Climate goal alignment and corporate bonds transition risk

The question of portfolio alignment with the 2°C or well-below 2°C goal is essential to investors. The report highlights the importance of building more robust analytics and capabilities to support climate-aware investors for better decision-making across the full scope of their investment portfolios.

The corporate bond universe

The size of the global bond market is roughly $100 trillion globally, with sectors like agriculture and forestry, chemicals, and glass. The report also discusses the importance of environmental, social, and governance (ESG) issues in the corporate bond universe, including reporting on carbon footprints. Investors would need to embed climate considerations into their bond investment decision-making process, including credit analysis, and regulatory actions could play a critical role in driving this process.

Climate scenario analysis for corporate bonds

This section shows the application of the 2° Investing Initiative asset-level data 2°C scenario approach to corporate bonds. Asset-level data is one of the potential solutions to the challenge of identifying the climate risk of non-listed companies. Further, sectoral estimates can be used as a proxy for overall exposure to economic activities covered in 2°C scenarios, but more specific analysis is needed. Optimising corporate bond portfolios as part of a 2°C alignment strategy may require a significant commitment of analytical resources.

The role of climate scenario analysis in credit risk and portfolio management

The report highlights the importance of assessing whether corporate issuers are misaligned with the IEA Sustainable Development Scenario. At the sectoral level, data from asset-level can be collected, such as physical production assets sourced from business intelligence databases and publicly available databases, for key high-carbon sectors. Furthermore, the report also outlines the importance of proxy measurements, for example, the percentage of revenue linked to high-carbon sectors, ESG ratings and other tools, in assessing emission reduction targets.

The use of climate scenario analysis in managed funds

Not only are managed funds becoming increasingly responsible in terms of investors’ key motivations and objectives, but they also need to ensure their investments align with the country’s climate goals where they operate. This section of the report acknowledges managed funds as a significant factor in the bond market with a growing focus on sustainable investment practices and alignment with climate goals. The report suggests that they can achieve such goals by using a range of tools, including providing capital, stock selection, sectoral screens, norms-based screening, and engagement.

Conclusion and potential for action

The report concludes by emphasising the importance of developing a more comprehensive understanding of the relative impact of various strategies adopted by investors. While most of the analysis to date identifies “soft” impact, such as awareness raising and cultural shifts, scientific evidence as to the relative impact of each approach is necessary. The report suggests that financial supervisors, investors, and rating agencies work together to build that evidence base and assess every approach’s potential impact. To illustrate, investors’ potential actions include adjusting their portfolio strategy, withhold capital, influencing pricing, and engagement. Policymakers can also play a critical role in aligning bond markets with climate goals by implementing regulatory measures to increase disclosure and adopt common methodologies for analysing climate-related risks.