IIGCC BLOG

How green are your govvies? Carbon footprinting for sovereign bond portfolios

Daniel Ingram, Head of Responsible Investment at BT Pension Scheme (Twitter @Daniel1ngram)

“Carbon footprinting”, namely accounting of emissions that can be attributed to an investment portfolio, has become the go-to method for investors wanting to assess their contribution and exposure to climate change. It’s easy to see why footprinting is such a success story – the calculation is simple, intuitive and regulators are pushing investors down this route, albeit sometimes inadvertently (e.g France’s article 173). But as we all know there are still a number of major unresolved problems with footprinting: it’s backward-looking and offers limited insight into supply chain emissions.

But stepping back a bit, there are some pretty fundamental questions still to answer: “What specific aspects of climate change risk are we trying to measure? What does footprinting tell us, if anything, about the speed and scale of a country’s energy transition, the magnitude and location of potential asset stranding and which of our assets are most exposed/resilient to future physical impacts from climate change? Is it feasible or even helpful to footprint all of our assets including unlisted and sovereign debt? For more detail see Kepler Cheuvreux’s “Carbon Compass” (Nov 2015) and Q&A report (March 2016).

Part of the problem is that we can’t simply replicate footprinting method used say for public equity. For that asset class we sum the total emissions of our share of a company’s total market capitalization (the “ownership” approach). This help us measure the total present volume of emissions we’re financing and our potential exposure to carbon price changes. But as sovereign bond investors we’re not necessarily directly financing a country’s emissions by buying its debt. Also this method doesn’t tell us anything about a country’s mitigation plan or adaptation measures and it doesn’t help us compare across countries.

Another option is to look at the total emissions of the government issuing the debt but what does this tell us about the risks faced by the sovereign such as extreme weather events impacting GDP? Other methodologies look at footprinting the total carbon consumed per capita or production activities within the nation’s borders.

To help address some of these unresolved methodological questions you may be relieved to hear we’ve formed a small investor working group, convened by the Global Footprint Network @EndOvershoot and @southpolegroup and we’re hoping to publish a short paper on the topic to be launched in the Autumn of 2016.

Carbon footprinting aside, what’s really encouraging is the growing body of research investors can use to help understand climate risk exposure in sovereign debt. In the “Heat is On: How Climate Change Can Impact Sovereign Bond Ratings”, S&P concluded the ratings of some Southeast Asian sovereigns could come under pressure as a result of rising sea levels and more frequent and severe weather patterns. In ERISC Phase II @UNEP_FI we’ve got better insight into how food prices link environmental constraints to sovereign credit risk.

So we’ve got plenty of research out there to help us begin to at least ask the question, “How green are your govvies?”