Chapter 1 - Intro the climate and investing

Question 1

The WEF Global Risks Report 2023 ranked ‘failure to mitigate climate change’ as the number one long-term threat to the world and in the top five global short-term risks (ie. within two years)

Answer 1

2023 was hottest year on record, 1.48C warmer than the long term average before humans started burning fossil fuels

Question 2

The IPCC says chance of breaching 1.5C target as early as 2030 stands at 50%

Question 3

CLIMATE CHANGE DEFINITION

Answer 3

• a large scale, long term shift in the planet’s weather patterns and average temperatures
• changes associated with global warming, and
• a long term shift in global or regional climate patterns. climate change often refers specifically to the rise in global temperatures from the mid-20th c to the present

UNFCCC - ‘a change of climate which is attributed directly or indirectly to human activity that alters the composition of the global atmosphere and which is in addition to natural climate variability observed over comparable time periods.’

Question 4

CC driven by set of GHGs (7!) under Kyoto Protocal and Doha Amendment which operationalise in the UN Framework Convention on Climate Change (UNFCCC)

Answer 4

• Carbon dioxide (CO2)
• methane (CH4) eg. from natural gas wells, 28x more powerful than co2
• nitrous oxide (N2O) eg. in fertilizer
• hydrofluorocarbons (HFCs) eg. HFC23 is a ghg 12400x stronger than co2, used in refrigerants
• perfluorocarbons (PFCs)
• sulphur hexafluoride (SF6)
• nitrogen trifluoride (NF3)

relative strength expressed as carbon dioxide equivalent

Question 5

2 UNFCCC definitions - interconnected
1. Adverse effects of climate change mean changes in the physical environment or biota resulting from climate change that have significant harmful effects on:
- the composition, reseilience or productivity of natural and managed ecosystems,
- the operation of socio-economic systems, or
- human health and welfare

Answer 5

CLIMATE SYSTEM means the totality of the atmosphere, hydrosphere, biosphere and geosphere and their interactions

compounding effect - exacerbates existing issues and multiple climate change issues combine

Question 6

some immediate impacts from increased GHGs in the atmosphere:

Answer 6

• changes in precipitation patterns - drier summers, wetter springs
• the loss of ice sheets and sea ice - melting glaciers
• an increase in extreme weather events - stronger storms, longer droughts, heatwaves

Question 7

Taskforce on climate related Financial Disclosures (TCFD but the financial stability board (FSB)) - physical risks (chronic and acute hazards)
chronic = sea level rise, drought, temp patterns

acute = precipitation/flooding
extreme wind, cyclone

Answer 7

Transition risks - eg. policy and legal, market risk, reputation risk

Question 8

PHYSICAL risk impacts inc physical damage to assets (urban centres, buildings, production and service facilities)
from extreme weather events - acute
and chronic - erosion, sea levels rising

direct and indirect impact on livelihoods

Answer 8

TRANSITION RISKS occur as the global economy decarbonises. The TCFD identifies policy and legal, technology, market and reputation as risks

• In some industries, these technology and market risks combined with regulatory risk are creating STRANDED ASSETS, meaning a significant negative impact on the value and future cash flows of the companies who own them

Question 9

Scenarios and time horizons

Answer 9

• scenarios used to study how climate change might progress, how phys and transition issues may manifest
• Climate-related scenario analysis - key tool in studies and applied in finance and business

Question 10

Challenges of scenario analysis

Answer 10

• Historical data insufficient as humans have never experienced an environment where CO2 concs in the atmosphere exceeded 400ppm nor the current accelerated rate of change
  Concs above 400ppm were last experienced 4m years ago and the last time they increased by 100ppm took 10000 yrs

2. scenario modelling does not rely on linear or historical trends to forecast the future. Instead, the challenges is to use integrated climate and economic models to develop potential future pathways
3. Climate change interacts with many other existing issues - scenario modelling needs to take this into account and use feedback loops - help study the network of interactions
   Timing of impacts (extreme weather events, tipping points) and their magnitude (initial, incremental, total) is uncertain and feedback loops not fully understood. model cannot reflect magnitude of interaction with other aspects of nature and the socio-economic system. more uncertain in longer time frames.

