Climate changing for asset owners - fast view

Carbon emissions rose in 2017, after three years of stability

4 Mar 2019

38 minutes

The fast view 

  • With a duty to underlying savers and investors, asset owners must integrate carbon analysis and fully consider the impact of climate risk over the long-term, including both transition risk to a decarbonised future, and the physical risk posed by climate change itself.
  • Pension schemes, sovereign wealth funds, and the insurance industry are in the front line: This is a vast problem of almost unprecedented complexity and solving it will require a comparative breadth of solutions.
  • Increasingly governments and international bodies are including climate risk as part of the fiduciary duties for many types of asset owners. A step change in disclosure of climate-related risks is a key development.
  • The work and recommendations of the TCFD will help companies understand what financial markets want from disclosure in order to measure and respond to climate change risks and encourage firms to align their disclosures with investors’ needs.
  • Much of today’s thinking focuses on risk mitigation, avoidance of carbon sectors and ESG screens applied to investment universes. The important part of the equation for asset owners to consider is which part of your portfolio will offset climate risk.
  • We have constructed a proprietary universe for this purpose referred to as the Global Environment universe because it actively reduces carbon emissions and includes companies that benefit from the structural growth areas of a de-carbonising economy.

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A matter of urgency

"The challenges currently posed by climate change pale in significance compared with what might come. . . The more we invest with foresight; the less we will regret in hindsight"

- Mark Carney, Governor of the Bank of England, 20151

Carbon emissions rose in 2017, after three years of stability2, driving global warming almost inexorably towards 1.5°C above pre-industrial levels. Breaching the 1.5°C threshold, in a “best-case” scenario, or 2°C in the worst-case, risks unleashing disastrous climate change that threatens the wellbeing of the planet and life that inhabits it.

So much we already know.

It is also clear that profound economic change is necessary to keep global temperatures within these limits. In some cases, this change is already underway, but the bulk of cleaner infrastructure, technology and other solutions are not – and must happen at an unprecedented scale. More sustainable development of this nature can be driven through capital allocations from the financial sector, particularly asset owners through their asset managers.

This is a vast problem of almost unprecedented complexity and solving it will require a comparative breadth of solutions. One of the things asset owners need is better data, from and about companies. This will enable more effective assessment and integration of climate risk and opportunity and it will facilitate decision making that can deliver materially beneficial financial and environmental outcomes. This is all achievable – and asset owners can play a central role through frameworks such as those of the Task Force on Climate-related Financial Disclosures (TCFD).

“We are the first generation to fully understand climate change and the last generation to be able to do something about it”

– WMO chief Petteri Taalas.

The opportunities for meaningful steps are there – and new ones are emerging, as asset managers offer more products to enable such capital reallocations.

There is still time.

Integrating climate risk

Asset owners are arguably heavily incentivised to contribute to a capital markets system built on socially inclusive, environmentally sustainable economic growth. With a duty to underlying savers and investors, they must integrate carbon analysis and fully consider the impact of climate risk over the long-term. This has two components:

1. Transition Risks (to a decarbonised future)

The economic and energy transition to a decarbonised future will have a direct and significant impact on asset owners’ portfolios. The major themes include the rapid energy transition to renewable sources and the adoption rates of electric vehicles. These transition risks are gaining clarity as each country moves to address climate change. More specifically, the risks come from policy and regulatory change and the shocks created as stakeholders address the impact of climate change.

Transition risks also include changing consumer preferences or shifts in technology that can replace incumbent goods or services with lower emissions. Failure to consider the risks and opportunities from the energy transition may have a severe impact on future wealth, the consistency of income received from portfolios and the ability to meet long-term liabilities.

2. Physical (climate) risks

Asset owners are increasingly aware of the dangers posed by extreme weather events to the physical assets and securities in their portfolios. Changes in precipitation patterns or rising sea levels all contribute to the physical risks that can impact asset valuations.

