The merits of scenario analysis and the ambitions of the EU’s Sustainable Finance Action Plan were high up the agenda at this year’s Green Equities conference in London.
Climate scenario analysis – as recommended by the Task Force on Climate-related Financial Disclosures (TCFD) – can be "infinitely confusing", Environmental Finance's Green Equities conference heard.
The comments from investors and the results of an audience poll indicate that many agree with a controversial statement in the days ahead of the event from BP CEO Bob Dudley, that climate scenario analysis is “potentially confusing for investors”.
Matthew Smith, head of sustainable investment at Storebrand Asset Management, said the TCFD was a helpful tool but added that scenario analysis has potential pitfalls.
“TCFD has moved the focus from one point in time to governance and strategy … from quantitative metrics to more qualitative descriptions about where a company is going. It puts a great emphasis on engagement for us,” he told a panel on how investors set climate goals.
But he warned that the conclusions from scenario testing are closely correlated with assumptions, summarising this problem as: “[put] shit in, [get] shit out”.
He said this can be because of “technical optimism” such as excessive faith in carbon capture and storage, or because the pace of transition risk is underestimated.
“It’s infinitely confusing because there’s an infinite number of ways to put the scenarios together. That doesn’t mean it’s useless, it has a significant role to play – but we need clarity on how the process is standardised.
“We are looking for companies that use stress tests that actually create stress, rather than making a nice pathway to the future where business as usual is possible,” he said.
A poll of the audience revealed that many share these concerns. When asked to vote on whether climate scenario analysis is confusing for investors, 53% either agreed or strongly agreed.
Investors that want to push companies to align their business models with the Paris climate agreement should ask them to set targets, rather than getting “lost in a world of scenarios”, said Adam Matthews, head of engagement at the Church Commissioners and Church of England Pensions Board.
He warned that the information requested by the TCFD does not provide the whole picture. Instead, investors should ask companies to set targets for how they will transition their businesses to be in line with the goals of the Paris agreement – to limit warming to 2°C, with the aim of limiting it to 1.5°C.
“The TCFD has been helpful because it communicates [this issue] as something you can’t ignore,” he said. “It’s really important, but let’s be clear – it’s not the whole picture.
“My fear is that you could be lost in a world of many scenarios. Be sure your engagement is on the right track and don’t be led too far down the path of [seeking] the right scenarios.
Meanwhile, investors discussed the EU’s Sustainable Finance Action Plan, including its plans to create a taxonomy of what is green.
The task of writing taxonomies for sustainable finance is best left to the private sector, argued Ian Simm, CEO of Impax Asset Management.
“One of the great benefits of having the private sector write taxonomies, as opposed to the public sector, is that it leaves scope for innovation and competition and gives consumers choice,” he said. “So, we are great advocates of leaving the private sector to determine taxonomies.”
Private equity firms will struggle to implement the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) across their many portfolio companies, a stream at the conference dedicated to private equity heard.
They are currently ill-prepared to respond to what is likely to be growing demand from their investors for climate-related information, according to Alison Hampton, a lawyer and founder of Alma Verde Advisors.
“I cannot see that there is going to be anything other than a move from LPs to say that 'we are reporting globally as asset managers on TCFD, we need you to contribute as well’,” Hampton said.
“I think private equity is going to struggle initially, and is going to have to get up to speed on how it gathers that information from its myriad portfolio companies,” she added.
Phil Case, a director at ‘big four’ auditing firm PwC, appeared to agree: “My own sense is that the private equity response is some way yet from conducting scenario analysis.”
James Burdett, co-chair of law firm Baker McKenzie’s global funds group, said private equity is right to approach reporting in line with the TCFD slowly, even if legislation is likely to require compliance with the recommendations within five years.
Meanwhile, Burdett added that efforts to clarify investors’ fiduciary duty with regards to environmental, social and governance (ESG) factors in regulation are misplaced and could “unnecessarily box investors in”.
A panel on ESG investments heard from Jim Totty, managing partner at Sustainable Technology Investors, that food technology is “one of the hottest areas of venture capital in play”.
Peter Bachmann, a director at Scottish Equity Partners, said: “Food tech [is] a $7.8 trillion market globally. 40% of the global population is involved in food production. That’s probably the one industry that’s not been ‘uberised’. That’s a huge opportunity for disruption and technology to go in there, and sustainable decarbonisation.”
“I’m not a fan of having a standard definition of green,” added Simm. “I think green is a spectrum, and clients or asset owners need information about what elements of green [are being employed]. This can be explained via disclosure or by private sector labelling, such as [the system used by] LuxFlag.
“I don’t really think the government needs to intervene to set standards.”
Simm pointed out that Impax had already written its green taxonomy, in 1999, called Environmental Markets, which was subsequently adopted by FTSE Russell.
But in a later session, Thomas Tayler, a senior counsel at Aviva Investors, said he felt the Commission’s plans to establish a green taxonomy had been widely “misinterpreted”.
“I think the Commission sees the taxonomy as a tool to define what is dark green,” he said. “It’s a way to show they are not greenwashing and are committed to sustainability. It’s seen as one way of doing that, but not the only way.”
Tayler continued that he thinks the Commission’s plans to reform definitions of investors’ duties are potentially significant.
“It [the proposal] is trying to ensure that there is consideration [of investors and asset managers] of sustainability in every product in the investment process, in the way that firms are set up,” he said.
Rachel Ward, head of policy at Institutional Investors Group on Climate Change (IIGCC), added that she sees the potential of the proposal to drive “real systemic change of the whole financial system”.
By Peter Cripps and Elena Johansson
