A study from think tank 2° Investing Initiative (2DII) and Swiss consulting firm Wüest Partner has shed light “on the distinction between portfolio reallocation and real-world emissions reductions over time”, according to Jakob Thomä, managing director of 2DII Germany.
Focusing on the Swiss market; 179 financial institutions, comprising 80% of the market, took part in the research.
It looked at the extent to which their investments aligned with the Paris climate goals across relevant asset classes and financial sectors, while also moving toward assessing the climate impact of various portfolio strategies.
The Paris Alignment Capital Transition Assessment (Pacta) tool was used to assess bonds and listed equity, while Wüest Partner developed a module for real estate.
Despite improvement compared with a similar exercise in 2017, the study found that the 2020 assessment showed the Swiss financial market is still not aligned with the Paris Agreement goals.
Thomä added: “With the insights we’ve gleaned from both the quantitative study and qualitative survey, we’ve taken an important step towards better understanding how the financial sector can contribute to climate goals.”
In particular, coal investments lagged the the International Energy Agency’s ‘business as usual’ scenario. In line with the actual trajectory of the global market, participants are still investing in the expansion of coal mining.
The study also found that over 50% of listed equity and over 70% of corporate bond investors with coal divestment policies still have exposure to coal.
But the findings highlighted the benefit of looking beyond portfolio level to real world changes.
For example, the 2017 assessment found that portfolio companies increased their coal power capacity by almost 50% – whereas the 2020 study showed the Swiss financial institutions have reduced their exposure to coal power.
Overall, the build-out of renewable energy capacity also lags the Paris goals.
However, when comparing investor type, asset managers were ahead of pension funds, insurance companies and banks and the only peer group whose build-out of renewable power capacity in their corporate bond portfolio is aligned with a 2-degree climate scenario.
Swiss investors also need to improve investments in real estate, in particular mortgages, to reach the climate target, the study said.
Real world impact
In the qualitative research, the assessment found that climate ambition and strategies need to be translated more effectively into concrete real-world emission reductions.
“The ability of [institutional investors’] climate actions and strategies to deliver impact in the real economy vary greatly across actions and modalities of implementation,” the authors wrote.
Among the climate strategies, banks focus heavily on exclusion strategies and best-in-class investing, while pension funds and insurance companies often employ voting rights and engagement.
Around three-quarters of participants had identified a climate ambition or overarching strategy across at least one asset class. But only 15% reported they had gathered any evidence for impact on the real economy following their climate actions.
“This points to a lack of the accurate translation of climate ambition into specific actions and consistent application of these actions,” the study said.
It concluded: “While alignment analytics has dramatically improved, we are still at the beginning of understanding real world impact.
“When looking at the historical data, there is clear evidence that a pure portfolio alignment approach misses potential dramatic increases in emissions, ‘hidden’ by portfolio reallocation to other parts of the system.
“Further work is needed on supporting the private sector in designing effective climate actions and setting impact-oriented targets.”
Financial institutions could also receive a stress-test scenario simulation for their equity and corporate bond portfolio.
The stress-test analysis, which applied shocks with the start year 2030, demonstrated that a small minority of participating institutions may face significant losses of upwards of 10% under a climate transition to their listed equity and corporate bond portfolios.
From 2020-21, the assessment will be run in Switzerland, Liechtenstein, Austria, Sweden, and Norway.