Iancu Daramus looks at how effectively companies in different regions and sectors are responding to climate change
As public concern over climate change grows, so too does the expectation that investment professionals will address it. Regulators are also increasing their focus on climate risks: for example, climate stress tests are making their way into the supervision of banks and insurers, and UK pension funds are required to report on their management of climate risks and opportunities.
A key challenge is that the data required to accurately quantify climate risk is not fully available – and, in some cases, it is not very meaningful without forward-looking analysis. For example, two oil companies might have the same emissions today, but if one is linking executives’ pay to reducing emissions and the other is incentivising oil and gas production, their risk profiles may diverge. Past emissions performance is not a guarantee of future emissions.
To bridge this gap, additional research is required. As an example, Legal & General Investment Management (LGIM) has developed a framework for analysing companies’ climate strategies and has published data on key climate performance indicators for around 1,000 companies covered by its Climate Impact Pledge engagement programme. The latest progress report on these companies (bit.ly/LGIM_CIP2021) reveals some positive indications on climate action, albeit with substantial disparity between and within regions and sectors.
Climate momentum is growing
While climate change is a global threat, the emphasis that companies place on addressing it varies significantly by region. Spurred by public and investor concerns, companies in the West have historically led the way, but a different story is now emerging. European companies continue to top climate ratings, but Asian companies have overtaken North America, with the largest relative increase since 2020 coming from emerging markets. Figure 1 shows the scores by region, and how these have changed since last year.
All sectors are exposed to climate risks and opportunities to some extent. Reaching net-zero greenhouse gas emissions will require far-reaching changes, beyond simply the phase-out of fossil fuels.
There are indications of momentum on climate action across sectors. The number of companies setting net-zero targets, for example, has almost doubled since October 2020. Apparel and cement companies top climate rankings on this measure, with a fifth of these sectors covered by net-zero targets – a remarkable increase from just 7% and 3%, respectively, last year.
“The gap between leaders and laggards is often higher within a given sector than between sectors”
It may seem counterintuitive that a high-emission sector such as cement could top rankings on net-zero targets, but these sectors are subject to persistent scrutiny, meaning more attention is devoted to putting in place environmental policies and emissions-reduction programmes.
For example, more than two-thirds of the shipping, utilities and oil and gas companies analysed have an emissions-reduction programme in place, compared to around a third of food, technology and telecommunications companies.
Significant variation remains
The existence of an emissions-reduction programme may not necessarily indicate its importance for a company’s management and leadership. Indeed, analysis indicates that, in the shipping sector, there is a disconnect between disclosed emissions reductions targets and the accountability of the board members responsible for meeting them, which lacks details.
The gap between leaders and laggards is often higher within a given sector than between sectors. Figure 2 shows climate change metrics across and within sectors, and highlights the extent of variation. For example, while the technology sector has the second highest average climate rating, the percentage of companies within this sector that meet set minimum standards is one of the lowest.
Pressure from investors, particularly through proxy voting, can help improve climate accountability across and within sectors. For example, in 2020, LGIM announced that it will be voting against all companies globally not meeting a sufficient proportion of its minimum standards. Figure 3 shows the split of companies with voting sanctions by sector.
Financial and technology companies dominate the voting sanctions list, which may seem surprising at first glance, but reinforces the need for scrutiny outside the ‘usual suspects’ in the fossil fuel industry. For example, while oil and gas companies are beginning to take steps to reduce their emissions, financial institutions in general have been less forthcoming in setting targets for the emissions associated with their portfolios.
Looking at a subset of the financial industry – real estate investment trusts (REITs) – less than 10% of the sector fully meets minimum standards requiring the full lifecycle emissions analysis and disclosure covering the carbon embodied in construction materials, as well as the emissions associated with the use of buildings. With new regulations in the UK calling for all new homes to be ‘zero-carbon-ready’ by 2025, unsatisfactory disclosure in this area may be a proxy for companies being exposed to future regulatory risk.
Momentum on climate action is growing across regions and sections. However, significant variation remains and substantial progress is required. Investors have an important role to play in influencing companies to improve on their climate policies and commitments; they can assert their influence through proxy voting, engagement – and if that fails – divestment.
As always, however, markets work best when supported and shaped by the right policies. The world’s eyes will soon be on COP26 in Glasgow, where policymakers are expected to strengthen ambitions to deliver on the Paris Agreement. As finance professionals, we must also rise to this challenge.
Iancu Daramus is a senior sustainability analyst at Legal & General Investment Management