Climate change was at the center of Qontigo’s Investment Intelligence Summit last month, as climate-related data permeates the world’s largest funds and becomes a mandatory disclosure requirement for investee companies.
In the week of the fifth anniversary of the Paris Agreement, presenters at the Summit showcased how efforts to meet global warming goals have translated into adapted mandates, strategy changes and new legislation that are shaping the allocation of capital worldwide and bringing about financial risks.
“Climate risk is indeed a source of structural change in the economy and the financial system; its impact will be far-reaching in breadth and magnitude,” said Bertille Delaveau, Head of the Sustainable Finance Division at the Banque de France, who presented on the work from the Network of Central Banks and Supervisors for Greening the Financial System (NGFS).
“Central banks and supervisors not only in Europe but worldwide have identified and recognized that taking action against climate-related financial risks is part of their mandate,” Delaveau added during her presentation at the Qontigo Summit. The NGFS, which turned three years old in December, last year published a guide on climate scenario analysis that is geared to policymakers and supervisors but is also useful for financial firms.
2020 was an important year in terms of climate-related legislation and investment initiatives. In July, the European Commission put forward the new Climate Benchmarks framework.1 Thirty of the world’s largest investors in October agreed to drastically reduce their portfolio’s emissions and match a 1.5°C temperature increase pathway. New Zealand and the UK became the first countries to impose mandatory climate-related financial reporting.
Large investors embrace Paris-aligned pathway
The EU Climate Benchmarks legislation, in particular, is already affecting investment flows and its leverage may grow as more asset owners adopt environmental principles. Nicolas Fragneau, Head of ETF Product Specialists at Amundi, explained during the Summit how his company embraced the new regulation by launching the first-ever fund carrying a EU benchmark-aligned label.
The fund was created with a mandate from 12 leading investment firms and tracks the EURO iSTOXX® Ambition Climat PAB Index, part of the STOXX Paris-Aligned Benchmark Indices (PAB) family.
“The issue of climate change is something that needs to be done at all levels, from daily habits all the way to the largest institutional investors who need to change the way they invest,” said Fragneau. “The trend with (climate) indexes was set by the Paris Agreement. There is a need to align investment flows and investment opportunities and investment vehicles with those goals.”
The new Climate Benchmarks are part of a new and innovative group that, unlike the first generation of indices that only took carbon emissions into account, consider more comprehensive climate issues at the heart of the construction process, Fragneau explained.
“It is about, of course, carbon; but they take into account the transition risk, and the actions that companies are putting together in order to face that climate transition and to tackle the objective of maintaining the temperature rise below 2°C,” he said.
The new risk category
Sarah Peasey, Head of Responsible Investment Strategy at Legal & General Investment Management (LGIM), echoed the Banque de France’s Delaveau in underscoring how urgent an issue climate risk is for investors.
“This is very much a problem for today, not a problem we can deal with in a decade’s time,” Peasey said. To illustrate the scope of the challenge, she reminded the audience that as of today, there is about USD 11 trillion invested in the listed energy sector.
Peasey walked the audience through a proprietary ‘Destination’ portfolio risk calculation model. She showed how investors can estimate at present day their companies’ climate transition costs and physical costs, and hence the change in their earnings and valuations, from various climate scenarios.
Maria Lombardo, Invesco’s Head of ESG Client Strategies for EMEA, recounted the experience of her company since subscribing to recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) in 2019. The first step in that journey was the publication last July of Invesco’s inaugural report based on TCFD considerations, which details the company’s approach to assessing and managing climate risks and opportunities across the investment process, assets and business operations.
Cost of transitioning
Olivier D’Assier from Qontigo’s Applied Research team presented a new study2 that looks at the effect of transitioning a portfolio to a carbon-neutral pathway. His study compared the active risk from style factor and sector exposure of the STOXX® USA 900 Paris-Aligned Benchmark (PAB) Index against a market-capitalization-weighted portfolio. One conclusion from the analysis is that in a majority of market-stress episodes since 2001, the PAB and benchmark portfolios didn’t show a meaningful difference in performance.
Rounding up the debate on climate transition presented throughout the Summit, D’Assier’s analysis also included an estimate of trading and turnover costs of moving a portfolio to a climate-aware strategy. The results show that the longer the transition is delayed, the more expensive it gets and the higher the market impact.
“Investors considering a move to a climate-aligned benchmark should do it slowly but do it early,” D’Assier said. “You are going to have to make that transition whether it’s out of client demand or regulatory demand in the next five years. So, what we are going to see is a race for that.”
The Qontigo Investment Intelligence Summit provided a great stage to hear about the multiple effects of climate change on investing and on ways to incorporate a changing environment into portfolios. At Qontigo, we were particularly pleased to host experts on this subject and heed our tag line – ‘Optimizing impact.’ Visit us in coming days as we keep reporting on the event’s highlights.
To access the recordings of the event, please click here.
1 On Jul. 17, the European Commission adopted new rules setting out minimum technical requirements for the methodology of EU climate benchmarks. The delegated acts are currently subject to a scrutiny period by the European Parliament and the Council.
2 D’Assier, O., Au-Yeung, J, ‘Climate Impact Investing Is Coming on Fast…,’ Qontigo, December 2020.