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The world’s first climate rating for equity funds will help catalyse a shift towards greener investment

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There is growing momentum in the financial sector towards disclosing and reporting risk related to climate change.

Last week, the Task Force on Climate-related Disclosures –  a G20 initiative led by Bank of England governor Mark Carney and Michael Bloomberg – outlined how companies should disclose climate-related information in their financial filings, with the aim of allowing economies to properly value climate-related risks.

The central idea is that by getting companies to be transparent about their levels of climate risk, the true vulnerability of assets and investments becomes visible. This will help shift financial flows to ensure there is a pipeline of bankable green assets.

Standardising reporting data

But one of the major challenges in getting disclosure to a critical mass that will catalyse a shift is in standardising reporting data. Currently, the wide variety of disclosure frameworks and underlying data quality make it difficult to develop robust and reliable services for investors. Standardised reporting, with robust and scalable services are needed to compare funds and signal where the greenest assets are.

Climetrics, the world’s first climate rating for equity funds, which launched today, represents a breakthrough in dealing with this issue. It is one of the first initiatives to transform climate risk reporting into an offering that actually enables investors to take action.

Comparing the climate impact of investments

The Climetrics rating, scored by green leaf symbols on scale of one to five, enables investors to gauge and compare the climate impact of investments in funds and encourages growth in climate-responsible fund products. Importantly, this rating also can be used by retail (individual) investors, when considering the impact of their own investments.

Led by a consortium of CDP and ISS-Ethix Climate Solutions, and catalysed and funded by Climate-KIC, Climetrics targets the equity fund market, a market worth more than €3 trillion in Europe[1] — a significant lever for changing investment patterns towards green assets.

Further challenges around disclosure

Of course, this is just one of the challenges that lie ahead. The Task Force on Climate-related Disclosures recommends that companies disclose all of their direct and indirect greenhouse gas emissions, and describe the risks and opportunities caused by climate change under a range of potential scenarios.

That means reporting not just company targets and underpinning metrics, but also strategy, risk management and governance approaches.

This raises many questions: how do we shift relative comparisons of company performance to a 2°C benchmark? How do we factor in “Scope Three” emissions (those emissions produced throughout the production process) to understand the full extent of emissions occurring throughout the value chain? How do we factor in physical risk to understand how to adapt to climate impacts?

Science-based targets

Right now, there’s a lot of emphasis on ambition levels, ranking and comparisons between best or worst performing sectors or companies. But to make a real difference, we need to shift from relative comparisons of current performance to a forward-looking, holistic assessment in line with a 2°C world.

Without the adoption of validated science-based targets to benchmark performance against, it’s difficult to know if companies are really meeting the climate challenge, or how best to track them. Essentially, one plane might be flying faster than the other but it’s pointless if they’re both missing the destination.

Scope three emissions

Setting and monitoring such targets is not easy, particularly given the blurred boundaries between companies and sectors. Including “Scope Three” emissions, is critical to understanding the true picture. According to the GHG Protocol Corporate Standard[2], they can represent a company’s biggest greenhouse gas impacts. When testing with Kraft Foods, for instance, the GHG PCS found that value chain emissions accounted for more than 90 per cent of the company’s total emissions[3].

Physical risk

Another major challenge is the need for better disclosure of physical risk. Water availability, poor harvests and extreme weather can damage premises, operations, supply chain, distribution or affect employee safety – all crucial to a company’s financial performance.

Physical risk is rarely included in reporting, and when it is, it tends to be in varying ways and quality. It could be incorporated into scenarios, based on probabilities and magnitude. But the challenge is how to break down the risks and evaluate the likelihood of these occurring in a way that is both robust and accessible.

Climate-KIC work

Climate-KIC, together with its partners, is exploring how to address these challenges.

Climate Risk Information, one of Climate-KIC’s flagship programmes, is working to support companies, cities and regions in understanding and managing catastrophe and climate-related risk. A range of hazard, exposure and vulnerability data is fed into its open source loss modelling software to calculate the potential financial cost of extreme-weather events and damage from fires or floods. This sort of information on physical risk is vital to adapting to climate change.

At the same time, Climate Risk for Asset Managers (CRAMs), another Climate-KIC initiative, is developing a global assessment on the economic impacts of climate change on corporate activities. CRAMS takes a forward-looking view, incorporates physical risks and translates the results into a value at risk that can be understood by mainstream investors. These are just two of a number of such projects that Climate-KIC is working on.

Climate-related financial disclosure may be on its way to becoming mainstream, but we are still at the beginning of this journey. There real challenges lie ahead with physical risk, scope three emissions, absolute targets and standardisation. When we start to address these, we can start to shift financial flows to ensure there is a pipeline of bankable green assets.


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by Malte Schneider

Director of Decision Metrics and Finance, Climate-KIC

 


You can read more about the launch of Climetrics here.

References:

[1] UCITS funds across all asset classes as per end of Q1 2017)

[2] www.ghgprotocol.org/calculation-tools/faq

[3] http://www.ghgprotocol.org/files/ghgp/public/FAQ.pdf

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