All investment classes are now wide awake to the next systemic shock facing the global economy – the climate crisis – and they are actively de-risking portfolios to support a net-zero transformation, writes Emitwise CEO and co-founder Mauro Cozzi


 

In between the global financial crisis and Covid-19, numerous corporations operating under the halo of globalisation were thought to be ‘too big to fail’. The scale of global supply chains was viewed as a mark of resilience – a self-fulfilling prophecy that fed continued capital investment into large firms.

The pandemic changed that, inflicting a huge cost on society and giving both investors and bosses a visceral wake-up call: multinationals are just as exposed to external systemic shocks as smaller firms, if not more so.

Asset management giant BlackRock has increased its ‘green’ engagements by more than 50% in the past year. And in the utility sector, net-zero leaders have outperformed the laggards over the last two years. The writing is on the wall: exposure to carbon emissions in your balance sheets and supply chains is a key determinant of your ability to fundraise.

Traditionally, private equity investors have been rewarded for their courage and patience in spotting and funding new ‘ripe for scale-up’ market entrants. Riskier investments in disruptive business models, as part of diversified portfolios, will of course continue – especially in the current low-interest-rate environment. But the volatility of the last year is burned onto the minds of investors. De-risking is the order of the day, and carbon intensity is a proxy for costly opex and risk.

Investor activism used to mean excluding ‘sin stocks’ such as coal and tobacco from portfolios. But research into the rapidly growing ESG market shows that 45% of investors now undertake ‘positive screening’, proactively selecting best-in-class companies that score highly on Environmental, Social and Governance criteria.

With global governments now aligned to realise a global net-zero economy, climate risk is synonymous with investment risk. Carbon prices have never been higher, and both the US and EU are pushing a carbon frontier tax to create a ‘green level playing field’, punishing free riders and rewarding leaders as they ratchet up the carbon price. In the post-Covid world, investors are assessing opportunities with new clarity. For companies seeking to attract capital or raise share value, a clear climate plan is a prerequisite for success.

The death of ‘set and forget’

To steer corporate climate action, traditionally, companies hired an external consultant to measure a base-level carbon footprint – and calculate an (often arbitrary) long-term reduction target that sounded ambitious in an annual report. That is no longer sufficient. Corporations must now be prepared to disclose detailed, costed transition plans on climate change. Investors expect access to carbon data to see into the future of their investments, to see exactly how companies will play their part as economies are re-orientated towards net-zero greenhouse gas emissions by 2050.

It is not only a company’s current carbon emissions profile that is important – how much it emits versus its annual revenues, for example – but also when it will arrive at net zero. Would you set a destination into Google Maps without checking that the time of arrival aligns with your next meeting or appointment? A passive ‘set and forget’ approach to carbon footprinting is like that, only the stakes are much higher. If we are late for net zero, we will be remembered as the generation that had the chance to avert irreversible climate damage and blew it.

The clearest, most sincere commitment to decarbonise is setting a science-based target (SBT), which guides the quantity and speed of emission reductions along the value chain, to constrain global warming to 1.5 degrees Celsius. SBTs carry major upside. Reducing exposure to greenhouse gases over a longer-term, science-based horizon increases resilience to external shocks and tightening carbon policy. It also spurs innovation and enhances reputation and licence to operate. That is music to the ears of CEOs, private equity and shareholders, but practically how can firms move from a passive understanding of carbon to becoming ‘climate proof’?

Data is the secret weapon to fully understanding the climate risk of a company’s entire activities – and taking real action.

The most effective carbon accounting, supercharged by machine learning, can absorb the vast complexity of a global value chain, apply algorithms to analyse data, learn from it and make predictions that create real impact. Once a baseline has been measured and aligned with global regulations, AI can dynamically assess carbon exposure ‘hotspots’ and set controls to mitigate emissions. In this way, carbon accounting steers strategic action. It moves corporates beyond operational decision-making into a more strategic role, driving decisions on everything from suppliers to acquisitions.

For AI and machine learning to realise its potential, data granularity is key. One of our own investors, Schroders CEO Peter Harrison, calls the current climate disclosure imperative “a 1929 moment, a once-a-century shift in the way companies are valued. Before the Wall Street crash, a company could report whatever level of profits it chose. In the aftermath, and amid the Great Depression, robust accounting standards were introduced and remain with us today.”

I could not agree more. Capital is shifting away from carbon-intensive models, and investors are primed to support the net-zero transformation. Through full disclosure and clear standards, we can help to ensure the right horses are backed.