Chapter 7

Question 1

What are the two overarching approches within listed equities that enable investors to align climate-related considerations into investment allocations?

Answer 1

Operational activity versus economic activity

Question 2

What is a difficulty with equities on alignment?

Answer 2

Capex attribution, although methodologies are emerging

Question 3

What’s the concern with carbon abatement technologies?

Answer 3

1. Uncertain effectiveness and cost
2. Not clear that society is better off
3. Do not create innovation and behaviour changes necessary to protect business from competition

Question 4

What is an example of an index targeting thematic climate opportunitie?

Answer 4

FTSE Russell Environmental Markets Index Series. 20% of revenues must be from tier 1 (clear and significant exposure) and tier 2 (net positive impact)

50% tier 1 for FTSE Environmental Technology Index

Question 5

What is the Scope 3 economic intensity approach under SBTI?

Answer 5

7% annual compounded reduction in scope 3 emissions per gross value added. Assumes all companies are growing in line with the predicted GDP, which is a blunt assumption to make

Question 6

What has the International Accounting Standards Board said about climate in accounts?

Answer 6

Investor demand is itself a materiality threshold that should compel companies to include disclosures in accounts

Question 7

Which accounting standards are the mostly commonly employed?

Answer 7

IFRS. Not adopted by US, Japan, or China

Question 8

Which countries have mandated TCFD reporting?

Answer 8

G7 ans others

Question 9

Which countries have mandated TCFD reporting?

Answer 9

G7 ans others

Question 10

What is a key issue with TCFD recommendations?

Answer 10

Full adoption does not equal high quality underlying processes, since no auditing standard

Question 11

Key difficulty with fixed income versus equity on climate?

Answer 11

Lack of quantity and quality data
Also double counting, e.g. if holding both muni and gov debt

Question 12

Key difficulty with fixed income versus equity on climate?

Answer 12

Lack of quantity and quality data
Absence of voting rights
Aggregation challenges to avoid double counting

Question 13

Which institute provides league table of banks ranked by syndication practices on climate?

Answer 13

Anthropocene Fixed Income Institute (NGO), ranked by net green/fossil impact

Question 14

What is happening to support sovereign engagement?

Answer 14

World Bank organises engagement fora and has issued guidelines for sovereign bond engagement

Question 15

What’s a key issue with passive climate bond portfolios?

Answer 15

Allocates most to largest issuers, which may not well reflect which technologies are optimal for society in tackling climate change over the long term

Additionally, climate indices increase tracking error from standard benchmarks

Question 16

What attracted institutional investors to green bond market?

Answer 16

Use of Proceeds (UoP) standards and principles, e.g. Climate Bonds Standard from the Climate Bonds Initiative (and the Climate Bonds Taxonomy as part of this)

Additionally, ICMA’s Green Bond Principles

Question 17

What trends have occurred in green fixed income markers?

Answer 17

MDBs playing less of a role while sovereign issuances increasing

Energy is largest beneficiary followed by buildings and transport

Question 18

Who produces guidance for other sustainability linked bonds?

Answer 18

ICMA (also for transition bonds)

Question 19

What does the EU have on green bonds?

Answer 19

EU Sustainable Finance Action Plan includes proposed European Green Bonds Standard, which draws on EU Taxonomy

Question 20

What is to note about securing of labelled bonds?

Answer 20

Usually not secured against assets funded by UoP, so no additional credit research required

Question 21

Strengths of sustainability-linked bonds?

Answer 21

More forward looking than UoP / green bonds
Can engage issuers not committing large capex to individual projects
Can obtain pricing benefits if management estimate that higher chance of achieving KPI than investors expect

Question 22

Green bonds for adaptation are covered by what principles?

Answer 22

Climate Bonds Intitiative’s Climate Resilience Principles

Question 23

What 2 sovereign climate metric methodologies are available?

Answer 23

Government expenditure approach - Scope 1 and 2 of central gov activities and related emissions from policy measures (scope 3)
Territorial approach - measurement of emissions from an entire national territory, calculated with either production or consumption approach

Territorial production approach is most popular, as adopted by UNFCCC

Question 24

What was developed to assess sovereign exposure to climate risk?

Answer 24

PRI’s Assessing Sovereign Climate-related Opportunities and Risks (ASCOR) project. Indicators include emissions pathways, climate politics, and climate finance

Assesses 75 countries in 2024

Differentiated approach for emerging markets

Question 25

What are the two primary ways climate risks impact fixed income valuations?

Answer 25

1. Prevailing market interest rate
2. Credit risk premium

Question 26

Fixed income valuations are what compared to equities?

Answer 26

Less sensitive to climate risk

Similarly, higher credit rates sovereigns are little impacted by credit or climate risk

Question 27

What are the challenges in considering climate risks within rating agency frameworks?

Answer 27

1. Time horizon misalignment. Agencies usually consider only 2-5 year time horizon.
2. Lack of granular and plausible forecasts - usually conservative assumptions on policy development due to uncertainty
3. Lack of historical data to justify downgrading credit ratings

Question 28

What are ILS?

Answer 28

Insurance-linked securities, tapping fixed income capital to avoid insufficient equity capital to cover natural disasters

E.g. cat bonds

For investors, not correlated with stock market performance, so can be resilient against economic risks

However, recent performance has Deteriorated and some correlation with reinsurance premia

Question 29

Challenge with ESG funds and ILS?

Answer 29

Limited “look through” to insured, so difficult to ascertain ultimate beneficiary ESG data

Question 30

See photo of different issuer base risk versus investor transparency options

Answer 30

See photo

Question 31

How can the price of cat bonds / ILS be useful?

Answer 31

Indicates society’s changing view of climate risks

Question 32

If climate risk increases capital requirements for insurance companies, which if the following most directly helps to free existing capital?

Answer 32

Sidecars where reinsurer buys a portion of the policy

Question 33

WACI calc?

Answer 33

Revise it from specimen paper!!