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They also require CREs to report other metrics which they consider as relevant (“any other key performance indicator used to measure or manage climate-related risks and opportunities”).
Let’s explore existing advanced metrics from the perspective of an entity managing an investment portfolio – although the same concepts could well be adapted to other sectors.
Determining the carbon footprint of a portfolio is a worthwhile exercise to appreciate the distribution of its transition risk. However, it is backward looking, as it will use emissions from the holdings as they were reported at the end of the reporting period. Climate risk is the epitome of a risk where the past is not a suitable indicator of the future, and hence cannot be well extrapolated from historical data. It would require a tool for forward looking analysis – enter Climate Value at Risk (CVaR).
Developed initially by Carbon Delta (which was acquired in 2019 by MSCI), CVaR is usually expressed in %, showing an expected return or loss, for a given scenario. CVaR can be split into several components, associated with the climate risk drivers: policy risk, technology opportunities and physical risk.
Physical risk is derived from the physical assets held by the investees and the associated potential losses due to physical risk events at their location. The transition risks are estimated from the consumption of energy and corresponding emissions, in the light of the emission reduction requirements. CVaR allows for an estimation of future-looking impacts in the portfolio, and drills down to the underlying risk drivers, which in turn will help shape new products and provide actionable insights into the climate related risks and opportunities.
From the perspective of the New Zealand disclosure requirements, CVaR can help to quantify current and anticipated financial impacts, which is a crucial area for disclosure under the Strategy pillar.
The Paris agreement, ratified in 2015 aims to limit global warming to well below 2°C and pursue efforts to a 1.5°C increase as a limit. Companies can set a course of climate action to reach net zero by a specified date, which confirms the alignment towards the goals described above.
However, this is more difficult for investment funds which are widely diversified across sectors and geographies – prompting the need to assess how aligned an investment portfolio is to the Paris agreement target, something which the Implied Temperature Rise (ITR) intends to illustrate.
The ITR methodology revolves around the estimated use of the carbon budget available to the investees, provided that by 2100, global warming does not increase by more than 2°C. The estimated emissions until the end of the century are then compared to the “fair share” of the carbon budget, which leads to an understanding of whether the carbon budget will be under or oversubscribed – this is translated to a temperature increase, thanks to a modelled relationship between emissions and temperature.
Calculating the ITR is a good way to demonstrate the alignment of a portfolio to the Paris Agreement, which is typically the target state (as defined in the Strategy pillar).
Examples of disclosure reports using these metrics are:
· AXA (2022) - 2022 Climate and Biodiversity Report | AXA (ITR – p.50; CvaR – p.52)
· Amundi (2022) - Sustainability-related disclosures | Amundi Institutional (ITR – p.46)
· AVIVA (2022) - Climate-related financial disclosure - Aviva plc (ITR – p.73, CvaR – p.27)
The requirements for climate-related disclosures can be daunting due to the breadth of scope and additional data and process needs. Once these are well understood, running advanced metrics could be beneficial beyond the disclosure as they will be decision-useful and could facilitate the transition to a net zero target.
The Mosaic team of experts can help you navigate through the complex climate risk environment.