Question 11

Many climate and integrated models available inc:
- policymaking, which looks at a desired outcome and works backward
- catastrophe models - designed for insurance industry and must be adapted to include climate information
- economic models, which must integrate the physical side of climate modelling

Answer 11

Common scenarios that are analysed include an end state of:
- 2C warming
- below 2C warming (usually 1.5)
- high carbon scenario (above 2C warming, often 3C warming or above)

Realisations drive mitigation efforts - also adaptation, resilience

Question 12

Climate change mitigation, adaptation and Resilience

Answer 12

Mitigation - reduce GHG emissions

Corporate GHG emission scopes
Scope 1 emissions - GHGs that occur from sources that are owned or controlled by a company, activity or asset eg. GHGs from combusting natural gas in a boiler or burning coal to electricity or steel. In some sectors these are the main source of emissions

Question 13

Scope 2 emissions

Answer 13

GHGs associated with PURCHASED electricity, steam, heat and/or cooling -> ‘purchased energy supply’). This is a share of the related emissions produced, for example, at the power production plant that supplies that electricity of the methane released in gas supply

Question 14

Scope 3 emissions

Answer 14

include all other GHGs that are a consequence of a company’s activities or associated with the asset but are from sources not owned or controlled by the company or asset owner eg. the production of purchased materials.
For many sectors, scope 3 emissions outweigh direct emissions; in some cases very significantly.
for example, the vast majority of oil and gas companies are in the customer value chain ie. where the fossil fuel gets burned.
In other cases, supply chain plays big role -emissions from deforestation and livestock for a meat producer.
Understanding the supply and customer value chains underpins understanding the impact of a company or activity.

Question 15

Carbon neutral - covers Scopes 1 and 2 and means that any GHG emissions from a company’s activities or an asset are balanced by an equivalent amount being removed and that Scope 1 and 2 GHG emissions do not increase

Answer 15

Net Zero - covers scopes 1,2,3.
About reducing GHG emissions to the lowest amount possible and where possible to zero.
Aims to reduce emissions using carbon sequestration, with a preference for long-term nature-based solutions (nbs), allowing for technological solutions eg. direct air capture (DAC) with permanent underground sequestration.
to achieve it requires all areas of the business

Question 16

FINANCED Emissions are Scope 3 Category 15 emissions (as in GHG Protocol) for a financial corporate, which requires looking through to the emissions of investee and borrower companies, activities and/or assets.

This includes their Scope 1 and 2 emissions as a minimum, but also ideally their Scope 3 emissions, to understand the full carbon impact of providing financing to the entity

Answer 16

In the case of sovereign and other government debt, it is about the country’s production and/or consumption GHG emissions, and what share of those are enabled through the debt

Question 17

Mitigation includes energy efficiency -> representative of a DEMAND SIDE initiative.

Answer 17

An example of mitigation based on shifting to a cleaner energy source is when a power generation utility changes the fuel they burn to generate electricity from coal or natural gas to renewables -> example of SUPPLY SIDE initiative

LONG timeframe and GLOBAL scale of climate change especially challenging. how this dynamic interacts with financial instruments, which typically have shorter time horizons challenging.

Question 18

Other mitigation initiatives that rely on innovation and behavioural change include:

Answer 18

• using alternative construction materials to reduce embodied carbon in buildings (eg. incorporating low-carbon material, such as low carbon cement or recycled plastic cladding), and making properties more energy efficient
• changing soil tilling and irrigation practices to keep Co2 trapped in the ground
• switching from carbon-intensive meat to plant based diets
• designing and building cities to be pedestrian friendly with lower single passenger vehicle use

Question 19

Adaptation and resilience

Answer 19

• global av temp rise is well over 1C but some areas of the Earth have experienced a much higher rise (polar regions) - global consequences

create resilience to climate change impacts:
- a reduced risk of loss of property, life, information, value
- less business disruption
- faster disaster recovery times

Question 20

Benefits of reducing risk of loss and addressing vulnerabilities at national level to protect core services to ensure social and economic sustainability:

Answer 20

• increased positive reputation and credibility
• lower borrowing and insurance costs
• an ability to secure more insurance at appropriate terms
• lower operating costs
• a larger market share
• stable or higher exit values

