Climate investing: can structured finance and indexing save the planet?
Asset owners concerned with bringing about meaningful change in the environment are entering a market that is offering greater choice but also greater diversity and complexity in investment methods than ever before, analysts say.
Kerry Craig and Marcella Chow, global market strategists at JP Morgan Asset Management, highlighted in a report issued last week that the financial industry is getting closer to meeting investors' needs as global policy edges towards net-zero emissions.
“Achieving net-zero emissions by 2050 has become the new benchmark,” according to the report.
At least 58 countries (54% of global GHG emissions) have now set net-zero targets. Most notably, China recently reiterated its ambition to achieve the net-zero goal by 2060, "allowing itself more time, but setting a more ambitious change relative to others," the report said.
On April 21, Chinese authorities issued an updated catalogue of economic activities eligible to be financed by green bond issuance, known as the Green Bond Endorsed Projects Catalogue.
“It completely excludes coal and other fossil fuels – even ‘clean use’ of such fuels – from green activities,” said Conrad Tan, investment strategist at Bank of Singapore, in a paper issued last week.
Tan said this clearly signals China’s policy intention to direct capital raised from green bonds to support the transition away from fossil fuels and towards low-carbon projects.
China is working to mobilise “massive green investment”, and has identified green finance as a priority for the next five years, People’s Bank of China (PBoC) governor Yi Gang said on March 21.
The PBoC plans to develop a mandatory disclosure system that would require all financial institutions and firms to follow uniform disclosure standards and is also working with the European Union to harmonise green taxonomies, Yi said.
Achieving net-zero emissions will require huge changes to the global economy in terms of energy mix, consumption, housing and even human diets.
Some carbon-intensive industries will be easier to decarbonize than others. Power generation, for example, is much easier to decarbonise than steel or cement production.
“The complexity of this problem highlights why it is important for policymakers and investors to precisely map, quantify and analyse global emissions,” said the JP Morgan analysts.
STRUCTURED FINANCE WILL HELP
Ben Caldecott, founding director of Oxford University’s Sustainable Finance Programme acknowledges that climate risk management is important for investors, but said it is important to make a distinction between risk management and making a difference to the environment.
“I’ve seen a lot of literature and investee reports making the claim that because we’re disclosing our climate risk exposures we are tackling climate change. We’ve got to be much better at calling this out.”
He expects the structured finance world to provide investors with the tools, in the form of sustainability linked loans (SLLs) and green bonds, to make a greater impact: “that will take it to another level," he told an online ESG forum.
The move towards green financing has, up to now, been driven by equity investors and Caldecott said, “We see growth opportunities across a range of industries, including climate-resilient infrastructure enterprises, renewable energy, electric transport, and digital agriculture solutions.” That’s now translating into the debt market, he said.
As Asianinvestor has reported, the supply of social and green bonds is still relatively small.
The availability of cleantech debt financing has been constrained by a lack of certainty regarding future regulation, a general lack of liquidity in the capital and loan markets, and a shortage of suitable debt-financing structures.
Investors also remain unconvinced by the pure investment returns available. Dong Hun Jang, CIO of Korea’s Public Officials Benefit Association (Poba) told AsianInvestor that while Poba has been considering investments in public equities, real estate, and infrastructure, it could not invest in ESG bonds because the potential returns do not meet the pension fund’s yield expectations.
INDEXING APPLICATIONS
Carbon beta, which is smart beta capturing positive climate factors, is expected to become a useful option for climate-focused investors in the next few years. Index providers are also making greater progress in rating companies and issuers on their environmental friendliness.
S&P Dow Jones has just released a series of ESG industry report cards for structured finance. In their analysis, for example, auto- and commercial mortgage asset-backed securities have above average environmental exposure. ESG-related rating actions over the first quarter edged up to 201 (83 in March), of which 126 were downgrades, with 30% related to environmental influence.
Adam Matthews, chair of the Church of England Pensions Board and also chair of the Climate 100+ initiative, said the most important step his fund has made to date, which fits in with a net zero investment framework, was having a large passive allocation tied to the FTSE/TPI climate transition index.
The $4.2 billion pension fund allocated £800 million ($1.13 billion) to this strategy.
“It meant we could look at company commitments on a forward trajectory and align with those that are beginning to transition (to net zero) and equally make sure we are not invested in those that are resisting the transition,” said Matthews.
An additional challenge for the Asian market is in the collection of the appropriate data. According to the JP Morgan analysis, only 2% of MSCI China index constituents reported Scope 3 greenhouse gas emissions. “Metrics being disclosed are often based on inconsistent methodologies, which limits comparability and increases potential for misuse.”