The Paris Agreement concerning climate change, adopted by 196 countries in 2015 (and re-entered by the U.S. on January 20) calls for net-zero (climate neutral) greenhouse gas emissions by 2050. It’s a key piece of the puzzle for any investor or fund aiming to follow environmental, social and governance (ESG) criteria-based investing. To follow the agreement’s guidance, investment funds need certain information and data as tools and resources, to ensure they are investing in companies that aim to meet the treaty’s net-zero emissions standard.
Investment managers with diversified assets that include unlisted or illiquid funds want an assessment method that will be consistent across all those asset classes and types of securities. While data for listed liquidity and debt may be readily available, data on private equity, private debt, infrastructure and real estate may be harder to get.
Key Indicators for Emissions Data
The key indicators firms and managers need include carbon footprint; transition risk, which is measured in scenario analyses and stress tests, and is the cost and value at risk in a portfolio if carbon prices rise; physical risk; and alignment with the Paris Agreement, which can be measured in terms of the temperature rise caused by a company’s emissions. For reference, the Paris Agreement sets a limit in the increase of global average temperature of 1.5 degrees Celsius or 2.7 degrees Fahrenheit.
Companies without science-based targets for reduction of greenhouse gas output may have securities that are illiquid. Without such target data, what else can investors look for? A number of new data services can estimate emissions values for companies without this data. Aside from these sources, investors can model emissions of companies using their financial data, including revenue, gross profits, production and sectors.
In addition, funds can make a few other calculations to determine the impact of their portfolio companies’ collective greenhouse gas emissions:
- Absolute footprint. Calculated by apportioning emissions of investees, loan recipients or finance providers. The percentage a fund owns of a company is applied to the amount of carbon the company emits.
- Carbon to revenue ratio. Calculated by dividing apportioned emissions across all apportioned revenues across the portfolio. Indicates how efficient a company is within a portfolio in terms of revenues per ton of carbon emissions.
- Carbon to value ratio. Calculated by dividing apportioned emissions across the sum of all finance extended through equity, debt or loans. Indicates how efficient a company is within a portfolio in terms of carbon emitted per each dollar of financing received.
- Weighted average carbon intensity (WACI). Calculated by adding the product of each company in the portfolio or loan book to that company’s carbon intensity.
Investors should consider not just current emissions numbers, but also forecasts for companies over the next five years. With that information, investors can compare those numbers to the overall Paris Agreement carbon reduction goals over that time. If a company’s future emissions will meet or exceed the reduction goals, an investor can consider that a good choice for their portfolio. The major stock ratings agencies all have some measures for how companies are doing with respect to meeting Paris Agreement emissions reduction goals.
Knowing what pieces of information and forecasts to gather concerning Paris Agreement emission reductions is the starting point for investors and fund managers to get the most out of any solution they adopt to support their ESG initiatives.