Question 21

examples of adaptation including designing:

Answer 21

• stormwater and sewage systems to better withstand floods
• transit systems to continue to operate in extreme storms
• utilities to come back online rapidly after wildfires

Adaptation - restoring natural habitats to provide protection from tropical storms, extreme change - relocating from a high risk location to a lower risk location

Question 22

Climate Change considerations for asset classes and investment instruments

Answer 22

Important to distinguish between:
- credit risk (level of impact on credit rating)
- financial materiality (the financial impact now and in the near future) and
- broader materiality issues, which may become relevant in the future, bearing in mind that issues may escalate or be mitigated (the concept of dynamic materiality)

Question 23

Product labelling tends ot be regional and applied to all or many investment products. the EU Sustainable Finance Disclosure Regulation (SFDR) imposes assessment and disclosure requirements for labelled product providers and advisers in the European Union

Answer 23

part of a wider range of policies and regulations under the EU Action Plan for Financing Sustainable Growth, together w supporting the EU Taxonomy

risk management processes, banking industry begun to move towards incorporating climate change scenario considerations into stress testing

Question 24

Listed equity

Answer 24

Fundamental analysis of issuers should identify and assess the relevance of climate change risks and opportunities, as well as the financial impacts the company may face.
includes transition strategies, ie. how companies in high-emitting sectors and sectors linked to deforestation and pollution may be innovating to thrive in low-carbon, more circular economies

The liquidity of public equities, which allows relatively easy and swift exits, may help to mitigate exposure to climate-related risks that develop over the longer term.
While certain effects of climate change develop over long periods of time, some physical risks are affecting daily lives today

Question 25

Fixed income and private debt

Answer 25

The impact of climate issues on fixed income as an asset class will vary depending on the type of fixed income product.

Government bonds (national) are less sensitive to climate issues than municipal bonds (Munis) or corporate bonds.

However, there could be a differentiation between bonds from countries with a developed infrastructure and good insurance coverage versus countries with weaker infrastructure and heavy exposure to climate risks. Another example could be resource-intensive countries where a large part of the economy is reliant on fossil fuels versus a more diversified economy.
At the sub-sovereign level, physical climate issues may require climate adaptation project funding for urban infrastructure, coastal protectino, etc. In the USA, Munis are a primary instrument for raising funds

Question 26

Some of the considerations for Munis include:

Answer 26

• whether the municipality has considered climate risk issues and provides meaningful disclosures for investors to make informed decisions on risk premiums;
• the type of project the bond might finance eg. adaptation projects for climate-related flooding may be in high demand with climate-aware investors
• local climate impacts that may affect the cost of underwriting the bond eg. a sea level rise affecting the volatility of local government cash flows for debt repayment

Question 27

Corporate credit, inc financing government-related entities, such as national rail or public transit companies, can play a vital role in transition to low carbon economy.
It can also support activity, innovation and tech deployment that improve resilience and enable the funding of climate mitigation eg. financing lower carbon activities for companies with high GHG footprints through the use of green, sustainability-linked transition bonds.

Question 28

Certification schemes and taxonomies, especially the EU Taxonomy and the Climate Bonds Taxonomy, help with identifying economic activities , assets and projects that are aligned to the Paris Agreement goal of keeping global warming well below 2C.

Answer 28

Historically, external reviews and certification under the Climate Bonds Standards (CBS) have been voluntary, but issuing in line with the International Capital Market Association’s (ICMA) Green Bond Principles (GBP) and, for some, under the CBS, has helped build credibility for these instruments with investors - acceptance and growth of the green, social and sustainability debt market, particularly over the last five years

Question 29

Private equity and venture capital can be impacted by climate considerations in three ways:

Answer 29

1. Venture capital provides financing to the innovation and development of low-carbon technology that public sector financing may not be able to support
2. The construction of private equity funds, esp blind pool funds, makes climate risk identification and assessment difficult, as the relevance of climate issues is heavily influenced by the context of the underlying asset
3. The longer holding periods and exit considerations mean that risk assessments in the short, medium and long term become more important in this asset class

Question 30

Private equity funds usually require a holding period of five to ten years.
Private equity assets may rely on trade buyers or the secondary market for exit rather than raising an initial public offering. All of these characteristics make the identification, assessment and management of relevant climate change issues more important.