“The choice is an orderly transition to a low-carbon economy now or disorderly and costly transition later.”

Moreover, there is a significant difference between warming at 2°C, as agreed by 195 nations at COP21 in 2015, and the IPCC’s more recent proposal of 1.5°C. Given what we know now, the choice is between an orderly transition to a low-carbon economy where we invest now for change, or a late, disorderly transition with much more costly consequences, in terms of loss of capital, resources, and plant and animal life, and a significant deterioration in quality of human life.

Why target 1.5ºC, rather than 2ºC?

Source: IPCC Report, October 2018

A central role for asset owners

Asset owners have long-term liabilities that are subject to all the material challenges that society and the planet is creating, including climate change. The first of the UN-backed Principles for Responsible Investment (PRI) states that institutional investors should incorporate ESG issues into investment analysis and decision-making processes – 346 asset owners, representing $68 USD trillion, have already done so3. But this is just the first stage of a journey towards action with material benefits – signing up to the PRI is not an end in itself.

The opportunity now is to turn those commitments into widespread, deep and meaningful action. Some of this will come from asset owner volition, some from compulsion as regulators and governments accelerate action.

1. Pension funds

The stewards of long-term retirement assets have led the field in assessing, integrating and benefitting from ESG issues over the past few decades. Pension funds founded the PRI. But there are opportunities to act more meaningfully – and voluntary activity is being joined by compulsion. In the UK, just 5% of the top corporate pension funds have developed and implemented a climate change policy4. Moreover, the Asset Owners Disclosure Project (AODP) assessed the world’s largest 100 public pension funds and found that:

  • Climate change related risks are largely unidentified and unassessed by global pension funds.
  • The vast majority of pension funds are failing to align with the Paris agreement.
  • Around half of the global pension funds undertake company engagement on climate change.

As we explain in the following section, national governments have recently strengthened their legal wording and policies relating to climate change – not least by expanding the definition of fiduciary duty.

2. Sovereign wealth funds

State-owned investment funds (SWFs) invest globally across all of the main asset classes and instruments. They are funded by revenues from commodity exports or from foreign-exchange reserves held by a central bank. Total assets under management are some US$8.1 trillion, but few of them are green finance assets. Over the last five to ten years, SWFs have increased their awareness and focus on climate change, spurred particularly by the 2015 Paris agreement. Each of the 195 signatory nations agreed to determine its own plan, typically addressing a national economic system plus broader capital markets, such as the European economic system.

This spurred SWFs to act on climate change. In 2018, six SWFs representing US$3 trillion6 pledged to fight climate change by agreeing to a climate change charter, which commits them to investing in companies that factor climate change into their strategies. They have also committed to publishing data on how they are reducing their own carbon footprints and have referred to the opportunities offered by a low carbon economy. Despite such progress, the enormous SWF asset pool has minimal investments in green finance, with most estimates putting allocations at 1% or less of total AUM7.

Green finance: explained

As the economy starts to decarbonise, so the opportunities to seek new risks and returns start to proliferate. Many of these are in what experts now refer to as ‘Green Finance’. This encompasses public or private securities or investments (from equities and bonds to insurance products and derivative) issued in exchange for the delivery of positive environmental externalities that are real, verified and additional to business as usual, whereby such positive externalities result in the creation of transferrable property rights recognised within international, regional, national and sub-national legal frameworks.

Source: Climate Mundial, 2018

3. Insurers

Insurers are at the front line of climate change and have been active in researching and mapping it longer than perhaps any other industry. It should hardly surprise that the Mark Carney quotation above comes from a speech delivered at Lloyds of London in 2015. In the life insurance sector, where providers’ liabilities can stretch into the future for generations, many insurance companies have tilted their portfolios towards more sustainable investments, including renewable energy.

