A prudent investor approach to climate change is to first understand the climate implications and questions concerning their own investment strategy. Only then will the most appropriate analysis be chosen and applied.

November 23, 2020

10 Lessons From 10 Years of Helping Investors to Tackle Climate Change

In 2010, ISS ESG’s head of Climate Solutions Max Horster started one of the first companies to measure the climate impact on investments. From investment carbon footprinting to climate scenario analysis, from climate-linked proxy voting to climate neutral investments via offsets: Over the years, the team pioneered a wide range of today’s leading methodologies and approaches across all asset classes. In 2017, Max and his team joined ISS ESG to form the first climate specialist unit of a global ESG service provider. Today, they cover over 25,000 issuers on up to 600 individual climate-linked data points and have screened over $4 trillion of AUM on their climate risks and impact. On the occasion of its 10th anniversary, the ISS ESG Climate Team shares 10 lessons from 10 years of helping investors to tackle climate change.

Lesson 4: Measuring Mayhem – lots of answers, but to which question exactly?

In The Hitchhiker’s Guide to the Galaxy by Douglas Adams, an enormous supercomputer named Deep Thought calculated the answer to the “Ultimate Question of Life, the Universe, and Everything.” This super sophisticated machine comes to the conclusion that the answer is the number 42. Unfortunately, no one knows what the question is. Sometimes, this is the notion that investors have when running a climate analysis: Great output but what is the question I wanted an answer for?

In a world with no shortage of methodologies to measure portfolios’ climate implications, investors often feel overwhelmed with where to start. Rather than initially deciding on the type of understanding they want to gain on their portfolio, the first reaction is to run just any analysis that happens to be within reach. This typically comes down to one of two options.

1.) Investors pick up their phone and ask what their incumbent ESG provider happens to have on offer. The challenge is that not many providers have a holistic suite of analytical tools to cater to different climate-linked questions, but rather just one type of solution. In other words, the investor ends up with an answer to the climate-focused question behind the provider’s solution, rather than to the question that the investor might have had in the first place.

2.) Investors opt for a free analysis (such as the Paris Agreement Capital Transition Assessment, or PACTA) that is provided by the government, regulator or industry association – this, after all, means that no budget and no top-level approval is required for running the analysis. Such an approach can not only fall short of the quality of analysis that might result in C-suite level interest and allocated budget, it also raises the inevitable awkward question of what “free” means: it is typically paid by taxpayers’ money and is rolled out at the expense of commercial providers who then lack the funds to invest in further product development and R&D.

But the real issue is that freely obtained analysis still doesn’t solve for getting to the bottom of what really matters to investors. Or, as a group of institutional investors phrased it in 2018: “If Carbon Footprint is the answer, then what is the question?”

So, what is the investment climate question? It’s not that simple.

The question could be linked to a climate reporting regime: What should I report under the PCAF reporting initiative that originated in the Netherlands? How should I report climate risks in line with the TCFD? What are useful metrics for Net Zero targets and how do those differ from 2-degree scenarios? What does the EU taxonomy want to know? What unit, timeframe, currency, look-through date, denominator, etc., does the particular regime ask for? ISS ESG currently counts over 50 reporting regimes globally to which investors could or should adhere. Depending on the regime’s reporting requirements, the analysis must adjust accordingly.

The question could also link to investment metrics that don’t necessarily follow any standards or regimes. On the contrary, they might deliberately deviate from anything anybody else is using to establish that edge that makes their own investment product more competitive.

In other words, these questions about investment climate risk and impact can come in all forms and shapes and are likely to differ from one investor to another. Here are three simple steps that investors can follow to determine “their” analysis question and the respective answer:

1.) Analyze your climate-linked needs and requirements from internal and external stakeholders.

2.) Establish your specific climate objective – this will lead to the “question”.

3.) Survey the market to determine how your question can be answered with current methods, and be aware that more methodology development will need to happen.

In an area fraught with terminology and specialist methodologies, there are several key fundamentals to keep in mind:

  1. An answer without knowing the question doesn’t help.
  2. There isn’t just one investment climate risk question, and nor should there be. Risk versus impact, reporting versus investing, disclosure versus performance: all these dimensions require their own sets and subsets of data and analysis.
  3. An answer without knowing what to do with it, how it changes your action, is not worth much either. An objective for the analysis ensures that question-answer-action are linked.

A prudent investor approach to climate change is therefore to first understand the climate implications and questions concerning their own investment strategy. Only then will the most appropriate analysis be chosen and applied. And only then will an answer like “42” start to make sense – and most importantly be acted upon.

By Dr. Maximilian Horster, Head of Climate Solutions, ISS ESG

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