Stockholm (NordSIP) – The challenges faced by institutional investors seeking to align their equity and fixed income portfolios with low carbon pathways are addressed in the third edition of the London Stock Exchange Group’s (LSEG) Decarbonisation in Portfolio Benchmarks report. Published on 19 September 2024 in collaboration with the UN-convened Net-Zero Asset Owner Alliance (NZAOA), the latest report is the first edition to include coverage of both equity and fixed income as well as insights on Scope 3 emissions.
With investors making greater efforts to monitor their carbon exposure, either due to regulatory requirements or in the context of voluntary decarbonisation pledges, the LSEG’s report provides a useful overview of long-term market trends in absolute emissions and emissions intensity levels. The 89 members of the NZAOA have committed to steer their combined $9.5 trillion worth of portfolio assets to net-zero greenhouse gas (GHG) emissions by 2050. Many are still facing difficulties in terms of interpreting the variety of available data and accurately identifying whether they are on the right pathway. The LSEG report tracks emissions trends in representative market benchmarks across widely used absolute emissions and emissions intensity metrics as well as related attribution analysis to help understand the underlying drivers of change.
Carbon intensity down but absolute emissions up
Among the LSEG’s observations is the gradual decarbonisation of both the FTSE All-World equity and WorldBIG Corp fixed income indices, with revenue-based carbon intensity dropping 4.1% and 3.9% respectively between 2016 and 2022. However, the report presents a different picture when it comes to absolute emissions, which show a 2.3% per annum increase for equities and a relatively flat decrease of 0.7% for fixed income. The LSEG prefers to measure what it terms Chained Absolute Emissions, which pertain to companies that have been in the index for at least a year. This partly addresses the problem of absolute emissions being heavily influenced by benchmark composition, with decreases caused by sanctions-related exclusions of Russian securities and increases resulting from a greater Chinese presence since 2019.
The difficulty of tracking portfolio decarbonisation pathways is compounded by short-term effects that detract from the long-term trend. The LSEG’s attribution analysis identified fluctuations resulting from non-carbon factors including sector rotations, constituent churn, and changes to normalisation factors. Investors are recommended to use a broad range of emissions metrics to view their portfolios through a multi-variable lens that can smooth out year-on-year discrepancies.
Solving the Scope 3 conundrum
Scope 3 emissions typically represent the overwhelming majority of companies’ carbon footprints. Depending on the sector, average Scope 3 emissions can be four times higher than Scopes 1 and 2 combined. However, Scope 3 emissions are still largely underreported and the data that exists relies on estimates and assumptions that hinder the overall reliability of these metrics. The LSEG report points to research published this year by FTSE Russell that demonstrates that emissions in many sectors can be largely captured by using just two of the most material categories in Scope 3 disclosure, namely Purchased Goods & Services and Use of Sold Products. This method reduces volatility and improves the overall stability and accuracy of Scope 3 data.
The LSEG believes that by highlighting the root causes of emissions changes this latest report will help institutional investors track the evolution of their decarbonisation strategies more accurately.
