Since its inception a few years ago, a framework for net-zero-aware pensions investments, published by the Institutional Investors Group on Climate Change, has been evolving. Maria Nazarova-Doyle explains why she is a fan
It’s just 27 years until we will hit the 2050 deadline for achieving net zero, and with global warming and threats to the natural environment on the rise, we need to act. How can investors develop a strategy to support their climate-related ambitions? This question is particularly important because pensions can be a powerful tool in influencing change and tackling climate problems.
The Institutional Investors Group on Climate Change first published the Net Zero Investment Framework (NZIF) in August 2020. A ‘living’ or updateable document, it forms part of the global Paris Aligned Investment Initiative and is designed to help investors implement their net-zero commitments and align with the goals of the 2015 Paris Agreement. The document is a fantastic blueprint for transforming investment portfolios and making a tangible difference in the real world.
A focus to follow
The NZIF aims to give institutional investors the tools they need to develop, implement and measure an effective net-zero strategy.
It comprises four asset classes, with the intention of adding more over time, and aims to be applicable to as broad an audience as possible, providing flexibility to account for different contexts and geographic and regulatory environments.
The Framework’s focus is two-pronged:
- To decarbonise investment portfolios, in line with reaching global net-zero greenhouse gas emissions by 2050
- To increase investment in climate solutions to achieve this.
The NZIF’s key pillars offer a foundation on which to create a rigorous, measurable and achievable climate action plan that can be used by a wide range of stakeholders. The pillars are:
- Governance and strategy – set out the commitment to net zero and create a strategy to achieve it by 2050 or sooner. Also, assess current financial risk, publish proposals and set out plans for disclosure
- Targets and objectives – set out clear targets for reducing emissions and to enable progress to be monitored. This may involve overall portfolio carbon goals such as reducing the carbon intensity of investments over shorter timescales and achieving net-zero emissions by 2050 or sooner. It could also include more specific thematic goals, such as investing in climate solutions. The key is clarity, so the schemes and providers can be held accountable by their stakeholders
- Strategic asset allocation – set the asset class mix with climate targets in mind and integrate climate awareness into optimisation. Pension providers and schemes can look to develop and refine their fund range to navigate towards those that are investing in less carbon-intensive businesses or developing climate solutions. This could be achieved by investing in specific climate or impact funds. Another way to align with this pillar could be taking into account the long-term risk of climate change when projecting potential outcomes for asset classes, when reviewing the strategic asset allocation optimisation for multi-asset pension default funds
- Asset class alignment – assess assets and set targets, construct a portfolio based on targets and consider selective divestment
- Advocacy and engagement – manage at a policy and market level. As stewards of members’ investments, pension funds should ensure their appointed investment managers and investee companies behave responsibly and sustainably. Funds should work with their investment managers and investee companies to drive change and improve decarbonisation-related practices.
The NZIF says targets should be aligned with science-based pathways and should include:
1.Emissions reductions targets with:
- Clear evidence of how the target was determined
- Clear evidence of how it follows a net-zero pathway – in other words, “economic, emissions, and technology pathways that result in a high probability of achieving the 1.5°C goal”
- A plan for robust measurement and reporting.
2. Targets for allocation to climate solutions that increase over time and are aligned with the net-zero pathways.
The NZIF highlights three actions that should be considered when allocating assets:
1. Developing climate-aware investment strategies and climate solutions investments
2.Integrating climate considerations into asset allocation optimisation
3.Excluding high-carbon investments that lack an obvious transition pathway.
Climate-aware investment strategies could include adapting to become less carbon intensive, or developing climate solutions. Climate solution investments could be in firms whose revenue is derived from activities such as sustainable agriculture, energy efficiency or alternative energy.
Assess and measure
The NZIF delivers comprehensive guidance for asset class targets and measurement across sovereign bonds, listed equity and corporate fixed income and real estate.
Underpinning these targets and strategies is the need for accurate calculation of emissions as a starting point, and then on an ongoing basis to track progress and maintain momentum. An industry standard for calculating financed emissions, developed by the Partnership for Carbon Accounting Financials, has been widely adopted by many within the financial sector to measure greenhouse gas emissions that are applicable to investments.
Divestment and engagement policies are crucial in any net-zero strategy. It is important to engage with the market, investee companies and asset managers on achieving net zero if the industry is to meet Paris Agreement targets. There is a lot of debate in the industry over the right balance of engagement and divestment and we recognise that both are essential tools.
While selective divestment can be powerful (and, indeed, companies do not have an automatic right to receive investments just because they are part of an index), it must be balanced with active stewardship efforts. Investors can work closely with investee companies to support their transition plans and help develop strategies to manage net-zero progress, ideally incorporating just transition principles. The NZIF can be used to create standards and parameters that help pension funds to develop voting guidelines that provide clear expectations around what companies need to work towards and report on. There are also numerous activities encouraging pension industry participants to collaborate to enable net-zero progress.
With its easy-to-follow format and the Paris Aligned Investment Initiative’s emphasis on using benchmarks to spur companies on to achieve net zero, the NZIF offers practical support to investors as they move towards net-zero targets. With stakeholders becoming increasingly conscious of the importance of net-zero pensions and investments, and regulators taking a keen interest in this, the framework will become ever more useful.
MARIA NAZAROVA-DOYLE is head of responsible investments at Scottish Widows
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