A total $84 trillion of assets under management (AUM) is now captured by net zero commitments of the AUM of signatories to the three largest net zero initiatives, said Barclays in a new report.

Climate change has dominated headlines this year, with issuers and investors alike keen to advertise their commitments to decarbonisation, said the British bank’s latest ESG Research report.

An ever-increasing number of companies are setting ambitious targets: announcing goals to reduce their greenhouse gas emissions to net zero by 2050 or before. Investors are now following suit, making net zero commitments on their investment portfolios, joining initiatives designed to support this shift, and making high profile accompanying statements.

“We expect these commitments to have a significant impact on investor portfolios and the investment decision-making process. However, the effectiveness of portfolio decarbonisation will depend heavily on the goals, targets and implementation strategies that are used by each investor,” the report said.

“In particular, we see a risk of an alternate 'tragedy of the horizon' : that investors pursue a rapid decarbonisation of investment portfolios that is incompatible with the transition to a net zero economy. In this scenario, the rush by investors to divest problematic issuers and sectors leaves them with no seat at the table, or leverage to encourage changes in behaviour.”

The report says net zero investing can be categorised into two different buckets:

Reduction techniques: Investors attempt to reduce portfolio emissions as much as possible today, which typically involves selling high-emitting assets or using other forms of portfolio engineering such as short-selling, buying green-labelled securities, and buying offsets.

Alignment strategies: Investors focus more on encouraging long-term decarbonisation by issuers of financial securities, working to engage with and encourage them to reduce their GHG emissions. This often involves creating a portfolio of net zero aligned assets that are on a credible transition pathway – even if they might have high emissions today.

Only the latter approach – investing in issuers that are committed to reducing their emissions – has a direct impact on real world emissions, but we expect commercial pressure to push investors towards reduction techniques, including portfolio engineering, as they rush to achieve rapid reductions in their own reported portfolio emissions.

Under the Sustainable Finance Disclosure Regulation (SFDR), commercial pressures have triggered a scramble to increase the number of funds classified as Article 8 and 9, due to concerns that it will become increasingly difficult to distribute Article 6 funds.

“We expect a similar rush of investors both making portfolio-level net zero commitments and rapidly reducing portfolio emissions, amid rising concerns that it will become increasingly difficult to sell funds with high portfolio-level emissions and that lack a commitment to long-term decarbonisation,” Barclays said in the report.

However, the use of portfolio engineering is unlikely to encourage issuers to decarbonise, except where names and sectors become 'untouchable' for a large majority of the investment community. Indeed, when investors divest their exposure to an issuer, they lose their main tool for engagement. Hence, there is a material risk that investors manage to decarbonise their portfolios without decarbonising industry. This would fail to achieve the overarching goals of policy makers and climate-aware investors.

“We therefore believe that alignment strategies will be viewed more favourably as net zero investing matures as a concept and that short-term emission reduction techniques should always be complemented by long-term engagement in encouraging the decarbonisation of the underlying security issuers,” the report said.

“Specifically, we see much stronger arguments for investors to 'play tough' in primary markets, when issuers are seeking new capital, than for portfolio optimisation through secondary trading or use of carbon offsets. The major challenge to achieving this level of engagement today, and to identifying companies on a Paris Aligned trajectory, is disclosure: too few issuers disclose the required information, clearly, consistently and within an accepted carbon-accounting framework."

Net zero investor guide

Measure and reduce
Measurement of financed emissions is poorly defined for most financial instruments. Clear and consistent carbon accounting frameworks are required to credibly report net zero. They should also minimise the ability of investors to report net zero with minimal cost, effort, or engagement.  27 min read

The key to alignment strategies
Investors are on the search for forward-looking data to aid in their analysis of net zero asset alignment, an integral part of any alignment strategy. A variety of reputable tools have been developed by market participants, but most data suffers from coverage challenges, with many only focussed on high-emitting issuers.  6 min read

Net zero investor initiatives
Asset managers and owners, alongside investor networks, have been busy setting up initiatives designed to encourage and support the transition to net zero portfolio emissions. However, each group is taking a slightly different approach, further complicating the landscape of investor strategies.  – TradeArabia News Service