Quintin Rayer and Pete Walton share the Net-Zero Carbon 10 target, which provides a framework to help fund managers talk to firms about net-zero emissions
Many investors are acutely aware of the increasing likelihood of extreme weather events associated with global warming. While we can invest in adaptation measures, the primary focus must be on reducing greenhouse gas emissions, particularly carbon dioxide (CO2).
Despite the 2015 Paris Agreement, current warming appears to be heading for at least 3°C by 2100 – well ahead of the 1.5-2°C goal. Emissions reductions of at least 40% are needed by 2030, with net-zero emissions necessary for global warming to stabilise.
If the emphasis is only on reduction without a net-zero goal in mind, we risk a Malthusian trap. This occurs when incremental emissions reductions are taken up by population growth or increases in the carbon-based economy. To quote Malthus: “The power of population is indefinitely greater than the power in the earth to produce subsistence for man.“ For example, a 10% reduction in emissions per capita could be countered by a 10% increase in population, resulting in no overall decrease. Net-zero emissions are required to avoid this.
Companies will need to develop strategies that contribute to a carbon-neutral economy: both reducing CO2 emissions and identifying solutions to remove CO2 that is already in the atmosphere.
Sustainable fund managers can demonstrate leadership on global warming in the broader investment and business communities. P1 Investment Management's Net-Zero Carbon 10 (NZC10) target, launched in July 2018 and described below, provides a clear, systematic framework for investors on how to conduct conversations with firms. This target has been adopted by commercial funds with assets under management from £160m to £900m (£2.3bn in total), showing that it can be practically implemented in a real-world context.
Development of the target
The NZC10 target was developed with scientists in order to meet climate requirements. According to the IPCC's special report Global warming of 1.5°C, net-zero emissions by 2050 should be consistent with 1.5°C warming – and many initiatives adopted by sustainable investors reflect this aspiration.
However, greater ambition is required, which is why NZC10 uses a 2030 net-zero target. Many firms will be late adopters when it comes to the low-carbon transition, becoming net-zero after 2050 – if at all. Sustainable investors need to encourage companies to become net-zero well before 2050 in order to both reduce emissions and provide social leadership. The 2030 target embodied within NZC10 provides this leadership, expressing a climate ambition consistent with keeping warming below the lower 1.5°C bound of the Paris Agreement.
The target was designed to be challenging but achievable for fund managers. A balance was required: if the ambition were too high, few investors would be able to adopt it, reducing its impact. Conversely, a target that had low ambition but was adopted by many investors would only have a modest impact. NZC10 seeks a balance between ambition and ease of adoption in order to maximise impact and be challenging yet achievable.
The NZC10 target
Few sustainable fund managers challenge company boards on their strategy to achieve net-zero carbon emissions, mainly because they lack a systematic framework for beginning the conversation.
NZC10 allows fund managers to better align their investment policies with the requirement for carbon-neutrality, rather than just emissions reduction. The focus on net-zero emissions means firms can have some CO2 emissions as long as they are reliably offset.
The target definition is: 10% or more of portfolio assets invested in firms with net-zero carbon emissions; or realistic strategies using current technologies to achieve net-zero emissions by 2030; or the fund manager is actively engaging with firms to achieve this.
The definition of carbon-neutral is that firms meet the requirements of the British Standards Institution's PAS 2060 Carbon Neutrality specification or an equivalent. Net-zero emissions strategies are also expected to use currently available technologies. This avoids dependence on future technologies for CO2 removal; these may not materialise in the necessary timescales, or could prove incapable of being scaled to the required levels. It also reflects a view that transition to a low-carbon future is as much a social challenge as a technological one.
The intention is to tighten standards and thus raise this bar, following climate science under the guidance of P1's external ethical oversight committee. Apart from increasing the percentage of assets required above 10%, this will likely include minimum engagement requirements and improved definitions for carbon offsetting standards.
