- Institutional investors are increasingly setting targets to align their portfolios with a 1.5˚-2°C global warming scenario ahead of COP26.
- Measuring and reporting portfolio temperature rise remain challenging, as investors seek to meet the TCFD’s new alignment guidance. How can institutional investors measure the temperature of their portfolios?
- The MSCI Implied Temperature Rise metric, which closely follows the TCFD’s proposed guidance, offers a new metric to investors.
As world leaders prepare to meet at COP26 with the aim of keeping global temperature rise well below 2°C — and preferably to no more than 1.5°C — above preindustrial levels, institutional investors are increasingly setting their own net-zero targets.1 In doing so, they aim to reduce emissions associated with their investments to net-zero by midcentury.
But translating portfolio holdings into a temperature rise over the coming decades is no simple task. Nor are many companies aligned with net-zero targets. How can institutional investors measure the temperature of their portfolios?
The Task Force on Climate-related Financial Disclosures (TCFD), backed by an increasing number of financial regulators around the globe, is driving transparency and disclosures in this area.2 The TCFD stepped up the pressure, recommending that financial institutions “measure and disclose the alignment of their portfolios with the goals of the Paris agreement….”3
But getting the right metrics can be challenging. For example, MSCI’s Implied Temperature Rise methodology , which is aligned with the TCFD principles, provides temperature-rise data from individual holdings to a portfolio-level temperature reading. We measure each company’s temperature by starting with its 2°C-aligned carbon budget. Then we project each company’s annual emissions through 2070, including any reduction targets, to see how much it is over or under budget. That budget over- or undershoot can be translated into an associated rise in temperature based on how much the global temperature would increase if the entire economy were to over- or undershoot the budget by the same amount as the company.
To get from individual companies to a fund- or portfolio-level temperature rise, we compare the sum of financed projected emissions (the part of a company that an investor owns)4 against the sum of financed carbon budgets for the underlying holdings.
So what does the tool tell us about companies’ progress in meeting the Paris Agreement’s goals of keeping global temperature rise to 1.5°C or 2°C by midcentury? Currently, less than 10% of companies in the MSCI ACWI Investable Market Index (IMI) had an implied temperature rise of 1.5°C or less, and less than half were aligned with a 2°C temperature rise.
Less than 10% of MSCI ACWI IMI Constituents Had an Implied Temperature Rise of 1.5˚C or Less
As of Sept. 8, 2021. Source: MSCI ESG Research LLC
Reporting Performance in Degrees
An increasing number of investment institutions say they are serious about playing their part in limiting global warming. There is a long way to go, but intuitive, transparent, comparable metrics could help track progress and inform decision-making. And with regulators and standard-setting bodies such as the TCFD now looking at measuring portfolio temperature as a way to bring clarity to investors’ positioning on climate change, investors may soon start reporting performance in degrees as well as in returns.
1Mooney, Attracta. “Investment industry at ‘tipping point’ as $43tn in funds commit to net zero.” Financial Times, July 6, 2021. See also UN-convened Net-Zero Asset Owner Alliance hosted by the UNEP Finance Initiative (UNEPFI) and the Principles for Responsible Investment (UN PRI).
2According to the Financial Stability Board’s “Report on Promoting Climate-Related Disclosures” (July 7, 2021), 16 jurisdictions currently use climate disclosure for their financial risk monitoring, including Australia, Canada, the EU, France, Germany, Hong Kong, India, Italy, Japan, Korea, Mexico, Russia, Singapore, Spain, Switzerland, U.K. and U.S. We also observe a trend towards mandating TCFD-compliant climate disclosure: E.g., the U.K.’s Financial Conduct Authority is currently consulting on TCFD-aligned climate-related disclosure for listed companies and asset managers, as is the Hong Kong Monetary Authority in its draft guidance for banks on climate risk management.
3TCFD. 2021. "Measuring Portfolio Alignment: Technical Supplement."
4The allocation base used to define a fund’s financed stake is Enterprise Value including Cash (EVIC).