Scientists have been warning us that Earth’s climate is hurtling ever-faster towards dangerous temperature levels, polar ice caps are melting, sea levels are rising and weather patterns are starting to change. Amidst all of these warnings, the world’s economies have been slow to react. However, as evidence has continued to mount, actionable solutions are finally being put into effect. Among them is a call to action for the investment industry to increase its emphasis on sustainable investing.
In the summer of 2015, France passed new legislation called “Law on Energy Transition for Green Growth.” Article 173 of this legislation is a groundbreaking measure that is relevant for all members of the global investment community because it mandates portfolio level reporting on a “comply or explain” basis across three core data models including ESG (Environmental, Social, Governance), CO2 and Green Economy exposure. With France setting the transparency agenda on this subject in the EU, we may now see similar initiatives in other EU countries and elsewhere as the ripple effect of this mandatory reporting spreads.
The new French regulation, while groundbreaking, does not set an exact definition by which to measure ESG, CO2 and Green Economy portfolio exposures. It is up to individual institutions to decide how they will measure these things, which seems likely to lead the investment industry to determine a set of common standards. Is the industry prepared for this paradigm shift in how it analyzes and reports on sustainable investment ?
At FTSE Russell we believe the overall sustainability rating of an investment is driven by three distinct data models as illustrated below.
Source: FTSE Russell
The ever present challenge for the industry is to find accurate, transparent and disciplined ESG, CO2 and Green Revenue data for individual companies and industries. The second hurdle would be to to locate data that is "markets" quality with a detailed time series and transparent point estimates that can be modeled effectively across portfolios.
While there have been several sources of data for both ESG and CO2, there has until recently been no way to track and measure the last piece—Green Revenue generation.
On June 6, 2016, FTSE Russell launched its Green Revenues (LCE) data model and Green Revenues Index Series. The proprietary LCE data model tracks the data of over 13,400 public companies, going back seven years. Each company is assigned a Low Carbon Industrial Indicator (LOWCII) factor of between 0% and 100%, representing the ratio of its Green Revenues to its total revenues. These factors can be broken down and mapped to any one of 60 subsectors within the LCE classification system.
The Low Carbon Economy Industrial Classification System (LCE ICSTM) maps green revenues as generated by a company’s goods, products and services to one or more of the 60 defined subsectors. As illustrated below, for the goods, products and services of the company to be considered “green," they must, through their utility, either adapt, mitigate or remediate, the risks of climate change, resource depletion and environmental erosion.
The LCE Industrial Classification System Components
Source: FTSE Russell
The FTSE Russell Green Revenue Index series has been constructed using both the LOWCII factor and the LCE ICS. The series currently includes ten indexes based on the following: Russell 3000, Russell 1000, Russell 2000, FTSE All-World, FTSE Europe, FTSE Developed, FTSE Emerging, FTSE All-Share (UK), FTSE Asia Pacific and FTSE China All Cap.
As public and political attention focuses increasingly on the problem of environmental degradation and carbon emissions, the investment industry should be prepared for investors and regulators to place a greater emphasis on sustainability exposure reporting. The availability of a large data set that tracks Green Revenue generation should provide investment companies with the tools necessary to respond to these requests.
Please see the FTSE Russell website for further information on the Green Revenues (LCE) data model and Index Series.
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