By: Charles Fruitiere, sustainable investment analyst
There is a growing awareness among institutional investors globally that climate change and the policy and regulatory responses to it represent potential major sources of investment risk and investment opportunity. A transformation of the global economy is required to achieve the ambitions of the Paris Climate Agreement, with governments committing to keep global average temperature rise above pre-industrial levels to below 2 °C and, even further, to pursue efforts to limit the temperature increase to 1.5 °C. National governments have responded, adopting a range of measures to reduce greenhouse gas emissions, to improve energy efficiency and encourage the uptake of low carbon and energy efficient technologies. There is also a growing focus on ensuring that the power of capital markets can be enabled to support the industrial transition that is required, with a focus on addressing market failures and barriers to green investment and finance flows.
Climate change has been a long-standing area of focus for FTSE Russell and our clients since the launch of the Climate Criteria for FTSE4Good in 2007, which was unveiled at an event with the then UK Energy and Climate Change Minister David Miliband. Since then there have been ongoing enhancements and a wide range of new data, tools and indexes that we have developed over the last 11 years to help our clients integrate climate into investments and engagement.
As part of our ESG Ratings service we provide data on over 4,000 companies’ climate governance, management systems, processes, targets, strategies, greenhouse gas emissions and performance. This broad data set supports and underpins the Transition Pathway Initiative, an asset owner-led initiative that assesses how well large, energy intensive companies are preparing themselves for the transition to a low carbon economy. We also measure green revenue exposure. Using our Green Revenues data model covering 13,500 listed companies, we are able to measure the proportion of a company's total revenues in any single fiscal year that is generated from 50 clearly defined green subsectors.
FTSE Russell has played a leading role in policy debates on climate change. We were represented on the European Commission’s High Level Expert Group on Sustainable Finance, by David Harris, head of sustainable investment. This group produced detailed and wide ranging strategic recommendations for the European Commission on how to “hardwire” sustainability into European Capital markets and support long-term growth. We also contributed to the UK Green Finance Taskforce (GFT) participating in two work streams; capital markets and institutional investment to develop a series of targeted recommendations to the UK government to drive the integration of green finance into financial systems, and to maintain this as an area of global leaders
One of the key recommendations from both of these initiatives was that companies and investors should implement guidelines issued by the Taskforce on Climate-Related Financial Disclosures (TCFD). The Taskforce was established by the Financial Stability Board to develop voluntary, consistent climate-related financial disclosures that would be useful to investors, lenders, and insurance underwriters in understanding material risks. The TCFD’s framework is now backed by institutional investors with more than US$25 trillion assets under management.
Following the release of the TCFD recommendations in 2017, we conducted a full review of our climate-related indicators to ensure our methodologies and criteria are aligned with these recommendations. As a result, we made three major changes to our ESG Ratings model:
1. Updated categorization sector model
We updated our categorization of sectors to reflect carbon intensity. We categorize companies into “Low,” “Medium” or “High Exposure” depending on how material climate is to their industrial sector. This categorization then determines the indicators applied, the methodology and the weighting. We fine-tuned and updated the categorizations by re-assessing the carbon intensity of each industrial sector using the latest information.
2. New granular indicators
We added several new indicators to align our indicators with the TCFD’s recommendations. These included whether the company has conducted climate scenario analysis and described the business impacts of one or more climate scenarios, and whether the company has explained how climate-related risks and opportunities are incorporated into strategy—for example mitigation, new products, or research and development—and how capital is allocated i.e. through OPEX, CAPEX, M&A, or debt. We are also now collecting data on companies’ performance on Scope 3 emissions, which covers supply chain and product emissions, but expect that it will be sometime before this corporate reported data will be of sufficient quality for investor usage.
3. New sector-specific indicators
Finally, we have added sector-specific emissions and performance indicators for companies in the oil and gas, electric utility, cement, real estate, metals and mining, chemicals, steel, food producers, paper and forest products, agricultural products, beverages, agriculture and asset owner/asset manager sectors. For example, in the oil and gas sector, we added indicators on oil and gas production by hydrocarbon (oil, gas, oil sands), reserve replacement ratios (RRR), production cost by hydrocarbon (oil, gas, oil sands), flaring emissions (CO2e) and methane emissions (CH4).
These enhancements to our ESG Ratings model will enable investors to more accurately assess the climate change-related risks and opportunities in their investment portfolios, thereby enabling them to make better informed investment decisions. These enhancements will also provide investors with deeper insights into companies’ practices, processes and performance on climate change, thereby enhancing the quality of the dialogue between investors and companies.
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