Net Zero: A step in the right direction

By each passing day, climate change is getting more and more attention and some terms related to it are being used more often these days. For example, now a days “Net zero” is increasingly and more prominently in the news. So what is Net zero? Simply put, Net zero means achieving a balance between the greenhouse gases put into the atmosphere and the greenhouse gases taken out. In other words, Net zero will be achieved when the amount of greenhouse gases humankind emits equals the greenhouse gases it removes. It can also be called carbon neutral. Net zero can significantly contribute in tackling climate change through limiting greenhouse gas emissions.

However, Net zero is different from Gross zero, which means stopping all emissions. That is something which is neither desirable nor achievable. Gross zero is an unrealistic target considering it would mean the complete overhaul of modern lifestyle. Nevertheless, for mitigating the climate change risk, Net zero is good enough as it considers emissions on an overall basis. This Net zero target is still many years away even if all goes well, but practically speaking, it will be achieved using methods which include, a) reducing unnecessary and avoidable emissions, b) increasing forest cover as trees take carbon dioxide from the atmosphere, c) through new technology.

Net Zero Asset Managers Initiative: Asset Managers’ way to ‘Net zero’

If Net Zero is important, how can we achieve it or make progress in that direction? One important way this can be achieved is through ensuring that the flow of money gets directed by this objective. This is exactly what the Net Zero Asset Managers Initiative (NZAMi) has been trying to achieve in a planned and systematic manner. NZAMi was launched in December 2020 and the asset managers associated have committed to support achieving net zero greenhouse gas emissions latest by 2050 and will be aligning their investments to limit warming to 1.5 degrees Celsius.

For a Climate change initiative that was launched barely six months ago, NZAMi has grown rapidly and it has come a long way in a very short span of time. The NZAMi already has 128 signatories and a cumulative $43 trillion in assets under management with a focus on encouraging the global asset management industry to commit to a goal of net zero emissions and making progress in a timebound manner. What would you call a 47% growth in the number of signatories and a 16% growth in assets under management (AUM), in just two and a half months?

The first six months have been encouraging for NZAMi

This translates into a mindboggling 500% plus growth on a compounded basis annually for the number of signatories and 100% plus on AUM. Yes, that is exactly what Net Zero Asset Managers initiative (NZAMi) has delivered. From 87 investors and asset managers collectively managing $37 trillion as reported on 20th April 2021, to a total of 128 investors managing $43 trillion as on last Tuesday, 6th July, the growth has been substantial. The latest additions include big asset managers such as Amundi, Sumitomo Mitsui Trust, Franklin Templeton, MFS Investment Management and HSBC Asset Management. The list already includes Blackrock, State Street and Vanguard that had joined earlier.

For any new initiative, the support of the partner organizations is very significant in building the momentum and here too, NZAMi has six network partners including CDP and PRI (Principle for Responsible Investment). The others include Asia Investor Group on Climate Change, Ceres, The Institutional Investors Group on climate Change (IIGCC) and Investor Group on Climate Change. These investor networks are called ‘Network Partners’.

NZAMi works with several other organisations including UNEPFI, Climate Action 100+, Climate League 2030, Paris Aligned Investment Initiative, Science Based Targets Initiative for Financial Institutions and UN-convened Net-Zero Asset Owner Alliance. The good thing is that it is not all too much into the future as NZAMi mandates that setting interim targets for 2030, which are consistent with 50% global reduction in CO2, is very important. For NZAMi, we need to quickly transition towards global net zero emissions and asset managers can play a critical role in this.

Net Zero Asset Managers Commitment: Guidance and Details

There is a lot of detailing that has gone into drafting the commitments on Asset Managers’ part so that the desired results on Net zero are achieved, but first things first, there are three main NZAMi components expected from Asset Managers;

• Work in partnership with asset owner clients on decarbonisation goals, consistent with an ambition to reach net zero emissions by 2050 or sooner across all assets under management
• Set an interim target for the proportion of assets to be managed in line with the attainment of net zero emissions by 2050 or sooner
• Review interim target at least every five years, with a view to ratcheting up the proportion of AUM covered until 100% of assets are included

But this is where things get more interesting because it is not just top-level guidance. There is a clear focus on interim targets and NZAMi stipulates that in order to fulfil ‘interim targets’ commitments, Asset Manager will:

• Set interim targets for 2030, consistent with a fair share of the 50% global reduction in CO2 identified as a requirement in the IPCC special report on global warming of 1.5°C
• Take account of portfolio Scope 1 & 2 emissions and, to the extent possible, material portfolio Scope 3 emissions
• Prioritise the achievement of real economy emissions reductions within the sectors and companies in which they invest
• If using offsets, invest in long-term carbon removal, where there are no technologically and/or financially viable alternatives to eliminate emissions
• As required, create investment products aligned with net zero emissions by 2050 and facilitate increased investment in climate solutions

While there is no distinct priority order from NZAMi, we think all of these will have serious implications and some of the important fallouts could be;

