Stock photograph of a young Asian woman conducting a seminar / lecture with the aid of a large screen. The screen is displaying data & designs concerning low carbon electricity production with solar panels & wind turbines. These are juxtaposed with an image of conventional fossil fuel oil production.

This article is sponsored by MSCI.

Author: Thomas Verbraken, executive director, MSCI Research

Owners and managers of trillions of dollars in investments have pledged to align their portfolios with the goal of preventing the worst effects of a warming planet. Reducing financed emissions by nearly half this decade – and to net zero in the two that follow – is key to achieving this.

But while investors are increasingly committing to climate action, the carbon footprint of their portfolios can vary significantly across asset classes, our research shows.

Corporate bonds had the highest total financed emissions in a set of hypothetical $1 million portfolios invested in equities and various segments of the sovereign, corporate and municipal bond markets. High-yield bonds, meanwhile, were more emissions-intensive than their investment-grade counterparts, according to an analysis in which we used MSCI’s Total Portfolio Footprinting solution to examine data, as of 15 June 2022.

Within the corporate bond market, our analysis found variations in emissions intensity between high-yield and investment-grade USD bonds. The variations reflect a combination of large allocations to the more emissions-intensive energy sector for high-yield bonds, and the higher emissions intensity for the utilities, energy and financial services sectors in the high-yield portfolio.

Comparing high-yield to investment-grade USD bonds by sector

Emissions intensities of municipal bonds varied widely by project type. Power utilities contributed the highest Scope 1 emissions; economic and industrial development and government-related buildings registered the highest Scope 3 emissions; while energy-consuming facilities, such as schools and universities, represented the top Scope 2 contributors.

Clarity about data quality

Measuring the financed emissions of institutional investment portfolios is key to establishing a baseline that can be used to help manage the net-zero journey. To implement their climate commitments, pension funds, asset managers, banks, insurers and other financial institutions need to be able to quantify the greenhouse gas emissions of their investments. They must then set targets and report on progress.

Translating investor commitments into concrete action demands data that shows the carbon emissions of the companies they are lending to or investing in. Members of the UN-convened Net-Zero Asset Owner Alliance, for example, agree to publish both near-term and net-zero climate targets within 12 months of joining the alliance.

Both the quality and granularity of data for measuring financed emissions make a difference. To aid measurement of financed emissions, the Partnership for Carbon Accounting Financials (PCAF), was established as an industry-led initiative to provide a framework for greenhouse gas accounting. PCAF directs investors to use the highest-quality data available for each asset class.

The direction reflects the recognition that high-quality data can be difficult to come by. The largest share of issuers’ greenhouse gas emissions occur in their value chain, or Scope 3. But less than one-quarter of the world’s listed companies disclosed their Scope 3 emissions, as of February 2022, data from MSCI shows. According to a report published early this year, the components of emissions data reported over a decade to the environmental group CDP did not add up to the total reported footprint for 30 percent of companies.

GHG-disclosure rates for MSCI ACWI IMI constituents

The challenge of sourcing quality data can be compounded when measuring the emissions of some asset classes. To enable financial institutions to estimate annual emissions amid either a paucity of such data or inconsistencies in reporting by issuers, PCAF scores emissions data based on quality. The scale ranges from 1 for the highest-quality data to 5 for the lowest.

A score of 1 or 2 encompasses reported emissions that can either be verified or derived from the primary physical activity of an issuer’s energy consumption. A score of 5, in contrast, denotes projected emissions from an investment according to economic activity-based factors, such as the ratio of greenhouse gas emissions to revenue earned for similar projects. Scores of 3 and 4 range from physical-activity to economic-activity-based emissions; that is, they fall between Scopes 2 and 5.

Quality score 2 dominated the data quality for equities and sovereign and corporate bonds in our analysis. That means emissions are based on either reported emissions or data on the primary physical activity of the issuer’s energy consumption.

Data quality of the underlying financed-emission data

As the chart above suggests, for lower data-quality scores, we estimate missing emissions data based on the issuer’s production or revenue data or, if that is also unavailable, based on sector averages for emissions intensity. The financed emissions for municipal bonds, for example, fall within quality score 5 because they are estimated entirely via models.

Climate change affects every asset. The emphasis on data quality is designed to help investors gauge the alignment of their portfolios with a low-carbon transition and to allocate capital accordingly. Greater transparency into emissions intensities across asset classes and sectors may help investors identify opportunities for guiding the decarbonisation of their investments and, ultimately, the global economy.