In this report, the Australasian Centre for Corporate Responsibility (ACCR) explores the use of carbon exposure metrics to manage transition risk and highlights the issues with decarbonising listed equity portfolios by focusing on carbon exposure metrics alone. The report considers that both engagement and divestment strategies will need to be deployed by active owners and managers, complemented by reinvestment in climate solutions.

The report is arranged in the following sections:

Recommendations

With regards to investor commitments to decarbonise portfolios, the ACCR provides three recommendations to translate these commitments to a decline in emissions in the real economy:

• The scope and detail of portfolio decarbonisation must be transparent.
• Investors should provide a clear map of options for escalation and a timeline for when they are willing to employ these tools.
• It is particularly important that capital divested from fossil fuels or emissions intensive companies is redirected to climate solutions.

Why climate matters to investors

In the context of increasingly frequent and severe extreme weather events, investors are becoming aware of the highly visible risks to investments across a range of sectors. These risks include physical and transition risks. The potential for assets to become ‘stranded’ in a zero-carbon future is also a topic of deep concern for investors.

Australia’s emissions performance

Emissions in Australia from electricity and mining have increased in recent years. However, as a leading exporter of fossil fuels, the country’s largest contribution to carbon pollution is the burning (overseas) of coal, oil and gas extracted in Australian territory.

Investor commitments

The net zero investment framework for consolation developed by Europe-based Institutional Investor Group on Climate Change; and The draft 2025 target setting protocol developed by the UN-convened Net-Zero Asset Owner Alliance make strong efforts to define the methodology and mechanics of portfolio decarbonisation and suggest how divestment and reallocation efforts relate to engagement strategies. ACCR argues that these two documents give a sense of emerging shared goals and engagement standards around which the global investment community may coalesce.

Carbon exposure metrics

Within Australia’s superannuation sector, reporting of carbon exposure metrics is limited in several respects: the low number of funds disclosing, the variability of metrics used for disclosure, the infrequency of disclosures, and the presentation of data. This lack of disclosure prevents meaningful comparison between funds.

Cutting carbon

Reducing carbon exposure within a listed equities portfolio may not result in immediate emissions reductions in the real economy and may, in some cases, work against forceful and exhaustive engagement with carbon-intensive companies.

Implications for engagement

The report raises the potential for conflict between divestment reallocation behaviour and engagement activity. It argues that the reduction of carbon intensity in portfolios must be complemented by a focus on reducing emissions in the real economy. Investors should ensure that companies are reducing emissions rather than simply divesting emissions-intensive businesses or shifting emissions up their supply chain.

1. It is increasingly urgent that investors be accountable to their members and peers about the tools they are committed to using to engage with investee companies. Coordinated attempts at board renewal, strongly contested public discussions about company strategy, and legal avenues available to shareholders are rarely deployed. This undersells the power and responsibility of the investment sector in addressing the climate crisis.
2. ‘The principles for responsible investment’s inevitable policy response’ suggests any large-scale government intervention to address carbon emissions is likely to have a significant impact on companies that are yet to commit to ambitious emissions reductions pathways. This has implications for investors holding equity of these companies in their portfolios.
3. ‘The net zero investment framework for consolation’ emphasises investor engagement with companies as the primary strategy to achieve emissions reductions. The framework emphasises a holistic, portfolio-level approach to decarbonisation, proposing at least 70-90% of emissions from material sectors be either aligned to a net-zero pathway, or the subject of direct or collective engagement.
4. ‘The draft 2025 target setting protocol’ recommends that all members set engagement targets, using a priority sector-level approach, or the member portfolio’s top 20 (non-aligned) emitters, or those responsible for 65% of emissions in the member’s portfolio. The draft protocol recommends governments eliminate fossil fuel subsides, halt deforestation, and ensure investment in low-emissions infrastructure.
5. The Taskforce on Climate-related Financial Disclosures recommends that asset owners and asset managers report to their beneficiaries and clients the weighted average carbon intensity metric. This captures the relationship between carbon emissions and company revenue, which allows for greater comparability between companies and markets. Just six funds report weighted average carbon intensity.
6. Investors focused exclusively on reducing carbon exposure may overlook companies exposed to the fossil fuel supply chain, or companies exposed to the physical risks from climate change. Further, reducing portfolio carbon exposure does not grapple directly with the systemic risks of related upheaval and does not necessarily equate to reducing emissions in the real economy.
7. According to MSCI, the Australian share market is one of the most carbon-intensive indexes, so reducing carbon intensity in Australian equities is likely to prove more difficult than in international equities. For international equity portfolios, the larger number of companies and geographical representation in global benchmarks provide greater opportunity to reduce carbon intensity through stock selection.
8. 'The institutional investors group on climate change net zero investment framework' recommends investors set a goal for the allocation of a percentage of assets under management or revenues to climate solutions. Similarly, the Divest Investment movement suggests investors that divest from fossil fuels reallocate the funds to climate solutions, rather than simple reallocate the capital to existing shareholdings.