These will all contribute to negative impacts on human health, ecosystems and the economy.
Companies that fail to respond to the impacts of the transition to a lower-carbon economy face financial and reputational risks, potentially harming their credit ratings and share price. How they respond and adapt their business strategies and models will be critical, and there will be winners and losers.
However, the consequences of a failure to transition are far greater.
3. What is a carbon footprint?
The Greenhouse Gas Protocol, the most widely used international accounting tool for GHG emissions, classifies a company’s direct and indirect emissions throughout the supply chain into three ‘scopes’ – direct operational emissions (scope 1), purchased electricity, steam or heat (scope 2) and emissions resulting from the activities of the company but occur from sources not owned or controlled by the company (scope 3)4. Security level carbon footprints can be aggregated to portfolio level.
4. How can carbon footprinting help investors?
The TCFD recommended that asset managers provide the weighted-average carbon intensity, where data are available or can be reasonably estimated, for each product or investment strategy. The Task Force acknowledges the challenges and limitations of current carbon footprinting metrics but views this disclosure as a first step.
While carbon footprints do not tell us about the physical climate risks – the most important risk for some securities – it can act as a reasonable proxy for understanding transition risk, identifying the most-exposed securities.
Investors can use carbon footprint analysis to understand the exposure of companies to the potential effects of carbon pricing and as a simple proxy for gauging climate-related transition risk, both as a standalone tool and in combination with a carbon target, as part of an investment strategy.
5. What’s next for carbon footprint analysis?
As disclosure improves, we expect the use of carbon footprint analysis to develop in three respects.
Firstly, we believe there will be improvements in coverage and accuracy. Carbon reporting is particularly challenging for smaller and emerging market companies and for other asset classes beyond equities and corporate bonds such as sovereign bonds.
We expect the adoption of the TCFD recommendations to accelerate both coverage and the quality of the information, making carbon data more complete, accurate and useful for investment decisions.
The requirement for the financial sector to disclose its carbon footprint is also likely to spur more comprehensive coverage and methodologies beyond equities.
Secondly, going forward, carbon footprints are likely to be used in combination with exposure to climate-related investment opportunities (for example ‘green revenues’) to provide a more accurate exposure profile of risks and opportunities, and to determine if it is aligned with the Paris Agreement goal of holding the increase in the global average temperature to well below 2 degree C above pre-industrial levels. .