Reframing ESG: empowering investment decision-making

With climate change affecting every industry and business, investment decisions must now consider ESG commitments, actions and activities. How can data and insights ensure investors make successful decisions?

According to a recent report by the New Climate Economy, transitioning to net zero is set to deliver up to $26tn in investment and job creation opportunities by 2030. But unless investors are using a reliable platform to help them sift through rhetoric and company promises, they are left without a holistic picture to correctly assess opportunities.

For instance, take a cement company that naturally has high carbon emissions. To reduce emissions, this company then launches a project to offset carbon emissions and issues a sustainability-linked bond to finance this project. As a result, this company looks on track to meet both its targets and government legislation and investing in this company’s stock or in this bond suddenly looks pretty favourable to an investment firm.

Good investment, right? Not necessarily, says Patricia Torres, global head of sustainable finance solutions at Bloomberg LP.

“When Bloomberg calculates a carbon intensity score for this company to help investors compare it with peers, we don’t take into account this carbon offset,” she says. “We base our scores on how much companies actually emit, so cement companies that emit less compare better to others. Also, investment firms in the EU, or who market their funds in the EU, need to report to clients how much of their portfolio aligns with the EU’s taxonomy of sustainable activities, which provides clear definitions for which activities are sustainable.”

We help investors understand a company’s carbon footprint and compare it to peers based on a range of different ESG criteria

Bloomberg’s ESG investing capabilities and data platform can place a company’s sustainability plans in a wider, global context showing investors how much of the company’s activities will meet wider policy, in the case of the cement company, the EU taxonomy. Torres says: “In this example, for this company to pass the test the carbon intensity per tonne of cement it produces needs to be lower than 0.469 tCO2e. The taxonomy also allows offsets to be counted under some conditions. This shows why investors need solutions that provide them with a holistic picture.“

Bloomberg can help investors uncover unexpected findings and investment opportunities as well as shine a light on poor investments. The provider recently launched a government climate scores screen that helps investors understand not only the emissions outlook for a country, but also how well it is doing compared to other countries in terms of carbon transition, power sector transition and climate policies.

“Interestingly, China, which represents 35% of global CO2 emissions, has a relatively low score compared to other heavy emitters like the United States,” says Torres. “Investors can easily find out how different countries are transitioning, and that China is a leader in the development of solar and wind power capacity.”

She adds that data rom the company’s BloombergNEF (BNEF) analysts shows that China accounted for 53% of global investments in renewable energy in the first half of 2022. “This impact can be seen now in the Shanghai Shenzhen CSI 300 Index, which has 15 companies in the renewable energy sector today, versus seven last year.”

While evidence indicates that climate change is real, ESG investors everywhere suffer from a lack of quality data to do anything about it, missing anything from how much greenhouse gas corporates emit to how they will be affected by physical risks caused by extreme weather conditions, or transition risks such as government schemes to support green energy production, or innovation in the clean tech space.

“As we say at Bloomberg, ‘You can’t manage what you can’t measure,’” says Torres.

ESG assets under management are anticipated to reach $50tn by 2025, says Bloomberg Intelligence, as corporates seek to adapt to severe climate-related weather impacts such as rising sea levels, heatwaves and droughts, or mitigate those risks by shifting their production to satisfy government regulation, especially with the Paris agreement attempting to halve global emissions by 2030 and limit global warming to 1.5 degrees Celsius by end of the century.

However, according to Harvard Business Review, 70% of corporations are not even confident in the ESG data they disclose. With that in mind, Bloomberg is taking action by driving industry collaboration through the Task Force on Climate-related Financial Disclosures and the Glasgow Financial Alliance for Net Zero. This will provide comparable data from companies to assess how they will be affected by physical and transition risks.

Torres says: “Our data solutions help investors understand a company’s carbon footprint and compare it to peers based on a range of different ESG criteria and also assess if it is on track to reach its climate targets and its exposure to climate risks. Bloomberg also provides tools to help investors assess their investments and reporting obligations in line with sustainable finance regulations, which are no longer box ticking exercises, but require investors to shift their investment strategies and decision-making.”

