Climate change poses an existential risk for humanity. But it also presents enormous investment opportunity.
Investors are increasingly focused on tracking and reducing their portfolio emissions exposure. Research from FTSE Russell finds that global equity portfolios, as proxied by the FTSE All-World Index, saw a modest decline in carbon intensity between 2014 and 2020. The weighted average carbon intensity normalised by revenues decreased by 2% p.a. over the past six years, with the rate of reductions accelerating to over 5% p.a. over the last three years.
Weighted Average Carbon Intensity (WACI) is sensitive to changes in index weights of industries where emissions are concentrated. The five highest-emitting sectors in the FTSE All-World index account for 76% of emissions intensity but only 10% of the index weight. Due to disproportionate intensities, these industries contribute a larger proportion of the overall portfolio intensity level than would be expected from their portfolio weight, and thus are responsible for an overwhelming proportion of the yearly changes observed.
Our research found the most carbon-intensive industries – Utilities, Energy, Basic Materials, and Industrials – have contributed more than 100% of the decline of the WACI over the last three years. And declining index weights for carbon-intensive industries have been the primary driver for change in weighted average carbon intensity.
Chart 1. Decarbonisation in utilities and changing index weights driving change in waci - Contribution analysis in WACI, 2017-2020
Partnerships to guide the transition
As the global economy decarbonises, investors need to understand which companies are best placed to transform their business models. Since 2017, FTSE Russell has partnered with the Transition Pathway Initiative (TPI), providing ESG data to help the asset owner-led initiative assess companies’ preparedness for the transition to a low-carbon economy.
Recent FTSE Russell research has found that companies with high TPI Management Quality Scores are more likely to reduce their emission in the future. They also deliver larger emissions reductions, on average, than companies with low TPI MQ scores.
hart 2. Average annualised change in scope 1 and scope 2 carbon emissions per tpi mq score in ftse all-world (n=2075)
This research has informed our FTSE TPI Climate Transition Index Series, which enables investors to take on exposure to those companies that are well-positioned to manage the transition, while underweighting those that are more heavily exposed to climate risk. Meanwhile, we are deepening our partnership with the TPI, backing the establishment of its Global Climate Transition Centre, to increase its coverage from 400 to more than 10,000 companies.
New indices to support investors
In addition to the FTSE TPI indices, we are working with our clients to develop new indices and the data building blocks that allow them to express their views on the net zero transition.
For example, our FTSE Climate Risk-Adjusted Government Bond Index Series enables fixed income investors to incorporate climate considerations into government bond portfolios. Its constituents are reweighted towards those countries with lower climate risk, and away from those that are more exposed.
Similarly, our FTSE EU Climate Benchmarks Index Series offers exposure to companies with green revenues, high-quality climate governance and emission reduction goals aligned with those of the Paris Agreement. Its indices meet the emissions reduction standards set by the EU’s Low Carbon Benchmark Requirements:
- The FTSE Paris-aligned Benchmark (PAB) Indices target a minimum 50% reduction relative to the reference benchmark;
- The FTSE Climate Transition Benchmark (CTB) Indices target a minimum 30% reduction; and
- The FTSE Fixed Income EU Climate Benchmark index series target a 50% carbon intensity reduction relative to the base index and a 7% reduction in emissions relative to the index base year.
Working with investors to realise their climate goals
We have developed these indices to allow investors to efficiently express their investment views about climate change. For example, the Church of England Pensions Board wanted to integrate the insights of the TPI – which it co-founded – into a passive equity product. Its use of the FTSE TPI Climate Transition Index for a £600 million passive equity mandate allowed it to closely track its benchmark while delivering significantly improved climate performance.
In a similar vein, we helped the New York State Common Retirement Fund meet its objective to invest in US stocks that are aligning with the net zero transition. We developed the Russell 1000 TPI Climate Transition Index which, like its FTSE sister index, is tilted towards companies performing well against the TPI’s climate criteria. The Retirement Fund has allocated an initial $2 billion to a passive fund tracking the index.
We have also developed indices that allow investors in other asset classes to incorporate climate risk assessments. We worked with leading investment consultant Mercer to develop the FTSE Global Core Infrastructure TPI Climate Transition Index. The index takes the stocks from three core infrastructure sectors – transportation, energy and telecommunications – and adjusts stock weights to account for the risks and opportunities associated with the net zero transition. It enables investors who like infrastructure – which has greater sensitivity to inflation, defensive qualities during market downturns and potential yield enhancement – but who don’t like the sector’s typically high carbon intensity.
Facilitating the flow of climate data
As a financial infrastructure and data business, we recognise that investors can’t operate effectively without timely, accurate information from the issuers and assets in which they invest. How companies respond to the challenges of climate change will, over the medium term, drive their value. It is imperative that they report the climate information investors will need to know.
The recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) provide a consistent, investor-friendly framework for that reporting. We have integrated TCFD-aligned reporting into our Corporate ESG Reporting Solution. The solution simplifies the reporting process for issuers, and ensures they are providing investors with the data required to assess their prospects.
Making a market in emission reductions
Through the London Stock Exchange, LSEG helps bring together providers of capital with those who need finance. Our work on the net zero transition has shown there is a pressing need to bring together investors with entrepreneurs in the voluntary carbon market, who need finance to develop projects that reduce emissions.
Our Voluntary Carbon Market uses our well-established funds platform to enable funds to be listed that provide capital to emissions reduction projects, applying our existing regulatory regime to ensure high levels of market integrity. This solution promises to both provide capital at scale to the voluntary carbon market, as well as provide access for corporates and investors to a long-term supply of high-quality carbon credits.
Living our own transition
As well as helping our customers navigate the net zero transition, we recognise that we have our own climate impacts at LSEG, and our own contribution to make to address the challenge posed by climate change. In January 2021, we committed to halving our carbon emissions by 2030 and becoming net zero by 2040. In the same year, we published our first Climate Transition Plan, which sets out how we plan to meet those commitments.
That plan is designed to reduce the climate risk we face as a business. It also positions us to seize the opportunities presented by the net zero transition. By similarly helping our clients – whether investors, financial service providers or companies – seize opportunities and reduce risk, we can accelerate the net zero transition and help them create sustainable growth.
At LSEG, accelerating the transition to net zero is one of our strategic priorities. We can point to a long pedigree of helping our clients understand and participate in sustainable finance and investment.
Across LSEG, we deploy a wide range of expertise and capability that can support clients with the data, analysis and marketplaces they will need to navigate the sustainability transition.
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