Woods paper calls for carbon clarity

Ian Woods
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(pictured: Ian Woods)

Listed firms need to better disclose their exposure to carbon emissions, according to Ian Woods, AMP Capital Australia head of environmental, social and governance research. Otherwise, it is difficult for investors to assess climate risk.

In a paper published this month, Woods says carbon disclosure at the individual firm level is the “critical first step” investors rely on when judging climate change risk in their portfolios.

However, he says inconsistent carbon-reporting methods and the reliance on historical data make it difficult for investors to accurately assess climate change risks in portfolios or indices.

“Given the issue of climate change and disclosure by companies is something that has been on investors’ agendas for more than ten years, it is time that companies adequately report on their emissions,” Woods says in the paper.

He argues the most relevant CO2 emissions measure from an investor perspective takes into account a company’s “equity-based” exposure rather than operational-only carbon metrics.

Woods cites the example of ASX-listed building materials firm CSR, which also owns (but doesn’t operate) a 25 per cent stake in an aluminum smelter. Under the typical operationally-based disclosure methods, CSR would report just 20 per cent of a carbon exposure measure that included its part-share of the smelter.

“So, a metric of tonnes CO2-e/yr per $ million of invested funds, based on equity-based emissions of companies, is considered the most appropriate metric to assess the exposure of an equity portfolio and for meaningfully communicating to investors the exposure of the fund,” the report says.

However, the AMP paper also highlights some of the complexities involved in measuring portfolio climate change risk based on carbon emissions data.

For instance, investors are at risk of “double, triple (or even more) counting of the same emission” at the portfolio level depending on the carbon-reporting scope of underlying companies.

As well, investors apply a range of assumptions when measuring emissions risk including, the ability of individual firms to pass on carbon costs and a global standard carbon price.

“The choice of metric used to assess risk, and an understanding of the limitations of the metric, is critical if investors then incorporate the metric in their investment decisions,” the paper says. “Using the wrong metric can mean investors are not managing the real risk, despite their efforts. A better approach may be to understand risk at individual company level rather than relying on broad portfolio level measures based on an inappropriate metric.”

Based on a carbon price of $50 per tonne, AMP puts the MSCI “greenhouse gas emission intensity” at 156 tonnes CO2-e/$m invested, compared to the ASX 200 rate of 128 tonnes (on an equity-based measure) and 141 tonnes based on operational metrics.

“Given the perceived importance of the mining and energy sector to the Australian economy, it is perhaps surprising that the greenhouse gas emission intensity of the ASX200 is less than that of the MSCI World, as is the greenhouse emission investment risk,” the paper says. “…Given the smaller number of stocks in the ASX200, seven companies, which account for 9 per cent of the index, contribute two thirds of the greenhouse gas intensity of the ASX200.”

Despite the challenges, Woods says the global political response to climate change (as epitomised by the 2015 Paris agreement) and subsequent pressure from “members and non-government organisations” means investors are being forced to disclose “their carbon exposure and demonstrate they are managing the risks”.

The estimated greenhouse gas emission intensity of the MSCI Index was estimated at 156 tonnes CO2-e/$m invested. The distribution of this exposure is similar to the total emissions exposure and is given below.

The results show that the fund has consistently had less exposure than the ASX200 and during the same period has outperformed the ASX200 with respect to investment returns. It highlights that through active funds management, climate change exposure can be achieved without adversely impacting investment returns.

– David Chaplin, Investment News NZ

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