The asset management industry is still significantly underpricing ESG risk, and pension providers need to take a more practical approach to addressing this issue.
These were the main points made by Nathan Fabian, chief responsible investment officer, United Nations PRI, at the Corporate Adviser’s recent Sustainable Pensions online summit.
He also pointed out that ESG risks within a portfolio are not just long-term consideration. “This issues are playing out in portfolios today” he warned.
This he says make it critical that all pension providers have clear policies on how they manage these risks. More importantly he says they need to implement them, as this is not always happening at present, he says.
The UN PRI invites the asset management industry to become signatories to its principles of responsible investment. But although the number of UK signatories have increased in recent years, Fabian says this is not enough.
“Providers need to be really clear about what the purpose and approach is, and it is really helpful that within a broader ESG policy there is a specific focus on climate change.”
He says this ‘approach’ often stops by simply signing up to these principles of responsible investment. “There is often not a lot of clarity on how these will be implemented across all different asset classes, nor how ESG integration will be applied in a practical way, whether it is via tilted benchmarks, ESG adjusted risk budget or screening methodologies.”
Fabian says new tools – many of which have been developed in the EU – will help consultants better analyse pension providers’ ESG credentials.
These include the Sustainable Taxonomy, green bond standards and the Paris-Aligned and Climate Transition benchmarks for passive products.
The first essentially provides environmental benchmark data for different sectors of the economy, and shows whether this activity is consistent with the Paris Agreement — which was to reduce greenhouse gas emission and limit global temperature rises to no more than 2 degree above pre-industrial levels.
Consultants should be able to ask a pension provider what proportion of a portfolio is aligned with this taxonomy criteria, Fabian says. This should provide concrete metrics on what proportion of ‘green’, ‘neutral’ in terms of a carbon footprint.
The green bond standard offer similar benchmark criteria for the fixed income sector. Fabian says: “It is a way of demonstrating the level of exposure through fixed income portfolio to the economies of the future.”
Meanwhile the Paris Aligned and Climate transition benchmarks, are Fabian admits, somewhat more complex but he sees this as a “massively growing market and a way to assess and verify the climate claims made by various index providers.
He adds that pension providers may soon have to provide some metrics related to their annual statement on climate change. This is currently a work in progress he says, but there may be a move from regulators to require providers to publish a figure showing the weighted carbon intensity of the portfolio, for example.
Despite all the focus on climate change and ESG issues in recent years Fabian says that these risks are still often underpriced in the market. He says this issue may be priced in the coal sector, for example but was underpriced in gas and transport markets. He adds: “There is a total mis-price when it comes to assets like agriculture and land.
He adds: “Portfolios that are overweight in high priced carbon-heavy assets compared are carrying additional levels of risk that there will be a policy response by governments in order to tackle this issue.”
To put this in some context he points out that we are still tracking a 3 degree global temperature rise. Although emissions have fallen as a result of the Covid crisis, Fabian points out that we would need to see a similar fall every year between now and 2050 to meet the targets set out in the Paris Agreement. “This gives some level of the structural adjustments needed in economies, and the potential risk to portfolios that have a high exposure to this area.”
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