The climate-impact: Why are green house gas emissions so important to LGPS?

Photo by Christian Lue on Unsplash

Sponsored article: Global climate change is one of the largest challenges for local government pension schemes. James Parish asks why?

The carbon emissions gap, the difference between “where we are likely to be and where we need to be” to meet the 2°C goal of the Paris Agreement on Climate Change is still significant. By 2030, global greenhouse gas emissions will need to fall by 23% from 2019 levels to put the world on track to avoid a sub -2°C warming above pre-industrial temperatures.**

In May 2021, the G7 countries—UK, the US, Canada, Japan, France, Italy and Germany—announced more stringent commitments to tackling climate change.

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They are moving to keep their policies in line with 1.5°C, which implies much faster action to cut carbon emissions by 2030, placing additional pressure on companies and bond issuers to cut their emissions. For the UK this means, a target of reducing emissions by 78% on 1990 levels by 2035.

As economies and companies transition to low carbon, this creates risks in the underlying assets that local government pension schemes hold, beyond the physical risks of climate change and extreme weather events.

No one size fits all

A key step in understanding climate change risk is to recognise that it is multi-faceted. Rather than applying a standard computation, as might be the case with interest rates or inflation, there are multiple risks related to climate change that fall within physical and transition risks, which can be much more difficult to quantify.

Recognising this variability and investigating these challenges should help local government pension schemes better prepare, and understand how significant these risks could be to the funding and performance of their portfolios.

As governments and companies around the world have committed to reduce their carbon footprint, this will result in more decarbonisation regulation, driving companies to lower their carbon emissions as a part of the energy transition.

Understanding these transition risks are as important as quantifying the physical risks of climate change on portfolios. The decarbonisation transition poses a significant impact for economies and companies—some more than others, depending on how carbon-intensive they are—and how adaptable their business models are.

Measuring carbon

Carbon “footprint” is the process that shows the amount of carbon that companies or issuers within a local government pension scheme’s portfolio produce and, therefore, how much they contribute to greenhouse gas emissions.

To measure and monitor these metrics, so that you can begin to assess the associated risks, you must first be able to identify it, and this requires access to data. The most common way of doing so is to evaluate the total carbon emissions, carbon intensity, and carbon footprint of a company, fund and or portfolio.

There are three categories commonly used, which look at the emissions generated by companies. These are defined under the three “scopes”, described below, which are a recommended form of client reporting by the Task Force on Climate-Related Financial Disclosures (TCFD):

• Scope 1 involves the activities of a company or an organisation under its direct control. These might include vehicles, refrigerators and boilers, for example;
• Scope 2 involves indirect emissions. These might include the electricity generated by an external company and its heating and cooling;
• Scope 3 carbon emissions looks at everything beyond a company’s direct scope of operations. This includes emissions across an issuer’s supply chain and end-product usage by its customers. As such, scope 3 looks at a range of indirect emissions, such as business travel, employee commuting, purchased goods and services and capital goods. Scope 3 provides a full 360°-view of the total emissions that are attributable through the operation of a company.

Think big, start small: but start

Data standards are increasing and there are regulatory initiatives to drive consistency and develop reliable standard setting frameworks. The TCFD initiative, Partnership for Carbon Accounting Financials (PCAF), and GHG Protocol are some of those.

However, in the meantime, our recommendation for local government pension schemes that have not yet started the journey on measuring climate risks is to access independent carbon reporting data and establish a baseline understanding of overall carbon exposure and intensity scores.

This will enable more effective monitoring and aid the setting of realistic emissions targets at an investment and portfolio level.

Establishing a baseline now also means the momentum of change in the reduction of a scheme’s carbon footprint can be measured. This will help LGPS decision-making by determining their exposure to climate and transition risks and review how pooled and segregated mandates, and individual companies or bond issuers within those, are preparing for great decarbonisation transition.

How we partner with local government pension schemes on climate reporting

We already embark on cost transparency and benchmarking reporting for LGPS and we’ve extended our sustainable governance reporting solutions to include ESG and Climate Risks.

Our TCFD-ready climate risk reporting solution for pension schemes measures total carbon emissions (total greenhouse gas emissions attributable to a portfolio) and weighted average carbon intensity (weighting the carbon footprint based on a company or issuer’s holding size in a portfolio). We also report on scope 1, 2 and 3 carbon emissions.

Powered by Sustainalytics, an independent global leader in sustainability research ratings with a 25-year history, our tool provides LGPS with access to robust data and insight in a cost efficient and consistent way.

LGPS schemes don’t need to hold custody with us in order to access this reporting tool to help manage climate risks and benefit from a viewpoint of exposure to carbon emissions that’s independent from asset managers.

James Parish is head of UK pension sales and director at CACEIS.

Photo by Christian Lue on Unsplash

To learn more, speak to James Parish at 0207 580402 or email james.parish@caceis.com

**UNEP Emissions Gap Report 2020