Answer 30

The holding period raises the potential for climate risks to be realised during the ownership of the company.
however, there is also the opportunity to work with the company and improve its resilience to physical climate issues and/or change transition strategies to take advantage of potential opportunities.
This depends on the ownership structure, majority or minority shares and board positions, among other characteristics of the deal.
The resilience of the underlying asset and its preparedness to operate in a low-carbon economy may be considered by a trade buyer and may affect the asking price

Question 31

Real assets

Answer 31

Infrastructure, real estate, farmland and forests are directly exposed to climate-related physical risks, especially in some geographies or locations.
Farmland, plantations and forestry are also exposed to transition risks related to deforestation, changes in diet preferences and the adoption of sustainable practices for soft commodities and agriculture.
some assets targets for climate change advocacy eg. airports.
transport and farmland large contributors to GHG emissions and will be exposed to reputational and other transition risks and opportunities.

Such issues may impact real asset investments anywhere from operational expenses to long-term capital expenditures eg. extreme weather events can result in physical damage, operational losses and investment requirements for adaptation to make facilities resilient to similar vulnerabilities.
Chronic climate risks such as temp rise can have implications for operational and maintenance costs, and transition risks can have enterprise value implications if there is a risk of stranding and/or significant adaptation cost.

Question 32

Depending on how real assets are held, some of the considerations for private equity and listed companies (eg. real estate investments trusts (REITs)) may be relevant

Answer 32

These include challenges to climate risk identification and assessment due to the structure of funds, and exposure to long-term climate risk due to the time horizon of the investments.

Due diligence on underlying assets is critical as investments are often designed as a buy-and-hold as opposed to a buy and sell strategy.
This increases the potential of exposure to climate change risks, both physical and transition, that develop or become more pronounced over a longer period, as well as to regulations that may not have existed when the commitment was made.

Question 33

Retail products and funding platforms

Answer 33

Several banks and building societies have launched ‘green’ products aimed at individual savers.
In October 2021, the UK launched a sovereign green savings bond to retail investors through NS&I.
There is a also a growth in other options for investors such as crowdfunding. eg. Abundance Investment funding green infrastructure
eg. Sunfunder raises debt funds from institutional and other accredited investors, offering access to the solar sector in emerging markets

The growth in thematic funding platforms offer access to smaller projects.
These types of products expand the range of funding sources, particularly for smaller projects, and the range of small-lot investments for retail investors.
Developing green cash and savings products can help redirect financing.

Question 34

Climate Considerations and Investments

• Economies

Answer 34

CC could reduce global GDP by 14%
Overall, in the short, medium and long term, unabated climate change will produce unfavourable macro conditions, while climate change mitigation and adaptation open up opportunities as the transition to a low-carbon economy occurs

Question 35

Decarbonisation and net zero pledges.
Financial institutions have mobilised in industy-led collaborative initiatives to address some of the challenges of supporting the Paris goals -> Net-Zero Asset Owner Alliance in 2019;
Net Zero Asset Managers initiative in 2020
Net Zero Banking Alliance in 2021
Net Zero Insurance Alliance in 2021
overarching Glasgow Financial Alliance for Net Zero (GFANZ) in 2021

Answer 35

NZAOA, a UN convened alliance has published a methodology to set interim portfolio-level targets. transitioning their portfolios to net zero by 2050.
- GFANZ - unite financial sector into industry-wide alliance
- Paris Aligned Investment Initiative (PAII) to help investors align their portfolios with net zero eg. the PAII Net Zero Investment Framework
net zero investment strategy core components -> objectives and targets, strategic asset allocation and asset class alignment, alongside policy advocacy and investor engagement activity and governance

Question 36

Corporate disclosure and analysis

Answer 36

Regulation inc - EU Non-Financial Reporting Directive (NFRD) * CSRD Corporate Sustainability Reporting Directive, EU Taxonomy , TCFD in UK, US Securities and Exchange Commission (SEC)

Question 37

Aligning disclosure standards -> International Financial Reporting Standards (IFRS) Foudnation;s Sustainability disclosure standards eg. IFRS S1, IFRS S2 developed by International Sustainabilitly Standards Board (ISSB)
In the EU, the European Financial Reporting Advisory Group (EFRAG) also released the European Sustainability Reporting Standards, and these will form part of CSRD reporting from 2024

Question 38

Understanding the different perspectives of Asset Owners

Answer 38

Institutional, retail and private clients can have different investment objectives, risk/return profiles and drivers - influence portfolio design and types of strategies deployed

[See table!]

