In November, almost 200 countries will gather in Glasgow for the UN COP26 climate negotiations. At a time when temperature data from four international science institutions all continue to show rapid warming, with the last decades the warmest on record, the stakes have never been higher.
At the end of September 2020, BTPS set an ambitious 2035 net-zero goal for our £57 billion ($79 billion; €66 billion) investment portfolio. Since then, many other investors have set their own net-zero targets lending their support to the race to zero, which is hugely encouraging, but many more are still to take action.
Of the long-term risks monitored by the BTPS Trustee, it was increasingly clear that climate change posed the biggest threat to the scheme meeting its long-term commitments, both due to physical risks and from risks arising from the global transition to a low-carbon economy.
From a physical risk perspective, extreme weather events could cause shock waves in certain regions and, in turn, company assets. This raises potentially serious consequences for less resilient assets and companies.
Transition risks including those due to policy changes (such as high carbon prices) and disrupting technologies could impact a number of companies and sectors, both positively and negatively.
To better understand the potential impact of climate change on investment returns, we participated in studies undertaken by Mercer in 2011, 2015 and 2019.
We also undertook detailed analysis of our emissions as part of our Task Force on Climate-related Financial Disclosures (TCFD) report. While our listed equity portfolio and corporate bond portfolio are respectively 40 percent and 60 percent less carbon intense than for comparable indices, it was clear there was more we needed to do.
Roughly 80 to 90 percent of our emissions come from 10 to 20 percent of assets across our equity and corporate bond exposures. For example, in our equity portfolio’s scope 1-3 emissions, six companies represent over 50 percent of emissions, but just 2.5 percent of the portfolio by weight.
Unsurprisingly these companies are from the oil and gas, utilities and chemicals sectors. But, having this analysis means we know exactly where we need to focus our efforts.
A current risk
It has always been important to gauge our members’ views, and in January 2020 and January 2021, we surveyed our members to ask their attitudes toward responsible investment. The most recent survey showed that 76 percent of members said they expect the scheme to continue taking into consideration the environmental and social impact of the investments it makes. Over two-thirds (67 percent) said they expect the scheme to use its investments to make a positive impact on the environment and society.
At the start of 2020, we amended our core investment principle from finance first to sustainable long-term value creation. This was an evolution in our approach to responsible investment. One of the primary drivers of this change was the acceptance that climate change is a present risk to the scheme, not a future risk.
Many investors have set 2050 goals. Due to the fact that over the next 15 years there will be a major change in the investments held by the scheme as it matures, and because we are starting from a good position, we believed that we could reach net zero by 2035. By this date, almost all the scheme’s members will be retired. As a result, our investment strategy will shift towards safe, predictable income-generating assets such as bonds. This creates a unique opportunity, without incurring additional transaction costs, to make investments in companies that have lower emissions and increase investment in transition solutions.
“We […] felt confident that through our engagement activities we could see change relatively quickly”
As the majority of our emissions come from a minority of our assets, we also felt confident that through our engagement activities we could see change relatively quickly that will improve long-term outcomes for both the portfolio and the environment. Similarly, we expect profitable low-carbon transition-aligned opportunities to emerge over time, and capitalising on them will be an important part of the strategy.
In the long run, we believe that taking this step will result in a portfolio with the same or better investment returns. In fact, the cost of inaction has been established as a significant risk to the scheme and it far outweighs any additional costs experienced through the transition.
The scope 3 data challenge
While we believe that we can achieve our goal, as investors in the real economy there are a number of factors outside of our control. We are reliant on action from governments, companies and consumers.
“For those PE investors wishing to remain relevant with clients and prospects, having a strong grasp of climate change risks and opportunities will be critical to success”
A significant challenge we face is emissions and climate change data availability. While we have relatively good data on our public equities and corporate bonds, coverage of scope 3 emissions in some sectors and data for other asset classes is more limited. Private equity is one of these asset classes.
However, with the growing adoption of the TCFD recommendations and initiatives such as the Institutional Investors Group on Climate Change (IIGCC), the Principles of Responsible Investment (PRI) and Initiative Climat International (iCI) helping provide guidance for GPs, there is already a significant amount of support to help this asset class move past the current barriers. And for those PE investors wishing to remain relevant with clients and prospects, having a strong grasp of climate change risks and opportunities will be critical to success.
With all this uncertainty, we could have chosen to sit on our hands and wait for the depth and quality of data to improve or for clearer policy guidance, but having decided that climate change was a major risk for the scheme and given the size of the scheme’s assets, we concluded that we need to get started now.
Over the coming years we’ll be actively engaging with government and other investors to call for policy and regulation to require greater transparency. This is why we have chosen to support the IIGCC Net Zero Investment Framework and the Net Zero Asset Owner’s Alliance (NZAOA) since in the coming years, pushing for data improvements will be among their biggest initiatives.
Achieving net zero won’t be easy. But, if humanity fails to change course now, we risk passing the point of no return on climate change with disastrous consequences for the ecosystems that sustain us, the world’s people and the global economy.
This new goal marks a step change in the action we are taking and we hope that all schemes will align to net zero to safeguard their portfolios and the planet.