Responsible Investing

A primer on Transition Pathway Initiative

Our previous issue on Net Zero was where I hinted at investing in the right securities to take advantage of the global transition, to a low carbon economy. We heard about government spending towards the roadmap to Net Zero but I’d like to point out that there isn’t enough juice left for that among the largest economies, and the current war in Ukraine, the cost of living crisis etc., isn;t helping it either. A vast majority of the investment needs to come from private sources, and there is already some progress on that. Can you benefit from that? I think you can, please let me know what you think.

This issue of the Helix has had a significant contribution, from Saranya Asokan, a Qatar based management consultant, and risk professional. Please take a look at her profile by clicking here.

Discussions about climate change, and how to build corporates with conscience, is gaining traction now, more than ever.  There is hope of a future, where finally, the growth of a corporate will not only be geared towards maximizing returns for shareholders but also general public can demand growth of the corporate in line with betterment of the environment and society, and they no longer are mutually exclusive . Insurance giants, Allianz and AXA are proof that focus on revenue growth while exiting fossil fuel industries can go hand in hand. Both Allianz and AXA started a large scale divestment from coal back in 2015, have committed to completely exit coal business by 2040, and even restricts underwriting for coal-related business today which could further benefit the planet and its inhabitants.

To enable comparability between the efforts and commitment shown by companies in the fight against climate change, the Task Force on Climate-Related Financial Disclosures (TCFD) was created in 2015 by the Financial Stability Board. However, companies could resort to finding loopholes in the fine print, in terms of reporting and representation of data/facts and also be guilty of greenwashing. Fashion giants Nike & H&M announcing that their carbon emissions have reduced, and claiming higher scores from Carbon Disclosure Project (CDP), an independent body that awards grades for environment friendly performance, is an example. The true picture is far from this with total emissions reported against total revenues, which means as long as emissions grow at a slower pace as compared to revenues, the emission score can be reported as a decrease. This would be termed as “relative decoupling” by the economist Tim Jackson, author of Prosperity without growth where he points out that while relative decline in carbon intensive resources are easier to quote, it is the “absolute decoupling” that economies should focus on. How is then the environmentally conscious consumer supposed to track the true progress that companies are making in the pursuit of transition to a low-carbon economy? Enter the Transition Pathway Initiative (TPI), a global, open-access, data platform that empowers investors/consumers to track progress made by companies and how they compare with their peers. TPI, launched in 2017 in partnership between Church of England and Environment Agency Pension Fund, is backed by the research carried out by Grantham Research Institute on Climate Change and the Environment at LSE, and data provided by FTSE Russell, supported by asset owners. The objective of TPI is to identify the quality of companies’ processes for managing Greenhouse gas (GHG) emissions, the extent of alignment of companies’ disclosures with TCFD and the company’s future carbon performance compared to Paris Agreements, for around 400 publicly listed companies across 16 industries. There are similar initiatives elsewhere which we will cover in future issues. While the number of companies seems small in comparison to the investable universe, I think it is better to focus on those corporations that are genuinely making progress towards a low carbon economy. What do you think?

The TPI tool splits companies into small, medium and large by market cap, which is then broken down into various sectors, monitored for Management Quality and Carbon Performance. It assigns Level 0-4 for management quality, where 0 represents companies with no awareness on transition to low-carbon emissions, 1 represents some awareness, 2 represents companies building capacity, 3 represents companies in the process of integrating into operational decision making and 4 representing companies that make strategic assessments. The tool analyzes carbon performance based on the Paris agreement benchmarks of 1.5-2 degrees.

As of February 2022, 120 investors globally have pledged support for TPI, representing over $40 trillion, combined in AUM and advice. The biggest advantage of using TPI benchmarks for asset managers lies in the consistency of data, scenario assumptions over time, with same benchmarks and metrics which makes tracking of progress made by companies comparable. TPI findings as of November 2021 report that only 10% of the 140 global energy companies are aligned with a path to 1.5 degree while 57% failed to align with any of TPI’s temperature benchmarks. Interestingly, just the ten largest Institutional Investors put together hold more than $40 trillion of AUM as of Dec, 2021. Now imagine if these investors were to place climate data at the heart of decision making, the demand for accountability, can act as a catalyst for companies to adopt robust carbon management systems along with a need for consistent disclosures. Using climate data to make investment decisions will not only enable asset managers to better navigate transition, and reputational risk, manage reallocation of resources, identify long-term investment opportunities and align with societal demand for green investment opportunities but also empower them to demand concrete measures by companies. In line with this, organizations across the globe are already moving towards ethical and sustainable investments by appointing Chief Responsible Investment Officer (CRIO) or Head of Sustainable Investing, to support long term ESG goals and TPI data can help identify and compare the ambitions and preparedness of companies with regards to E.

An example of TPI-driven decision making is the Brunel Pension Partnership, one of the Local Government Pension Schemes (LGPS) pools in the UK, raising £30 billion in investments. Brunel uses TPI data as a benchmark to monitor the behavior of asset manager and companies and further uses this to persuade companies with low TPI ranking to advance a level up each year and similarly influences asset managers to build climate awareness into portfolio construction. Brunel uses TPI data to monitor companies that have lower ranking by TPI in terms of reporting of Scope 1 (direct emissions of the company and controlled resources), Scope 2 (emissions due to purchased electricity, water, heating, cooling) and Scope 3 (related to companies upstream and downstream activities, in other words, entire company operations) and remove companies from their portfolio that do not make the mark. There are many other examples of other asset managers using TPI data to exclude/monitor/include companies from/in their portfolio.

TPI data has also made way for the FTSE TPI Climate Transition Index  series, a first of its kind, 6 part climate indexes, that can embed forward looking carbon performance data to reward companies with targets aligned with Paris Agreement and underweight or exclude companies that don’t. This can be compared to the MSCI Global Low Carbon Index which includes large and midcap stocks from 23 Developed Markets and 24 Emerging Markets across 11 industries. The MSCI CarbonMetrics evaluates around 10,000 companies across industries for Scope 1 and Scope 2 emissions and where this data is not available, carbon emissions are estimated using MSCI ESG research’s proprietary carbon estimation model.

Going forward as more data becomes available, a key area for TPI to focus on might be to go past the declaration made by management regarding their ambition and look at the actual facts and figures to measure the gap between ambition and a credible transition plan. Perhaps even develop forward-looking metrics to predict the impact of corporates and industries on the climate and to enable asset managers foresee resulting loss on portfolios from stranded assets. For further information on TPI, kindly refer to this FAQ link.

A key area to think, as businesses progress through the transition, is how this will affect jobs. There are millions of jobs in high carbon industries that put food on the table, and people have crafted their careers on that. How will this transition make sure that there are enough and more green jobs, and there are transition programmes to retrain people into these jobs. Are you aware of any?