• Asset Managers will prefer investing in companies which have a clear path on Net zero and have set well defined emission reduction targets and scenario base plans compared to companies offering only vague assurances.
• The companies will increasingly come under more pressure to report their Scope 3 emissions and while Scope 1, Scope 2 emission are already mainstream, the number of companies reporting Scope 3 will increase significantly in coming years.
• As we have seen in several recent cases, the thrust on Scope 3 reporting by companies has increased significantly and this will be pursued by more and more asset managers. Reliable and verifiable Scope 3 emissions is a challenge for many companies.
• The companies will require to put in effort and resources to do the same. For asset managers, the focus has to be on their portfolios and capturing data on Scope 3 emissions. That will require some expertise and experience.
• The Asset Managers will tilt more towards companies and sectors which are structurally better placed on emissions reduction. There is a likelihood that the Asset Managers will need to allocate more resources to evaluate companies in more detail.
• The last point is the most relevant in our view. If Asset Managers need to create investment products aligned with net zero emissions by 2050, we can expect that the Asset Managers will be launching more such funds and that will give more choices to investors.

One clear takeaway is that the thought process on what asset managers need to do to address the climate change challenge is shifting from a company focused approach to a more comprehensive portfolio-based evaluation.

NZAMi guidance applies across all assets under management

The Asset Managers will also need to work on developing a robust ecosystem and creating awareness will be a critical part in this endeavour. As per NZAMi, the Asset Managers are expected to;

• Provide asset owner clients with information and analytics on net zero investing and climate risk and opportunity
• Implement a stewardship and engagement strategy, with a clear escalation and voting policy, consistent with ambition for all assets under management to achieve net zero emissions by 2050 or sooner
• Engage with actors key to the investment system including credit rating agencies, auditors, stock exchanges, proxy advisers, investment consultants, and data and service providers to ensure that products and services available to investors are consistent with the aim of achieving global net zero emissions by 2050 or sooner
• Ensure any relevant direct and indirect policy advocacy that asset managers undertake is supportive of achieving global net zero emissions by 2050 or sooner

Once again, we think that some of the important implications could be;

• The Net zero is not limited to any particular asset class and the Asset managers will have to think about their portfolios much more holistically. That is not a simple thing to do. While it is not easy to cover stocks, bonds and private investments will be even more complicated.
• Asset Managers will have to make more investments in creating an investor awareness plan and focus on explaining the terminology so that the investors can decide better on how to prioritise their climate change related objectives.
• The companies will increasingly come under more pressure from investors as shareholder activism increases. The Asset Managers will be more vocal and assert themselves on how the board and management take decisions on the emissions related environmental issues.
• Net zero is a fairly complex topic. Many of the terms currently in use are technical in nature and the Asset Managers will need to make more efforts to understand the path to Net zero. The choices they make have implications for how much progress they will make.

The focus on Accountability

NZAMi mandates that the Asset Managers will need to;

• Publish Task Force for Climate-related Financial Disclosures (TCFD) disclosures, including a climate action plan, annually, and submit them to the Investor Agenda via its partner organisations for review.
• This is to ensure the approach applied is based on a robust methodology, consistent with the UN Race to Zero criteria, and action is being taken in line with the commitments made.

Involving stakeholders and getting them excited about any new initiative is one of the core requirements for the future success and from that perspective, NZAMi has done a really good job so far. We think that this thrust on accountability will have important implications including;

• Apart from emission targets and portfolio alignment, NZAMi signatories are committing to a more transparent and rigorous accountability. For example, NZAMi associated Asset Managers will report progress annually against the TCFD recommendations.
• Usually, the challenge is bigger in evaluating the progress and if things are on track for the 2030 and 2050 goal, this disclosure on asset managers’ part could be extremely effective in addressing how to bring the laggards up to speed, in case there are any.

How EMAlpha can help Asset Managers

There is, undoubtedly, a profound ESG movement going all over the globe right now. From countries to asset managers, from millennial investors to the old school stalwarts, everybody’s counting on the ESG chip for a better future and a better return on investment. While more signatories and increasing AUMs at NZAMi is a positive development, this was the fairly easier part. The real struggle for asset managers is in ensuring that their portfolios get evaluated properly.

Once this evaluation is done in an objective manner, the portfolio managers will need to ensure that their AUMs then get aligned with Net Zero. While some asset managers can do it on their own, that proportion is very small and most of them would need external help. For example, EMAlpha’s proprietary portfolio evaluation tools for the ESG frameworks can help in these situations such as how a portfolio scores on TCFD and what that means relative to the benchmark.

In general, EMAlpha with its proprietary AI-ML techniques becomes useful for investors to gauge companies on the ESG front. As we have discussed, the changes in perception on ESG track record of a company and reactions from institutional investors have become an important driver of stock prices and especially in cases where the volatility is high, it matters even more. From individual stocks to a portfolio, the complexity increases even more and EMAlpha AI-ML is a helpful tool for Asset Managers in evaluating progress for their portfolios and take corrective measures, as and when required.