But this vast pool of assets, around US$1.9 trillion, could be directed far more effectively towards decarbonisation. General insurers already face significant risks from climate change. In the decade to 2018, according to research from Swiss Re, global natural catastrophe losses totalled US$2 trillion, 70% of which were uninsured. The uninsured losses from natural disaster events are expected to exceed US$150 billion annually9. Both life and general insurers have a significant volume of work in front of them if they are to effectively insulate themselves and their policyholders from the material impact of changing weather patterns and rising global temperatures.

A recent World Economic Forum report puts it quite succinctly: humanity is “remarkably adept at understanding how to mitigate conventional risks that can be relatively easily isolated and managed with standard risk-management approaches. We are much less competent when it comes to dealing with complex risks in the interconnected systems that underpin our world, such as organisations, economies, societies and the environment”10. As this Investec Investment Institute report seeks to demonstrate, the sheer complexity and scale of climate risk and the energy transition require a vast array of solutions – including a clear framework for asset owners.

The global risks landscape 2018

Source: World Economic Forum Global Risks Perception Survey 2017–2018. Note: Survey respondents were asked to assess the likelihood of the individual global risk on a scale of 1 to 5, 1 representing a risk that is very unlikely to happen and 5 a risk that is very likely to occur. They also assess the impact on each global risk on a scale of 1 to 5 (1: minimal impact, 2: minor impact, 3: moderate impact, 4: severe impact and 5: catastrophic impact). The survey responses were then aggregated in order to rank which risk factors were most likely and which would have the greatest impact.

Evolution in fiduciary duty

How will history judge actions taken today in financial services to address climate risk and invest accordingly? Attitudes shift.

And these shifts beget new prisms through which the past is judged. Car journeys without seat belts, smoking in the workplace and high mutual fund fees are now buried in history. In the educational sector corporal punishment in the classroom was once common place. Modern thinking offers room for neither. Will a future generation living with unpredictable weather patterns conclude ours did not act with sufficient energy and purpose? If so, the scale, complexity and urgency of the climate challenge is likely to shift attitudes quickly, with severe consequences for organisations who have not taken full account of the risk.

Asset owners who wish to move with energy and purpose can now include climate risk within their fiduciary duties. As the October 2018 Institutional Investors Group on Climate Change (IIGCC) report puts it, “Fiduciary duty bestows a requirement upon all trustees to consider current and evolving risks when making investment decisions. Insofar as climate change carries material financial risks, trustees will need to consider it as a core part of fiduciary duty”11. In so doing, “Fiduciaries need to be able to show that they have identified and assessed the risks (to companies and to their portfolios)”12.

In 2016, a legal opinion on fiduciary duty, the first in the UK, concluded that where climate risks carry material financial implications for fund performance, trustees must take those risks into account in investment decisions’13. Failure to do this ‘would not be a proper exercise of [trustees] powers14.

As Mr Angel Gurria, Secretary General of the OECD puts it, “Rethinking fiduciary duty is one of the keys to unlocking such potential. There are two parts to the fiduciary equation; first investors must put their clients’ needs before their own; second they must ensure that assets are managed prudently with due care, diligence and effective risk management”15.

And, as we have seen, regulators have intervened to add compulsion to voluntary asset owner action:


The Institutions for Occupational Retirement Provision (IORPS II) Directive was approved in 2016 and IORPs in Member States must explicitly disclose the relevance and materiality of ESG factors to a scheme’s investments and how they are taken into account, including an assessment of new or emerging risks related to climate change, use of resources and the environment, social risks and risks related to the depreciation of assets due to regulatory change16,17.


Article 173 of the law on energy transition and green growth came into force in 2016. This was the world’s first legal requirement to disclose climate-related risks. Listed companies are subject to mandatory carbon disclosure requirements. Both asset owners and asset managers must produce carbon reporting related to their investments and disclose how ESG criteria are considered in investment decision making … and how their policies align with the national strategy for energy and ecological transition”.


