues?
However, at this point in time, there are a variety of methodological challenges and data issues that could limit the usefulness of carbon footprinting as a decision-making, engagement or communications tool. Carbon footprinting raises practical issues and concerns. These concerns are being felt most acutely in relation to public reporting given the increasing calls for institutional investors to report on the carbon footprint of their investment portfolios. This pressure has grown following the ratification of the Paris Agreement and the publication of the final recommendations from the FSB Task Force on Climate-related Financial Disclosures (TCFD).
The key issues include:

• Carbon footprints often rely on backward-looking and out of date data.
• Despite the significant improvement in carbon data disclosure in recent years, in particular in relation to Scope 1 and Scope 2 emissions from listed companies (which have been the most studied and tend to have the best disclosures), there continue to be significant gaps and uncertainties in the data. These gaps and uncertainties limit the usefulness of these data for investment research and decision-making.
• Disclosures on Scope 3 emissions remain limited, and life-cycle emissions data are not of sufficient quality to allow full life-cycle assessments to be conducted.
• While carbon footprinting can be used as a trend indicator for a unique or specific portfolio, it is not suitable for comparing different portfolios or even pension funds. This is because, for example, mandates, geographic or sector focus, investment beliefs etc. will vary between funds making comparisons difficult and their results questionable.
• Relatively little work on carbon footprinting methodologies and data has been conducted in many major asset classes, notably sovereign debt, infrastructure assets and hedge funds.* Important methodological questions about the attribution of emissions and the relevance of carbon footprint-type metrics in different asset classes have yet to be resolved. For example, how should emissions be attributed between equity and debt (credit) in the same company? Similarly, with real estate, how should emissions be allocated between owners and tenants, and how should the asset class be benchmarked.

• The idea of a “portfolio carbon footprint” suggests that emissions can be aggregated across an investment portfolio (i.e. across asset classes) and summarised in a single numerical measure of performance. This introduces requirements for these data to be comparable and consistent across asset classes. At the current time, this is not practicable nor is it necessarily a useful or appropriate way to characterise an investment portfolio; given the data and methodological constraints in carbon footprinting, such a number will provide spurious accuracy.

• Carbon footprinting only describes one set of attributes of a portfolio. For example, if investors want to assess portfolio exposures to stranded assets, conduct 2oC stress testing, scenario analysis, or assess the adequacy of corporate actions on climate change, they are likely to require additional and/or different tools and data.

Additional thoughts and possible future steps
Investors’ decisions on how they choose to manage and report on their carbon performance should be driven primarily by their carbon and climate risk management-related aims and objectives. The carbon risk in an asset class tends to be specific to that asset class. Carbon footprinting methodologies and reporting will, therefore, be most beneficial when applied on an asset class
by asset class basis. For some asset classes, carbon footprinting might not be the most effective tool to support the management of any climate risk. Examples of this would include sovereign debt (where both the implications of amount of debt issued and a home investment bias will impact relevance) and real estate (where it is difficult to allocate emissions between tenants and owners of properties). More details of these and other examples are provided in the attached report. As a result, investors should consider, on a case-by-case basis, whether carbon footprinting is the right tool for specific asset classes or for their investment portfolio.
In order to overcome the issues identified above, and to improve the utility of carbon footprinting for asset owners and other investors, the participants identified the following areas for future discussion and collaboration:

• Developing the methodologies to assess carbon footprinting across a range of asset classes.

• Developing methodologies for dealing with unlisted debt in credit portfolios.

• Developing a footprinting methodology for investors with agricultural land holdings.* Improving disclosures from private equity.

• Reaching consensus on whether to report emissions by unit of capital invested or unit of revenue generated by the investment, or both;

• Encouraging widespread adoption of the TCFD recommendations and improving corporate disclosures across markets and asset classes, including on Scope 3 emissions;

• Developing further scenario assessment tools and methodologies to help asset owners comply with requirements of the TCFD.

It is hoped by all involved that the thoughts detailed here and in the linked document: “If carbon footprinting is the answer, then what is the question? Asset Owners’ reflections on current practice in carbon reporting” Link to report stimulate a constructive debate and discussion on the utility of carbon footprinting as a tool across all asset classes, and contribute to its development as a tool for climate risk management and investor communication.