Going beyond the standard metrics for climate change

Sponsored article: With climate change an investment imperative and an imminent reporting requirement, Ritesh Bamania argues UK pension schemes should look beyond today’s standard metrics.

With climate change an investment imperative, and an imminent reporting requirement, UK pension schemes should look beyond today’s standard metrics.

Current UK government proposals on climate-risk reporting by pension schemes show that in addition to being highly material for investment risk and returns, reporting on climate change has now become an imminent regulatory requirement. The first wave of these regulations will apply for corporate schemes with similar regulations expected for local authority pension schemes.

We fully support these regulations given the impact we are already seeing on assets, liabilities and covenants of many pension schemes as the climate transition accelerates.

We sympathise with trustees and investment professionals who will have to grapple with complex issues, multiple definitions and a general lack of complete data as they seek to quantify the level of climate risk in their portfolios. The risk of missed opportunities or exposure to stranded assets amid the transition to a low-carbon economy is high. So is the risk of making incorrect calculations.

Integration

It is clear that integration of sustainability and, in particular, climate risk, is part of the fiduciary duty of pension schemes.

The good news is that there are many organisations which have built strong capabilities in this area in recent years and are ready to partner with trustees and investment professionals on this journey.

At Lombard Odier, we have invested substantially in our Sustainable Investment Research, Strategy and Stewardship (SIRSS) team. These 13 specialists are equipped to provide extensive information to our portfolio managers and support clients with actionable sustainability intelligence and investment strategies, stewardship, and training.

We have also established an academic partnership focused on climate-transition research with the Smith School of Enterprise and the Environment at Oxford University, creating the first endowed professorship of sustainable finance at a major university.

Transition risk

Climate risk addresses not only physical events, such as the effect of hurricanes, wildfires or flooding, but also the transition risk that equity and debt issuers are confronted with as the economy de-carbonises towards net-zero emissions by 2050.

These transition risks include exposure to stranded assets, higher carbon prices, carbon-abatement costs, and demand-side shifts. The combination of physical and transition risk is what has truly brought climate risk to the fore today.

Carbon intensity is a key metric in assessing climate risk and is already used widely. It does not, however, provide information about the expected future emissions of a company and cannot therefore inform investors about the temperature trajectories of their assets or overall portfolios.

Aiming to fill this void, a new metric called the Implied Temperature Rise (ITR) is emerging. We have developed a new tool that assesses this new metric and call it Lombard Odier Portfolio Temperature Alignment (LOPTA).

This new tool enables us to better understand climate related risks in our portfolios and helps us create equity and credit strategies that demonstrate a lower forward looking temperature trajectory as desired by the Paris Agreement.

Natural capital

Sustainability is an immense theme with diverse yet interconnected strands, and we believe it is driving the next economic revolution. Climate risk is rightly a subject of focus right now. It is fascinating to see how the topic has become prominent over the last two to three years.

Given this trajectory, local authority schemes in our view should also be aware of the emerging topic of natural capital as we anticipate this to be the next big topic.

The natural capital-led growth opportunities enabled by the circular bio-economy and the transition to leaner, more efficient and less wasteful forms of industry will need to be understood by pension schemes as key long-term investment considerations. The return potential from these considerations can also be very strong.

Ritesh Bamania is head of UK and Ireland institutional clients at Lombard Odier Investment Managers (LOIM) information. Email r.bamania@lombardodier.com.

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