How charities and others can use their investments towards achieving net zero
13 June 2023 | Applicable law: England and Wales | 6 minute read
Why net zero?
Climate science shows that in order to avert the worst impacts of climate change, global temperature increase needs to be limited to 1.5°C above pre-industrial levels. We have a clear international framework in the Paris Agreement, signed by 196 countries, to keep global warming to no more than 1.5°C. This will require emissions to be reduced by 45% by 2030 and reach net zero by 2050. To get there we need huge structural shifts in societies and economies, from the ways we generate power to the ways we produce and consume goods and services. Policies such as carbon prices and taxes will be needed to incentivise these shifts. This transformative change will be a source of both value creation and destruction across industries, companies and investment portfolios.
For asset owners, setting a net zero target serves multiple functions. Setting a decarbonisation target and pathway is a way of assessing and managing exposure to the low carbon transition over time, reducing the risk that portfolio values are heavily disrupted by economic shifts that have a disproportionately negative effect on more carbon-intensive investments. At the same time, many charity investors also want to accelerate positive change in the world by channelling capital to sustainable and durable businesses.
Currently, the Earth is already about 1.1°C warmer than it was in the late 1800s, and emissions continue to rise. Asset owners have an important role to play in meeting the goals of the Paris Agreement. With increasing regulation and public scrutiny, the number of our clients setting net zero strategies for their investment portfolios, aligned to their organisation’s wider climate commitments, is growing. However, there is a gap between commitments and actionable plans. Depending on the starting point and end goal, the longer an investor waits to start decarbonising, the faster and more dramatic it may have to be.
Some decarbonisation is already happening; 70 countries covering 90% of global emissions and over 4,000 companies have made a net zero commitment. With increasing regulatory pressure and consumer expectations, we expect this to continue and hopefully accelerate.
Along with market forces, there are two key levers for decarbonising an investment portfolio:
- Active ownership: using influence as a shareholder to push for more ambitious climate action from the companies in which you invest. This can lead to faster decarbonisation of the companies you’re invested in, and have positive effects on share prices if executed successfully
- Investment reallocation: such as divesting from the most carbon intensive companies and allocating capital towards companies providing the solutions or allocating between different asset classes, regions or sectors
Motivations and circumstances
Before setting a net zero strategy, asset owners need to consider the following questions:
- What is the objective of my net zero strategy? The motivation for your organisation’s net zero goal will be an important determinant of the most appropriate investment strategy. Is it to protect your charity’s reputation? Are you primarily aiming to manage climate risks to your investments? Or is the impact of your investments on the environment and society also a priority? ‘Materiality’ or ‘inward materiality’ is the effect of climate change on a company’s finances and activities; ‘outward materiality’ measures the effect of finance and corporate activities on climate change, the wider environment and society. ‘Double materiality’ incorporates both; managing climate risks on your investments and the impact your investments may have in the world.
- How do I weigh my climate priorities versus others? Charity investors have many considerations beyond sustainability. They may need a certain level of income to meet their or to limit tracking error of their portfolio against an index. The appropriate pace of decarbonisation will be influenced by these variables.
- Should we exclude certain sectors or focus on engagement? For those that are focused on climate impact, how to best achieve this is still debated. Is exclusion a more effective strategy by raising the cost of capital for more carbon intensive entities, or does it have little implication if capital is instead raised by other sources? Does engaging companies, even if they have higher emissions, to set net-zero transition plans and take steps to decarbonise do more for getting the world to net-zero? For our sustainable strategies we advocate using both levers.
What do net zero targets look like?
Net zero targets can come in many shapes and sizes and there are a few aspects that a charity board will need to consider or discuss with their advisers:
- Time horizon: The charity will need to specify the time frame they are looking to reach – their overall net zero target. 2050 is the most common for those that have set financed emission targets, consistent with the majority of governments and companies. Some organisations have set interim targets over time to manage their pathway (for example 2025 and 2030 targets) and plan to set further interim targets as their net zero journey continues and they gather more information. They also need to choose a baseline year to anchor their interim targets – many have chosen 2019 given the temporary drop in global emissions during the COVID pandemic, but some organisations are choosing to start tracking progress from today, once a plan has been agreed.
- What to measure: An important step is figuring out what to measure. Is it financed emissions, the amount of carbon emissions associated with your portfolio? Or do you pick an intensity-based measure to not penalise issuers that have higher emissions simply because they are producing more? These emission measures are backward looking, so a measure based on projected emissions or whether companies have set targets (such as temperature alignment) can be more forward looking. The choice of measure is key, as it will have significant impact on how you implement your net zero strategy and the implications for your investments. We would suggest using more than one methodology as each has advantages and disadvantages.
- How to calculate and track progress: Now you have your measure, how should your target be calculated? This usually depends on the measure you have chosen. For financed emissions and emissions intensity, this could be a % reduction in the measure over a given time. For temperature alignment and similar methodologies, the target can be set at a specific temperature.
- Asset class coverage: Few would deny that emission targets should ideally cover all asset classes, but in practice targets for some asset classes are far more feasible currently than others. Most asset owners have set targets for their listed equity and credit portfolios in the first instance.
For charity investors, it will of course be important to consider the investment powers that are available, and the specific duties to which charity trustees are subject when making investments. The Charity Commission's CC14 guidance is a useful starting point (though this is currently under review) and it may be necessary to take legal advice.
Cazenove Charities are producing a guide for charity investors looking to set a net zero strategy, in collaboration with Nick Perks founder of the Funder Commitment on Climate Change. Please get in touch if you would like to be sent a copy once it has been published.
This is a guest contribution from our friends at Cazenove Charities.