Page 2 - If carbon footprinting is the answer, then what is the question?
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- Carbon footprints often rely on backward-looking and out of date data.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