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    RESEARCH  |  3 POINT PERSPECTIVE  |  SOLVING SUSTAINABLE

    Net Zero investing: No quick wins

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    Contributors: Charlotte Edwards & Zoso Davies

    20 Dec 2021

    Thousands of companies globally have committed to cut their net greenhouse-gas emissions to zero by 2050 and investors have followed suit. The three largest initiatives set up by groups of asset managers and owners now have over $80tn of AUM captured by “Net Zero” commitments. Here are three key takeaways from a recent report from our Research analysts on what it means to be a Net Zero investor.

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    Contributors: Charlotte Edwards & Zoso Davies

    20 Dec 2021

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    The Net Zero maze

    Barclays Corporate and Investment Bank clients can access the full report. Sign in

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    1. Terms can be vague and inconsistently defined

    There is no unified, globally accepted methodology for calculating emissions on behalf of an investment portfolio. As a result, investors need to explain how they are making these estimates, what sources of data they have relied upon, and the offsets being taken into account.

    For a business, Scope 1 emissions (direct emissions including fuel combustion) and Scope 2 emissions (indirect emissions that result from consuming purchased electricity) are relatively straightforward to estimate and are therefore widely reported. But Scope 3 emissions (upstream and downstream emissions from assets not owned or controlled by the entity) are harder to pin down. According to a recent survey of about 1,300 organisations by Boston Consulting Group, only 9% of respondents believe that they are fully capturing all Scope 1-3 emissions.

    Our analysts expect that, over time, total emissions per dollar invested in a fund will emerge as the most popular reporting metric for asset managers. However, that number will likely have some wiggle room in the calculation, as investors and lenders will not want to allocate all of a business’s emissions to themselves if they are providing only a small portion of the financing. Our analysts think that enterprise value – equity market capitalisation plus net debt – is the most appropriate denominator.

    Defining Scope 1,2 and 3 emissions

    2. It’s possible – but undesirable – to hit portfolio emissions targets quickly

    Many asset managers are seeking to classify their funds as either being fully or partly focused on sustainable objectives, so as to maximise the chances of selling them. We expect a similar rush of investors both making portfolio-level Net Zero commitments and rapidly reducing portfolio emissions, amid rising concerns that it will become increasingly difficult to sell funds with high portfolio-level emissions and that lack a commitment to long-term decarbonisation.

    This commercial pressure could lead them to dispose of high-emitting assets, or to use other forms of portfolio engineering such as short-selling, buying green-labelled securities or buying offsets, in order to achieve rapid reductions in portfolio emissions.

    Such shortcuts can be effective. Our analysts estimate that an investor tracking the S&P 500 could achieve an 80% reduction in reported Scope 3 emissions by selling just 6% of the index’s market value.

    Investors can achieve large reductions in reported emissions with minimal exclusions

    But these shortcuts are also unsatisfactory. If investors simply divest their exposure to certain issuers or sectors, they leave others to deal with the challenge of transition to a Net Zero economy. Our analysts liken such a scenario to the “tragedy of the horizon” evoked by former Bank of England governor Mark Carney, when he observed that the limited mandates of most policymakers have the effect of shifting the costs of transition to future generations.

    Moreover, the sale of a security is, in itself, unlikely to encourage a polluting issuer to decarbonise. Engagement becomes more difficult once an investor has divested, as they can no longer use their stake to get a seat at the negotiating table – or to use the threat of divestment as a tool for escalation.

    3. Engaging with businesses over the long-term could deliver better outcomes

    Our analysts argue that a smarter way to tackle the problem is for fund managers to invest in issuers that they believe are on a pathway to Net Zero by 2050. Investors would be able to hold high-emitting assets in a "Net Zero-aligned” portfolio – as long as issuers had firm and credible plans to reduce emissions and get to Net Zero by the investor’s target date.

    This approach could be viewed more favourably as Net Zero investing matures as a concept. For one, it provides greater incentives for businesses to decarbonise in meaningful and long-lasting ways. Issuers would understand that they are not automatically excluded by investors; if they were, they might decide there is little point in reducing emissions, as it is often harder to be removed from an exclusion list than to be added to one.

    The biggest challenge for fund managers is a lack of consistent and reliable data that would allow them to assess which companies are on a credible transition pathway, in order to make informed decisions and provide comprehensive disclosures to their own end-investors. Still, they have tools at their disposal. One such resource is the Transition Pathway Initiative (TPI), launched by the UK’s Environment Agency and the Church of England National Investing Bodies in 2017.

    Fund managers will also need to create engagement strategies with a methodology for prioritising engagements, clear targets and an escalation process for situations when no progress is made. They are likely to demand clear and quantified targets from issuers – and may seek assurances that capex plans are consistent with decarbonisation goals.

    Related content

    Emission impossible? Closing in on net zero

    Decarbonisation is a major global challenge. Our analysts have identified five key areas of focus over the coming 30 years for delivering the net zero pledge.

    Important content disclosures

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    About the experts

    Charlotte Edwards, CFA

    ESG Research analyst

    Charlotte Edwards is a member of the ESG Research team, based in London. She focuses on the ESG-labelled securities market and ESG strategy research which considers how investors approach ESG and the impact this is having on portfolio construction and valuations, leveraging her previous experience in the Credit Strategy Research team. Charlotte has also been instrumental in developing Barclays’ approach to integrating ESG into fundamental research across regions. Prior to joining Barclays in 2017, she spent nearly four years at HSBC, where she worked primarily in the Credit Strategy team as a European Credit and Global Green Bond strategist. Charlotte graduated with a degree in Economics from Bath University and is a CFA charter holder.

    Zoso Davies

    Director, European Credit Strategy

    Zoso Davies is a Director in the European Credit Strategy team at Barclays, covering Investment Grade and Macro Credit. As part of his role, Dr. Davies regularly contributes to cross-asset and thematic research. In particular, Zoso has worked extensively on central bank corporate bond purchases and the impact of monetary policy on the European banking system. Dr. Davies was also a key contributor to the development of Fundamental ESG Research and contributed to Barclays BlueTrack™, Barclays methodology for measuring our portfolio emissions. Dr. Davies joined Barclays in 2010, prior to which he was awarded a PhD in Physical Chemistry by University College London.

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