Assessing your portfolio’s climate change risk

Key points:

• Investors are likely to focus increasingly on potential transition risks and opportunities lurking in their portfolios
• Greenhouse gas emissions are embedded throughout business and society
• Carbon footprinting can help investors to implement a portfolio strategy that can prepare for the transition to a low-carbon world
• Carbon footprinting can be used to support investors in finding growth or diversifying opportunities in green investments.

As climate breakdown accelerates, so too do potential financial risks and opportunities for investors. Currently, global plans do not deliver the commitment to keep temperatures within 2C of their pre-industrialised levels, let alone the 1.5C ambition, of the 2015 Paris Agreement. Already the physical effects of climate change continue to intensify, at present, most visibly in this year’s California wildfires.

Nations are due to convene to review their progress and nationally determined contributions at the UN Climate Change Conference – COP26 next year. Given the trajectory, expanded efforts and pledges will be needed to achieve the targets.

As a low-carbon world nears, investors might want to increasingly understand the potential physical impacts and transition risks for portfolios. Carbon footprinting has emerged as a useful tool in informing and implementing a portfolio strategy that can prepare for these challenges.

Greenhouse gas (GHG) emissions are embedded throughout business and society. Accounting for an activity’s carbon footprint can help to understand the climate risk and opportunities in an investor’s portfolio.

Understanding GHG emissions

Carbon footprinting measures the impacts of an activity on global warming by calculating the GHG emissions of these activities – both the direct and indirect emissions. This is done to express greenhouse gases such as carbon dioxide, methane and nitrous oxide as a common unit, allowing easier comparison across different geographies, industries and organisations.

The GHG Protocol categorises Emissions Scopes under three distinct categories, generally known as Scope 1, 2, and 3, helping to systematically define different emission contributors. The categories allow for standardised emissions calculating and reporting. They can also help to gain a better understanding of emissions sources.

Most public companies report on the emissions from primary activities (captured by Scopes 1 and 2) and few reports incorporate disclosures about indirect emissions that occur in their value chain. However, Scope 3 emissions often represent a business’s most significant GHG contribution.

Calculating the carbon footprint

For investors wanting to calculate their portfolio’s carbon footprint, the first step is to understand where emissions specifically come from. At its simplest, the carbon footprint is the sum of a proportional amount of each portfolio company’s emissions (proportional to the amount of stock held in the portfolio).

Carbon intensity is commonly used to provide a carbon footprint measure and determines the amount of emissions, in tons of CO2, that companies in a portfolio produce for every million dollars of sales. Off-the-shelf and customised services are also available for measuring a portfolio’s carbon footprint. While there may be limitations, these tools can be useful to consider not only carbon but also natural capital, fossil fuel reserves and exposure to stranded assets.

Understanding a portfolio’s footprint can serve as an informed starting point for an investor to create and implement a broader climate change strategy. It provides insight to identify a portfolio’s climate risk exposure to physical and transition risks while also helping investors to consider allocation strategies for creating a lower-carbon portfolio and inform asset selection. It should also help to uncover diversifying or growth opportunities in green investments.

Most importantly, carbon footprinting shows investors their contribution to GHG emissions through the investments they make. By understanding their current path and serving as a reference point on what their investment plans are, investors can address climate change on a personal level too. While climate crisis is a global and systemic challenge, it is with collective action that it can be overcome.

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