The Department for Work and Pensions confirmed changes to pension trustee duties and rules, to make explicit trustees’ obligations to consider all material issues, including “those resulting from ESG considerations including climate change”18. By October 2019, pension funds must update their Statements of Investment Principles (SIPs) to disclose these considerations to this effect.


Relevant legislation is implemented at state level and, for example, California passed a landmark bill requiring two of the country’s largest pension funds (CalPERS and CalSTRS – with combined assets of US$564 billion) to consider “climate-related financial risk” when making investment decisions and report this to the public and the legislator19.

Revolution in the guidance for asset owners

In 2017, the TCFD, which is an initiative by the Financial Stability Board, published a ground-breaking framework for asset owners to assess and address climate risk.

It is creating voluntary, consistent climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers, and other stakeholders. These will consider the physical, liability and transition risks associated with climate change and what constitutes effective financial disclosures across industries.

The work and recommendations of the Task Force will help companies understand what financial markets want from disclosure in order to measure and respond to climate change risks and encourage firms to align their disclosures with investors’ needs.

Action to take, now

Asset owners must act through their own direct actions and the expectations they place on asset managers, to integrate the wide ranging and complex scale of the challenge, and the potential impacts over their time horizons.

Fortunately, several organisations have provided guidance for immediate action on disclosure. The Prudential Regulatory Authority recommends the firms it regulates to “identify, measure, monitor, manage and report on their exposure to these risks” and expects them to be able to evidence this in the context of their overall risk management framework20.

The PRI has also provided a guidance framework specifically for assets owners to review climate change risks in their investment strategies and align with the TCFD recommendations. The work is wide-ranging – from reviewing asset allocation decisions, manager performance review and due diligence criteria for future manager selection. The figure below is an excerpt from this guide21.

Actions for asset owners to achieve impact on investment strategy

Source: Implementing the task force on climate-related financial disclosures (TCFD) recommendations – A guide for asset owners, 2018

Interpreting the guidance

The ten key items of best practice:

  1. Embracing senior leadership and education in their climate governance
  2. Building organisational cultures that support responses to climate-related risks
  3. Building meaningful relationships with members, savers and beneficiaries around climate-related issues
  4. Publishing TCFD-aligned reports
  5. Pursuing a ‘whole of fund’ approach in their climate strategies
  6. Innovating in their low-carbon asset allocation
  7. Driving commitments from asset managers on climate-related issues
  8. Prioritising climate-related issues in their risk and investment analysis
  9. Refining, escalating, and collaborating in their engagement with investee companies
  10. Engaging on climate-related regulation and policy

Perhaps the most critical part of understanding the guidance is ensuring a comprehensive view of carbon emissions in your portfolio. Historically data accuracy and consistency in carbon emission data have hampered efforts, but considerable improvements are being made. We acknowledge data is still not perfect, but it does reveal the full extent of systemic climate risk that might exist in asset owner portfolios.

Asset owners could be underestimating climate risk

Armed with better data, from and about companies, asset owners and their asset managers can undertake more effective assessment and integration of climate risk. This can facilitate decision making that combines beneficial financial and environmental outcomes.

This is now starting to happen – and we are seeing vast improvements in our ability to harness expanding amounts of data which can help transform our understanding of environmental problems and solutions. Its results are shedding new light on the threats and opportunities in a decarbonising world. An important example being carbon emissions for many institutional investors, reporting so far has been limited to ‘Scope 1’ and ‘Scope 2’ emissions – covering direct emissions and those produced by purchased electricity.

What asset owners therefore miss are ‘Scope 3’ emissions, which examine the entire corporate value chain including those created by the products they have sold. ‘Scope 3’ data have been more challenging from an accuracy and consistency perspective but is far more comprehensive. It is estimated that over 75% of the carbon emissions attributable to the MSCI All Country World Index are in fact ‘Scope 3’, suggesting that levels of climate risk are likely being underestimated in asset owner portfolios.

