Global institutional investors—including pension funds, endowments, sovereign wealth funds, as well as retail-focused mutual funds—and many other investors have made pledges to reduce the impacts of their investments on global climate change. These commitments have increased the need for—and scrutiny of—approaches to measuring carbon emissions and climate impacts. At present, there are many gaps in the reported data, and several major unresolved measurement challenges. The issues include:
- Reporting inconsistencies: Carbon emissions reporting is voluntary and difficult to independently verify or peer-benchmark. A host of consulting firms and non-profit data collection-and-reporting entities examine and rank ESG metrics, including Scope 1, 2, and 3 emissions for publicly traded companies, and provide proprietary rankings to asset managers. Not all reported emissions are utilizing the same scope nor based on the same methodologies, making comparisons difficult, and in some cases impossible. For example, some companies report avoided emissions rather than total GHGs emitted.
- Use of estimated data: Due to low coverage, many company emissions are estimated. These estimates are often even more inaccurate than reported data. In addition, estimation models can be inherently biased against identifying better performers within sectors, the core need for portfolio managers.
- Scope 3 emissions: When companies self-report Scope 1 and 2 emissions, they are calculating direct emissions from their operations and their electricity consumption. The bigger challenge is Scope 3 emissions, which are emissions from their sometimes vast, far-flung supply chain companies. These are especially difficult to measure in any standardized, reasonably accurate manner.
- Absence of forward-looking estimates: Most carbon accounting focuses on past performance rather than likely future emissions. While useful to start, this sort of data is inadequate for two reasons: (1) It provides no basis for forward-looking projections and benchmarking, and (2) it matters little to an asset manager focused on managing their portfolio utilizing the normal tools of fundamental analysis, client risk-appetite, and future corporate performance, both against a benchmark-index as well as publicly-traded peers.
“Estimates of corporate carbon footprints currently show about as much consistency as the circa-1996 balance sheets that contributed to the Asian financial crisis.”
— Fickling and He, Bloomberg.com, 9/30/2020
IMAP’s Carbon Accounting Focus
IMAP is in the process of finalizing its carbon accounting workstream. The primary questions we are considering include the following:
- Is there a role for IMAP to play in making the case for mandatory, uniform reporting? Academic researchers like IMAP are objective third parties with a strong interest in high-quality, widely available data, but no vested interest in any one reporting system. Would research and advocacy for greater data transparency and standardization have a useful impact on the ESG community and its regulators?
- How are corporate carbon-reduction targets evolving? Which types of targets are incentivizing true reductions in global carbon emissions and not simply shifting the burden up or down the supply chain?
- How can investment professionals estimate future carbon emissions and climate change improvement? Are historical emissions, current reduction pledges, or recent trends in emissions reductions useful predictors of future emissions? Can we better predict future carbon emissions of a firm by examining their planned investments into operational changes? Can a standardized measure of the risk associated with meeting future carbon-targets become widely available and trusted?