A clear path towards net zero

A version of this article first appeared in the Responsible Investor publication “The Road to COP27: 27 Steps to Net Zero”

Investors are lining up to make commitments to achieve net-zero portfolios. But with many different considerations to keep in mind, the process can become daunting. Bruno Bamberger, senior solutions strategist at AXA Investment Managers, discusses the challenges that investors face in turning commitments into action and the role that proper measurement plays in the process. He also highlights the impact of climate-related risks on the road to net zero, as well as the importance of avoiding greenwashing.

How have commitments towards net-zero goals shaped the industry? What challenges do investors face?

There has been a huge and collective commitment to net zero across the entire investment industry over the last couple of years. Investors that have joined the Net Zero Asset Managers initiative have $61trn in assets under management. That’s an enormous amount of capital committed to net zero. These commitments send a clear and noticeable signal to all market participants.

The underlying companies themselves are very aware of what investors are focusing on, and many of them are changing their company strategy in light of this. Other market participants such as data providers, are also focused on the opportunity – they're collecting and releasing more and more data that asset owners and managers can rely on.

One of the challenges facing investors is the fear of greenwashing. A lot of due diligence from asset managers is needed to be able to overcome this valid concern. We also need to straighten out the confusion between achieving net zero portfolios, and actually getting the world to net zero.

How should investors see the relationship between net zero and the Paris Agreement?

Imagine a bathtub with water flowing in from the taps and out through the plughole. The water flowing in is the carbon emissions released by natural means and from humankind’s burning of fossil fuels. The water flowing out is the carbon sinks, like forests, and man-made technologies such as carbon capture. We get to net zero when the water flowing in equals the water flowing out, so the water level in the bath stops rising.

By contrast, the Paris Agreement relates to temperature increases – continuing the analogy, it’s about how full the bathtub is when the water stops rising. The fuller it is, the hotter the global temperature and the greater the impact on the Earth. The two are related, but not the same and it is important for investors when setting portfolio-level objectives to ensure they are achieving the goals they want to achieve.

How are actions on reducing emissions measured and monitored?

We've seen an explosion of interest in measuring and monitoring carbon emissions within our portfolios. When looking at carbon emissions, we can boil it down to two types. There are absolute emissions, the total amount of emissions attributed to a portfolio, and then there's carbon intensity – the emissions per million dollars invested. Both metrics have their uses, and both can be used in different ways by investors.

Most important, however, is how these metrics change over time. Company and asset owner portfolios may have different starting points and different end objectives. Therefore  progression is more important than stationary and historical emissions values. There are also metrics related to net-zero alignment which are different from common emissions. Several initiatives and frameworks are built on this.

How does data inform net-zero strategies? 

Qualitative and quantitative information from both internal sources and third-party providers are essential to measure net zero-alignment in client portfolios. One example of a third-party initiative which gives a high-level insight into company-level alignment is the Science Based Targets initiative, which assesses whether the commitments companies have made are compatible with limiting temperature increases to below 2°C.

But when looking at net zero, measuring alignment can’t be done purely on a commitment-only basis. When looking at each company’s transition plan, consideration must be given to capital expenditure and the proportion of ‘green’ revenue if we are to determine whether they are aligned to net zero or not.

What's important to asset owners is understanding what underlying companies are able to do, and also how governments are preparing to deliver regulations that will create the conditions for a credible and ambitious transition to net zero. Data plays a critical part in this journey.

How can climate-related risks be taken into consideration on the road to net zero? 

Climate-related risks and net zero are two separate but related concepts. A company can have high climate-related risks, but also be perfectly net zero aligned – perhaps because it has physical assets located somewhere exposed to significant physical risks such as seawater flooding. Even portfolios that have exited the fossil fuel industry could still be impacted by risks from the supply chain of their remaining companies, or from changing consumer habits impacting their revenue streams. So investors need to consider climate-related risks and the net zero transition, and not just one or the other.

If the entire industry divested from high emitters, we would have an even greater energy challenge on our hands. And those companies would not be stewarded towards changing their business models and wouldn’t be encouraged to produce energy from renewables.

Although climate change is a risk factor for asset managers and asset owners we do not think there is an advantage in suddenly removing that risk from portfolios. What is important is that risks are measured so that asset managers can determine how to adapt portfolios to support an effective transition.

How should investors engage with companies lagging behind in reducing emissions? 

Engagement is key to any net-zero strategy for asset managers and owners. At its most basic level, engagement could simply be letting companies know what you expect of them: providing more data across Scope 1, 2 and 3 emissions; setting net zero targets; and changing their business models to be more sustainable while sticking to the plans that they've already made.

But most engagement goes beyond this, going into greater detail about what strategy these companies should undertake to reach net zero, and how this can be done in a financially sustainable manner. This ensures that investors and companies themselves benefit from it.

Companies must understand the implications in terms of sourcing financing in the future. Releasing debt could become tougher and their cost of capital could increase if they're not sticking to their net zero commitments. Are companies falling behind for a justified reason? Or is it simply a case of greenwashing, where companies have committed to net zero with no intention of following through? The answer determines whether we continue to engage with them, whether we further escalate the efforts, or if we divest from them as a last option.