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Digging deeper into carbon footprinting

For financial professionals only

As countries and companies race to reduce their carbon emissions to mitigate climate change, we increasingly see fund managers reporting on their funds’ carbon footprints. But how should we interpret the results?

Scope 1, 2 and 3 emissions

To start, we need to define some important metrics. We’ve used a car manufacturer as an example:

  • Scope 1 emissions – These relate to the company’s direct operations. For our example, scope 1 emissions would be from manufacturing the cars.
  • Scope 2 emissions – These arise from purchased energy. So this would include the electric lighting in the car factory.
  • Scope 3 emissions – These are everything else, including the company’s suppliers and customers. For car manufacturers, the vast majority of emissions (c.75%) result from customers driving the cars (1). This means scope 3 emissions are a very important part of the overall footprint.
  • Scope 4 emissions – this is an emerging category which measures the emissions avoided, but it’s not commonly used at the moment.

How easy is it to get the data?

Scope 1 emissions seem to be reported reasonably accurately by the majority of companies issuing public equities or bonds.

Many companies issuing public equity also report their scope 2 emissions. However, for companies that exclusively issue bonds, data is less available and sometimes unreliable. This means that calculating a fund’s scope 2 emissions tends to involve additional analysis by the fund manager. Usually with input from external data providers like Trucost or MSCI, as well as the raw company data.

Where scope 3 figures are reported for a fund, they’re estimated by the fund manager because there’s a high degree of approximation in company data. However, it’s generally worth the effort because only including scope 1 and 2 emissions can be misleading. For example, the emissions from a bank’s loans to fossil fuel companies aren’t picked up in its scope 1 and 2 emissions, only scope 3.

“Individual results may vary”

Even for scope 1 data, each fund manager will have a different approach to interpretation. Equally, each fund manager will make their own decisions about using third party data providers.

The way fund managers calculate the average emissions across a portfolio is not standardised either. We may see more consistency in time, but for now it’s necessary to ask them to explain their data sources and methods.

How can the data be used?

There are four key considerations when using carbon emissions data:

  • Carbon emissions are only one factor – Investors concerned with a broader range of ESG issues will monitor other metrics alongside the carbon footprint. For example, many fund managers will report on their voting and engagement activity. Others will report on their funds’ alignment with the UN Sustainable Development Goals.
  • Look carefully at the units – Carbon emissions can be reported as an absolute measure (in tonnes) or the carbon intensity (e.g. tonnes per unit of sales). It’s important to be clear on which is being reported. A company may reduce its carbon intensity over time but could still be responsible for increasing absolute emissions if it’s growing its sales.
  • Engagement can be more powerful than avoidance – Some investors will be satisfied that their portfolio simply has a carbon footprint below the market average. But for investors wanting to actively support the transition to net zero, it can be more effective to invest in high carbon-emitting companies and engage with them to reduce their emissions. Another approach is investing in companies providing solutions. They may have relatively high emissions in their own right but help drive energy efficiency savings for their customers. For example in manufacturing, building or food production, reducing overall emissions.
  • Rate of emissions reduction is just as important as absolute emissions – The speed that a company reduces its emissions is important given carbon dioxide stays in the atmosphere and has a cumulative effect on global warming. Ideally, the company’s planned pace of reduction in emissions should be monitored, as well as the absolute level of emissions. This helps to assess whether it’s sufficient for a below 2 degrees warming scenario, in line with the Paris Climate Agreement.

Work in progress

Carbon footprinting is an evolving area. We’re beginning to collect information from our fund managers in our Ethical solutions about their funds’ carbon emissions, but there are challenges regarding lack of data and inconsistency. We’ll continue to question our managers and keep a close eye on how reporting develops.

1International Council on Clean Transportation (ICCT)