Scope 1

Scope 1 carbon emissions are the direct GHG emissions from sources that are owned or controlled by a company. For example, these include emissions from combustion in owned or controlled boilers, furnaces and vehicles.

Scope 2

Scope 2 emissions are from the generation of purchased electricity consumed by a company.

Scope 3

Scope 3 are those created by a company’s supply chain or from the company’s products and services once they are sold.

In the UK, the Association of Chartered Certified Accountants estimates that about 75% of any company’s carbon emissions sit within scope 3. This is particularly important for extractive industries which form a large part of the FTSE 100.

Portfolio emissions per sector – Global Equities

Source: South Pole Carbon, 2018
The data also lead us to conclude that a decisive move to tackle climate risk and support a successful transition requires active investment in businesses set to benefit from the transition to a low carbon economy.

In creating the Global Environment universe, our research approach includes a partnership with Engaged Tracking, a carbon data provider which provides the only public, fully transparent ranking of the world’s largest companies by their Scope 1, 2 and 3 carbon emissions intensity. These data sets are central to understanding the real impact of corporates, and the real influence of investors and their allocated capital. 

Much of today’s thinking focuses on risk mitigation, avoidance of carbon sectors and ESG screens applied to investment universes. Some asset owners have taken proactive steps such as allocating to green bonds or green infrastructure which can provide an income from important projects mitigating or adapting to the climate challenge. The important part of the equation for asset owners to consider is which part of the portfolio will offset climate risk by benefitting from the structural growth trends that underpin the decarbonising economy such as those outlined in The Rise of Renewables and The Future of Transportation.

As Mark Carney points out, understanding climate risk correctly is only the first part of the problem. The next step is to invest in the solutions that will support the energy transition and decarbonise the global economy.

When climate scientists warn of impending disaster from inaction, they also highlight positive investment solutions. They require, according to Jim Skea, co-chair of the working group on mitigation for the IPCC, “an unprecedented shift in energy systems and transport”. Many of the companies behind the solutions are in renewables and transportation, where rapidly improving technology and lower costs are creating structural growth opportunities for 20 to 30 years. More broadly, the companies most exposed to the energy transition sit across a wide range of sectors and geographies, often with smaller market capitalisations but higher than average growth rates.

We have constructed a proprietary universe for this purpose, referred to as the Global Environment universe because it actively reduces carbon emissions and includes companies that benefit from the structural growth areas of a de-carbonising economy. What is striking is that this universe has little or no overlap with traditional equity allocations such as the MSCI All Country World Index or the FTSE 100.

Decisive action

Investing with foresight in companies that are benefitting from decarbonisation and the energy transition can help asset owners hedge some of the systemic carbon risk that exists mostly unacknowledged in their portfolios. It can also save pension scheme trustees from regretting with hindsight.

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1. Source: Bank of England; 29 September 2015
2. Source: United Nations Environment Programme, UN News; 27 November 2018
3. Source: (PRI 2017 data)
6. Norway, Kuwait, Qatar, Saudi Arabia, United Arab Emirates and New Zealand
10. The Global Risks Report 2018, 13th Edition, World Economic Forum
11. Page 9, “Addressing climate risks and opportunities in the investment process – A practical guide for trustees and boards of asset owner organisations”, The Institutional Investors Group on Climate Change (IIGCC), October 2018
12. Ibid
14. Ibid
17. and Article 173 here
18. Clarifying and strengthening trustees’ investment duties: Consultation paper, June 2018 and the Government response, published in September 2018, here.
19. and
20. Page 5, “Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change”, Consultation Paper 23/18, Prudential Regulation Authority, October 2018
21. Implementing the task force on climate-related financial disclosures (TCFD) recommendations – A Guide for Asset Owners”, 2018

Authored by

Tom Nelson

Head of Natural Resources

Therese Niklasson

Global Head of ESG

Deirdre Cooper

Portfolio Manager

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