Question 39

TWO principal dimensions that drive the mindset in relation to climate change investing:

TIME HORIZON - period over which investor looking to invest, both in terms of value accretion and value preservation (will be a core driver of its ability to consider climate matters).

near term investors, most notably general insurers, which are typically investing over very short time horizons, take little temporal risk in their investment portfolios so their response in their investment portfolios may be more muted.
Some asset owners, such as pension providers and family offices, would need to consider multiple time horizons given the varying investment horizons for different beneficiary age cohorts and need to balance capital growth and income generation across time horizons.

Answer 39

Endowments investing over centuries will need to maintain an awareness that they will certainly be exposed to climate impacts, both physical and transitional, over that time span

Question 40

BELIEFS and FIDUCIARY DUTY: some investors are constrained in their investment approach and may give full rein to the personal or ethical perspectives they hold. both individual investors and HNWI or family offices.

Other investors - eg. pension schemes and insurance vehicles) operate within regulatory frameworks for investment and may be slower to adapt investment to incorporate factors that have historically been seen as non-financial, but are likely to become monetised over their length investment timespan.

Answer 40

third category of investor - sovereign wealth funds and endowments or foundations, sits somewhere between - depending on their mandate, may be required to prioritise narrowly understood financial returns or may be required to think more broadly about risks and opportunities.
This can shape how readily they incorporate the consideration of even clearly material issues like climate change across their investment approach

Question 41

RETAIL AND INSITUTIONAL INVESTORS, AND THE ADVISORY DIMENSION

Answer 41

role with respect to incorporating climate considerations into investment decisions and product suitability assessment -
- retail investors are typically buyers of settled products in a market, whereas institutions usually have scope to negotiate the nature of the product they want.
Smaller institutional investors may find their scope to negotiate more limited than larger investors given the scale of funds they have available to invest. may need to balance additional fees against product tailoring.
Retail investors typically invest in mutual funds (in US regulatory environment) or Undertakings for the Collective Investment in Transferable Securities (UCITS) funds (under EU regulations), with a set of existing characteristics.
To the extent possible, must identify the available fund that best suits thier needs.
As demand for ESG and climate-aware investment products has grown, regulators and the industry have seen the need to develop standards to address the risk of mis-selling, particularly for retail products.
EU’s SFDR is an example of regulatory intervention

Question 42

USA - the SEC created an ESG Task Force in March 2021 to identify and investigate violations regarding ESG investment products.
The SEC increasingly conscious of the need to assist retail consumers of ESG and climate-aware funds. Perceived need to avoid the mis-selling or mis-buying of funds for the wrong reasons.
Policy and regulatory changes - requirement for climate-related disclosure and info about climate-related risk that might impact a business.
Advisers play a key role for both the retail and institutional markets. - INDEPENDENT FINANCIAL ADVISERS (IFAs).

Answer 42

Institutional investors are advised by investment consultants, a small group of firms providing services to pension scheme trustees - consultants act as principal interface between asset owners and their fund managers - good overview of fund management services available so can assist clients in identifying the climate-related investments that best suit their needs.
Because many asset owners lack the resources themselves to assess the quality of services provided by fund managers, and because regulation often expects asset owners to use external advice, it is typically investment consultants who lead the request for proposal (RFP) processes and annual fund manager assessment meetings.

Question 43

The UK’s INVESTMENT CONSULTANTS SUSTAINABILITY WORKING GROUP (ICSWG) produced a Guide for Assessing climate competency of Investment Consultants - 5 competency areas:

Answer 43

1. firmwide climate expertise and commitment
2. individual consultant climate expertise
3. tools and software to support climate-related risk assessment and monitoring
4. thought leadership and policy advocacy
5. assessment of investment managers & engagement with them

[see key facts screenshot]