Ideally, significant progress to net-zero should be achieved via emissions reduction. However, residual emissions must also be offset. Carbon offsets must be high quality, realistic and credible, based on currently available technologies and capable of being verified. Following PAS 2060, under the Greenhouse Gas Protocol, emissions should include all scope 1 and 2 emissions and all scope 3 emissions that contribute more than 1% of the total footprint.
The different scopes classify how emissions originate from an organisation's activities. Scope 1 emissions come from sources that are directly owned and controlled by an organisation, such as fuel used by company vehicles. Scopes 2 and 3 cover indirect emissions: scope 2 emissions are from energy used, including electricity, heating, and cooling, while scope 3 emissions cover all other indirect emissions. Scope 3 emissions include upstream and downstream value chain emissions, including those of suppliers and customers using their products. Scope 3 emissions cover investments by financial institutions (including equity, debt and project finance) under category 15.
Carbon neutrality applies not just to CO2 but also to other greenhouse gases such as methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, sulphur hexafluoride and nitrogen trifluoride. PAS 2060 also requires that a declaration of carbon neutrality cannot be achieved solely through offsetting except as a concession during initiation of the process. At later stages emissions reductions are required, with a declaration of the achievement of carbon neutrality requiring the entity to have achieved reductions in its carbon footprint and to have offset remaining greenhouse gas emissions.
While using NZC10 incurs no charge, investors wishing to adopt it must register with P1. P1 monitors the target to ensure that standards are maintained and the target is not misused.
How it helps
NZC10 offers clarity to fund managers. While quantifying historical portfolio or company impacts is a valuable activity, NZC10 proposes further actions that investors can take to support the movement towards a net-zero emission economy. It provides a standard framework for corporate engagement.
Fund managers felt the target provided an excellent framework for company engagement on carbon-neutrality, with a positive response obtained from many investee firms. Company discussions have included the acceleration of strategies to achieve neutrality by 2030 rather than 2050.
The participating managers show how investing can help address climate change. Recent UK Committee on Climate Change recommendations for carbon neutrality by 2050 seem ambitious, but many climate scientists advise stronger action.
Working with climate scientists, we are undertaking a gap analysis on how future net-zero carbon targets can be more closely aligned with climate need. Although the emphasis on strategies for carbon-neutrality by 2030 represents significant climate ambition, there are other aspects to consider. Potential areas for development include the proportion of portfolio assets covered (currently 10%), methods of engagement, collaborations between investors, improved offsetting requirements, and verification. On offsetting, climate scientists tend to prefer schemes that remove CO2 from the atmosphere into a robust repository, rather than a reduction in emissions.
All participating managers are engaging with company boards to obtain information on their plans to achieve net-zero emissions, and are planning to follow up with multi-year programmes. Apart from registering with P1, the managers adopting NZC10 are publicly demonstrating their commitment by participating in our planned Net Zero Carbon Target Seminar, which was due to be held at the Caf√© Royal in London on 18 March 2020 but has been postponed due to COVID-19.
A survey of participating managers is guiding enhancements. For example, they are keen to move beyond the initial 10%, with 20% attainable. Developments will follow climate science under the guidance of P1's external ethical oversight committee.
Recent work on sensitive intervention points for a post-carbon transition suggests the importance of seeking feedback amplifiers for climate investment initiatives to deliver outsized impacts. Leadership from investors provides amplification as fund managers engage with multiple investee company boards. Adoption of targets such as NZC10 offers an opportunity for a 'silent pro-climate majority' of underlying investors to express their views. Apart from individuals with savings, this can include pension funds, trusts and charity funds. The Pensions and Lifetime Savings Association recommends that trustees explain how climate change relates to their investment strategy, and how they are mitigating climate risk and seeking low-carbon investment options.
Enhanced net-zero carbon targets will intend to be challenging yet achievable while leaving no-one behind. The existing NZC10 target will remain, both for existing users and as a stepping-stone for investors who wish to adopt it at a later date.
Dr Quintin Rayer is head of research and ethical investing at P1 Investment Management.
Dr Pete Walton is a research fellow on the UK Climate Impacts Programme at the University of Oxford.