23 Mar 2021
23 Mar 2021
For Marketing Purposes - FOR QUALIFIED INVESTORS ONLY– This document is reserved and must be given in Switzerland exclusively to Qualified Investors as defined by the Swiss Collective Investment Scheme Act of 23 June 2006 (as amended from time to time, CISA).
More investors than ever want their financial choices to have meaning – to grow their wealth, but also contribute to some of humanity’s biggest challenges. Led by emerging science on climate change, they have been leading a boom in climate-action investments.
Lyxor was delighted to recently discuss how investors can help fight climate change in an audio documentary with Citywire. Alongside experts from the Climate Bonds Initiative and S&P Dow Jones Indices, we discussed the urgency of global warming, improvements to carbon disclosure, and the global initiatives that can help investors make informed climate decisions.
Below are a few edited highlights from the audio documentary, which you can listen to in full here.
Manuel Adamini, former Head of Investor Engagement at the Climate Bonds Initiative, started by explaining the emergency of global warming and the important role that investors have to play.
Citywire: Manuel, we hear that Earth risks heating up to dangerous levels. What could an apparently small rise in global warming of 1.5 degrees mean for the planet? And how would that compare to, say, 2 degrees?
Manuel: One degree or two degrees might not sound like very much. But we have to keep in mind that those tiny changes mean an awful lot on a planetary scale. In the last ice age – when the world was dramatically different, and most parts of Europe were under thick ice cover – the sea level was 20 metres lower because there was so much ice. Yet the global average temperature was just five and a half degrees lower than it is now.
You can imagine that a difference of one degree, on that scale to five and a half, makes an awful lot of a difference. We already have about one degree of global warming on the planet as we speak today.
Citywire: What’s the role of investors in this scenario?
Manuel: The role of investors is to divest from a future we do not want and to invest in a future that we do want. If we continue on our current path, depending on what predictions you’re taking, science tells us that we’ll see about three to four degrees of average global warming towards the end of the century. Let’s not forget this global warming event is average global warming, so it will be much lower in the oceans and much higher on land, where we live. The planet would become uninhabitable.
As we know many of the technologies that we must get rid of, the message for investors is just “put your money into the right things”. One, no new fossil fuels. Two, phase out coal as quickly as you can. Three, no further deforestation or peatland conversion and four, have clear greenhouse gas policies around those things and report the impact that you’re having. It’s not that complicated.
Regulators around the world have been taking steps to encourage investors to finance green projects and use common benchmarks. François Millet, Head of ESG, Strategy and Innovation for Lyxor gave an overview of the new regulation in the EU…
François: The European regulation is a very ambitious plan. It started in 2018 with an Action Plan for Financing Sustainable Growth. It’s continuing with the European Green Deal and the recovery plan, creating a whole ecosystem of policies. These are being watched worldwide, because what is currently achieved at European level for defining the taxonomy of green projects and assets will benefit everyone.
This regulation includes the launch of new benchmarks for investments and new benchmark regulation, which is now entering into force. There is an obligation for fund managers to improve their disclosure on sustainable products and, of course, this so-called taxonomy that will be at the centre stage of the whole process. This regulation is willing to push investors to reallocate capital aggressively towards the companies which are the most successful in decarbonising their activity.
Citywire: What is EU benchmark regulation trying to achieve?
François: The benchmark regulation is all about having a wakeup call for investors by raising their attention on the fact that they are, today, invested in portfolios and indices that are on a trajectory of global temperature warming which is somewhere between four degrees and six degrees. This consists of pushing index administrators to disclose whether or not their current benchmarks are following a decarbonisation trajectory or are aligned with the most ambitious goals of the Paris agreement, which at the lowest end is 1.5 degrees with no or limited overshoot.
There is a very complementary effect between forcing index administrators to improve disclosure on the existing benchmark and providing a response, an alternative to that, which are the EU benchmarks with different levels of ambition in terms of immediate reduction of the carbon intensity. The essential part of this regulation for indexes is to force investors to continue going forward to set their portfolios on a decarbonisation trajectory of 7% per year, which is a scenario that has been chosen by a number of major investors, worldwide and the European Union and now, 120 countries.
Jaspreet Duhra, Head of EMEA ESG Indices at S&P Dow Jones Indices, explained how the benchmark regulation works, and why it is so important…
Jaspreet: The EU benchmark regulation is part of a broader action plan from the EU. The EU wants to encourage more money to flow into sustainable finance and they’ve undertaken a number of different initiatives to try and make that happen and this benchmark regulation is one part of that. So, they’ve convened a technical expert group and they’ve come up with recommendations, more broadly, on green finance, but as part of that, they’ve come up with these two benchmark labels: Paris Aligned Benchmark and a Climate Transition Benchmark.
The hope is, that by having two clearly labelled benchmarks, it will be easy for investors to identify them and compare the two different types. It will hopefully prevent greenwashing, which is a big concern the EU has: that people are saying they’re doing ESG or green investments and they’re not.
Citywire: What’s the difference between the Paris Aligned and Climate Transition Benchmarks?
Jaspreet: The Climate Transition Benchmark is more lenient. These indices are targeted at a more diverse audience, targeted at institutional investors who are looking to consider these benchmarks, potentially, as part of their core allocation. The Paris Aligned Benchmarks are more restrictive, and they’re targeted at highly ambitious climate investors.
Both have this requirement to decarbonise at a rate of 7% every year. This is a really important distinction from many other climate benchmarks you see at the moment. This 7% number the rate of decarbonisation that’s required for us to hit net zero emissions by 2050 and to hit that target of limiting warming to 1.5 degrees.
An interesting shared feature of both benchmarks is that you can’t just tip all the weight into low impact climate sectors to achieve that decarbonisation, you have to maintain the same exposure to high impact climate sectors as well.
That’s important as we try and transition because we can’t just transition by only investing in IT stocks and media stocks – you have to stay invested and you have to encourage industries and sectors to transition. I’d say the most important difference between the two benchmarks is that the Paris Aligned Benchmark applies exclusions related to fossil fuels. So, say, for instance, if you are driving over 1% of your revenue from producing coal, you’ll be excluded from the Paris Aligned indices.
Equities have been the traditional go-to instrument for sustainable investing, but green fixed income has boomed in recent years. Manuel tells us what solutions the $100 trillion bond market proposes to combat climate change and the latest trends in this area.
Manuel: In the past, responsible investing was very much tilted or biased towards equity investments. The thinking behind that was that equity owners had a stake in companies and would therefore, have a voice. They could influence management because they are owners to a certain extent. That is understandable, but now there’s a move into the fixed-income space and that’s where all bonds are. Where investors really understood, hang on a minute, this is the bigger pool of capital – so, we have to activate that one as well.
Let’s go on with equities, as that’s a success story in terms of responsible investing, and also activate that other massive pool [fixed income]. The thinking initially that, as a bond investor, you’re not a co-owner of a company, you don’t have a share, you don’t have a vote, you don’t have voice, has really changed. Investors have understood, “hang on a minute, companies have to come back over and over again to refinance their debts”. Arguably, they need you much more than the equity investor, who just buys and holds, maybe forever, or just sells the stock for someone else to buy.
So, companies have to keep a very close and positive constructive relationship with investors and that arguably allows for even closer and more constructive and more powerful engagement between the bondholder and company management.
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