The goals of the Paris Agreement cannot be met without asset allocators playing a constructive role in the low-carbon energy transition. This requires us to take account of the varied objectives of asset owners, and the complexities of predicting policy and technology pathways.
The Paris Agreement and why it matters to investors
The 2015 Paris Agreement aims to “hold the increase in the global average temperature to well-below 2°C above pre-industrial levels and pursue efforts to limit the temperature increase to 1.5°C”. The more ambitious target of 1.5°C requires carbon emissions to reach ‘net zero’ by 2050. That means any residual emissions from hard-to-abate industries must be removed from the atmosphere through technology or nature-based solutions.
The Paris Agreement also seeks to align financial flows with these objectives. The International Energy Agency estimates we need around US$2 trillion every year to meet the Paris decarbonisation goals. This level of funding implies substantial investment opportunities. Currently, the world is allocating only around half that amount, largely because of inadequate government policies.
Demand for Paris-aligned investment solutions is growing rapidly as asset owners increasingly incorporate climate into their objectives.
Demand for Paris-aligned investment solutions is growing rapidly as asset owners increasingly incorporate climate into their objectives. The Net Zero Asset Owner alliance is one example highlighting this trend, with £5 trillion of assets under management.
What is ‘Paris-aligned’ investing?
The concept of ‘Paris-aligned’ investing has come to imply alignment with achieving net-zero emissions by 2050. In practice, that means adopting three principles: shifting capital towards climate solutions; decarbonising at the rate required to meet net-zero alignment by 2050 and the interim goal of 50% emission reductions by 2030; and net-zero-consistent corporate stewardship. These principles are enshrined in the IIGCC Net Zero Investment Framework. This provides the foundations for aligning investments with net-zero goals, with flexibility over translating these principles into investment strategies.
Source: ASI, June 2020. Transition sectors include steel, mining, chemicals. Estimates are indicative and for illustration.
The challenges of Paris-aligned investing
But Paris-aligned investing is not straightforward for several reasons.
- Which pathway to Paris?
- Global climate policies are not Paris-aligned
- Which companies have credible Paris-aligned transition plans?
- Asset managers and owners have different levels of control over goals
- Paris-aligned approaches are hard to compare
There’s a vast array of country/sector allocations, policy choices and technology options compatible with the Paris goals. There’s also uncertainty about which low-carbon technologies will prove viable. Consequently, there’s huge variation in company spending plans and, thus, Paris-aligned portfolios. So, it’s hard to assess progress against a Paris-aligned pathway that could be defined in multiple ways.
Despite a big increase in ‘net-zero 2050’ pledges to limit warming to 1.5 degrees, our research shows that global government policies even fall short of a below-two-degree target. Uncertainty around Paris-aligned policy incentives limits investors’ ability to make full, Paris-aligned changes in their own capital allocation. Nevertheless, there’s no doubt a major energy transition is underway. Moreover, because this transition is not yet fully priced into assets, it represents a major investment opportunity.
A growing number of companies are pledging net-zero targets. But are these robust and credible? Targets must include both upstream and downstream emissions. They must focus on real decarbonisation, rather than offsetting, and be incorporated into short-term targets and investment plans.
Asset owners have freedom to set their own long-term investment objectives, so can choose to set a Paris alignment goal for their portfolios. Asset managers, however, are bound by pre-agreed mandates, which they can’t alter without the client’s consent.
Because of differences in investment objectives and strategies, Paris alignment can’t be defined the same way for every investor. For instance, comparing Paris alignment across investors using just a single temperature-alignment score masks the complexities outlined. And the choice of methodology can greatly affect temperature outcomes for the same portfolio.
Overcoming the challenges
While investors can’t, for instance, dictate global policy decisions, they can exert influence by lobbying governments for stronger action. Investors can also allocate capital to companies looking to transition, and ensure transition plans are credible. And investors can partner with asset owners to make Paris-aligned investing more viable.
Here are some of the principles we follow at ASI.
Public policy advocacy – Government policies are vital to achieving Paris goals. Investors can play a part by pushing for more policy ambition. And they can help in designing policies that will drive net-zero-consistent capital flows. ASI publicly joins with other investors in calling for stronger climate policies.
Rigorous climate change analysis – We’ve developed state-of-the-art climate scenario analysis tools to help us understand the risks and opportunities associated with climate change. Our bespoke scenarios reflect our views on the plausible ways in which climate policy and low-carbon technologies may evolve. This helps us assess the financial effect of Paris-aligned pathways on our funds, and fund resilience under different scenarios.
Responsible stewardship – Through strong engagement with corporates, we encourage them to set ambitious climate goals most relevant to their business. We have clear climate stewardship expectations. For transitioning companies, we demand improvement against transparent, measurable criteria. We also consider the policy environments, low-carbon technology options and social aspects affecting a company’s operations.
Tracking carbon and climate solutions – We track the carbon footprint of our portfolios and are developing tools to measure our exposure to climate solutions. These help us to understand where risks and opportunities are concentrated and to monitor decarbonisation progress.
Paris-aligned investment solutions
We’ve developed - and continue to develop – solutions for investors with Paris-aligned goals.
- Climate-aligned funds and benchmarks – our climate-related products cover a range of asset classes. They invest in low-carbon climate solutions and energy transition leaders, whose progress we track over time. We’re also developing benchmarks tilted away from carbon-intensive industries to help redirect capital to companies spending on climate initiatives.
- Net-zero investing solutions – for clients with net-zero targets, we offer funds tilted away from carbon-intensive activities towards transition leaders and climate solutions, overlaying this with net-zero stewardship. This allows us to track funds against a Paris-aligned emissions pathway so decarbonisation happens at the required rate.
To read our full Paris Agreement statement, click here.