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How much stock can we put into portfolio emission goals?

A new report by Universal Owner Initiatives suggests fatal flaws in the use of portfolio emissions measurement as a means to real net zero.

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U.N. Secretary-General António Guterres: "International financial institutions must overhaul their business approaches to combat climate change.” Image via Shutterstock/NicoElNino

I’ve written a lot about ESG in this newsletter — what it is and what it’s not, what it’s meant to achieve and what lies outside its scope.

Financial products tied to ESG concerns move trillions of dollars through global capital markets, although it’s unclear as to what that achieves in the real economy. In the United States, one side of a confusing cultural tug-of-war claims ESG is the slippery slope to socialism in financial form. A former BlackRock chief sustainable investment officer’s calls to debate the merits of the firm’s hottest product with CEO Larry Fink go unanswered, while, according to Sphere, a majority of 401(k) participants still think ESG stands for Economic Stock Growth. 

It’s all genuinely interesting stuff. But sustainable finance and investing has been pigeonholed into one single initialism whose 15 minutes are bound to wane. 

What isn’t waning is the $176 trillion "funding gap" of transition finance that my colleague Joel Makower covered following his fall European visit to major asset managers and banks. And, at its core, isn’t this funding gap really the substance of sustainable finance’s mission? 

GreenFin Weekly readership has grown more than twofold this past year, so I want to set the scene for the year ahead. I’ll be looking more closely at transition finance: how financial institutions are addressing the gap we need filled to get us to real net zero, with speed and measurable progress. 

As COP27 in Egypt approaches, I wanted to offer a pulse check about where the largest global asset managers are in their progress to net zero, brought to you via a new report from finance think tank Universal Owner Initiatives. 

Paltry results of measuring portfolio emissions

The report, "Failure by Design," focuses on the Net Zero Asset Managers Initiative (NZAM), one fifth of the five-part Glasgow Financial Alliance for Net Zero (GFANZ) family of sector-specific coalitions, including asset managers, asset owners, insurers, banks and financial service providers. 

NZAM’s 273 signatories, representing $61.3 trillion in assets under management (AUM), are meant to convene in support of a net zero by 2050 ambition, in line with global efforts to limit warming to 1.5 degrees Celsius. 

In May, NZAM released its new portfolio emissions targets, conceding that "a portfolio emissions reduction approach … can encourage investors to sell high-carbon assets rather than engaging to drive real-world impact" and that "the initiative encourages the use of a combination of targets and actions to ensure real-world impact." 

Universal Owner’s analysis points out fatal flaws in the use of portfolio emissions measurement as a means to real net zero, primarily: the method doesn’t account for the fact that emissions are often unevenly distributed in portfolios; and the overwhelming use of intensity-based portfolio targets. 

Simply put, the first flaw allows implicit misrepresentation. Just as less than 100 or so companies are responsible for most historical emissions, similarly 10 percent of the largest NZAM members’ holdings are responsible for 85 percent of total portfolio emissions. 

As the report identifies, if this group of firms decided to include less than 90 percent of their AUM in the target — which they could do, as NZAM allows asset managers to choose what percentage of their AUM to apply targets to, with a minimum of 0.5 percent — then their target could technically exclude 85 percent of portfolio emissions. 

And what do transition targets offer?

Maybe not much. This is in large part why the Universal Owner report concludes NZAM is "weighed down by such a multitude of problems that it is currently unfit for purpose."

NZAM members are notably moving from portfolio emissions targets toward company transition targets. That is, targets that measure investors’ net-zero alignment via a portfolio company’s own net-zero commitment and strategy. That’s different from measuring a portfolio’s carbon footprint as the sum of a proportional amount of each portfolio company’s emissions. This shift, in theory, sounds like a substantive solution to some key challenges with portfolio emission measurement.

The key issue is, again, how exactly this measurement can be applied. The report uses the example that, on average, NZAM members chose to apply transition plan targets to 63 percent of their AUM. While that may mean that many trillions of dollars in portfolio holdings are covered, 63 percent of the equity portfolios Universal Owner analyzed were responsible for only 2 percent of total portfolio emissions. As far as the climate is concerned, that’s clearly unhelpful. 

To be clear, this analysis isn’t meant to antagonize the asset management industry. Universal Owner works closely with asset managers itself. 

As is the case with all GFANZ ambitions, signatories to the sector-specific groups have been consistently clear that the commitments made are contingent on government action to introduce policies consistent with the 1.5 C goal.

Which is why every subsequent COP is so important, and equally why the overwhelming presence of lobbyists and fossil fuel industry representatives is so disconcerting at a "brought to you by Coca-Cola" COP. 

As U.N. Secretary-General António Guterres has said, "while pursuing their own ‘drop-in-the-bucket initiatives,’ international financial institutions must overhaul their business approaches to combat climate change." 

Here’s hoping the trillions stop trickling and that the bucket begins to runneth over.

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