This ESG data is also reviewed to Bloomberg’s editorial standards making sure it is fully transparent – investors simply need to click to get to the source document of the data – and has real breadth, ensuring each profile covers 80% of operations or employees. Beyond climate change data, Bloomberg is also working to help investors understand wider environmental and social impacts of companies, e.g. on water and biodiversity, or on their diversity, equity and inclusion practices and interactions with the communities in which they operate.

“We also provide ESG indices that fund managers use to benchmark their portfolios or launch ETFs,” says Torres. “Many fund managers, mainly in Europe and the UK, shifted their investments to Paris-aligned benchmarks, which are based on methodologies aligned with EU benchmark regulation. It’s important to be rigorous when selecting a benchmark, to make sure it is based on credible data, uses rigorous methodologies, and a clear, well-defined process for how companies are included or excluded.”

Understanding the rapidly changing climate and its impact on companies and their long-term outlooks, investors will need to turn to reliable sources of data and analysis in order to make educated decisions around investments.

Q&A: How can investors assess climate risk?

With climate change affecting every industry and business, investment decisions must now consider ESG commitments, actions and activities. How can data and insights ensure investors make successful decisions?

Why is climate risk so difficult to assess?

Climate-related risks are more difficult to measure than ‘traditional’ financial risks because, rather than looking at historical patterns as is customary in risk management, climate change looks forward. Furthermore, as climate change is a process, not a single event, its impacts evolve and may be very different in the next five to 10 years compared to the next 20 to 30 years.

In 2020, the Australia bushfires are estimated to have cost $5bn and wildfires on the US’ west coast led to damages of $20bn. Floods in Pakistan led to $1.5bn that year, and we are seeing a similar situation in Pakistan today. Climate scientists have shown that, in the best-case scenario, global warming causes rises of 1.5 degrees Celsius by 2100, and physical risks will be bigger than today. So, investors are rightly concerned, but how to manage this risk is very much the issue they are trying to solve for now.

Climate-related risks are more difficult to measure than ‘traditional’ financial risks because, rather than looking at historical patterns as is customary in risk management, climate change looks forward

How can investors assess climate change as a financial risk?

Broadly, climate risk can be divided into two interrelated risks: physical risk to assets from flooding and storms, and risk associated with transitioning to a low carbon economy, for example if fossil fuel reserves need to be written off.

Firms with large loan or mortgage portfolios should ask themselves how they will be affected when rising sea levels, droughts, and other adverse conditions become the new normal. Firms with exposures to heavy emitters should evaluate their positions if more stringent regulation comes into force.

From there, there are at least three challenges. The first is to find the right data as climate change is not well reflected in historical data. We therefore rely on scenarios and climate models to understand the risks we are exposed to going forward. The second challenge is, while many areas will be exposed to more severe weather such as extreme heat or rainfall, it is difficult to estimate how these unprecedented events will impact financial valuations. The third challenge is, even if you have the data and models to estimate what could happen, it is hard to know what to do with this information given the huge uncertainties around which future is most likely.

What does the future hold for those assessing climate risk?

Will the future be one where we successfully transition to a low carbon economy – with high transition risk but low physical risk as a result – or will we fail to take sufficient action and face much more severe physical risks? We are working on a solution that looks at all possible futures and provides risk estimates based on the probabilities of all the various outcomes.

However, companies often do not disclose complete data on how they are exposed to climate risk, and when they do, the provision of this data is voluntary and unaudited, and not always reliable. But as new disclosure rules take effect notably with the help of the framework developed by the Task Force on Climate-related Financial Disclosures, the quality, consistency and availability of data will improve.

How will government strategies on climate change impact investors over the next two to five years?

Firms have a variety of reasons for considering climate risk, and regulations are an important piece of the puzzle. Momentum to reduce greenhouse gas emissions is building, with numerous UN initiatives and the creation of the 450-firm Glasgow Financial Alliance for Net Zero. Governments and regulators are increasingly asking financial firms climate questions. The survey we conducted recently showed that regulation and disclosure requirements came in first for 25% of respondents. The Bank of England also asked banks and insurers to evaluate how holdings could evolve if countries limited emissions in line with the Paris agreement, or if intervention is limited and economies instead face physical risk from extreme weather.

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