Decisive action is still necessary to keep global warming to below two degrees. So LGIM is pressing on with plans to offer a solution for assessing the climate risk and temperature alignment.
As scheduled, the 11th Petersberg Climate Dialogue took place in late April, involving ministers from dozens of countries exploring solutions for international negotiations. But instead of speaking face to face, the officials met via video conference – and in the knowledge that the focal point for climate talks this year, COP 26, has been postponed.
The Petersberg event illustrates how efforts to tackle the long-term challenge posed by climate change have taken something of a back seat as countries and individuals strain to contain COVID-19, upending economies and the fabric of everyday life.
At LGIM, even as we recognise the urgent need to fight the pandemic, which has caused so much suffering in such a short amount of time, we believe that decisive action is still necessary over the near term to keep global warming to below two degrees.
Assessing climate risks
Investors can and must play a crucial role here, too. That’s why in 2019 we concluded a year-long review of the global energy system in partnership with Baringa Partners, a leading consultancy.
As part of that strategic partnership, we created a model called “Destination” to analyse scenarios for how the energy system may evolve over the next 30 years – and their investment implications.
Destination utilises more than 10 million data variables, in a low-cost and efficient manner. This means the energy scenarios we now use to assess climate and transition risk for our clients are independent from those produced by third-party agencies.
We are pleased to say that the model is already proving useful: L&G Group took the output from Destination as a starting point in a project to establish a strategic approach to managing the financial risks from climate change. This work helped to support and guide how our parent company’s commitments on the climate would be achieved.
Indeed, thanks to Destination, L&G’s last annual report for the Task Force on Climate-related Financial Disclosures (TCFD) included three fundamental climate metrics:
1) Carbon analytics – measuring the exposure to high-carbon sectors
2) Climate risk assessment – determining a portfolio’s Value-at-Risk for climate risks
3) Temperature alignment – establishing which implied rise in global temperatures the portfolio is aligned to
Ambitions for the future
Our next step is to take the output from the model, and blueprint from the TCFD report, to design a platform through which we can interpret the impact from different climate scenarios on individual company valuations, called Destination@Risk.
This tool will take a bottom-up approach to assess how much of a company’s earnings would be at risk under a range of energy transition scenarios. These scenarios can be used to derive impacts on credit spreads and equity valuations, in order to aggregate up to the portfolio level.
By the end of 2020, we aim to convert Destination@Risk into a fully interactive and customisable climate ‘solution’ for assessing the risk and temperature alignment of any company, country or real asset.
The unprecedented steps taken worldwide to combat the coronavirus prove that we really are capable of decisive action, on a truly global scale, when faced with an existential threat.
Climate change poses just such a threat – and one that cannot be deferred, like a summit. We do not know how countries will change their policies on climate following the fight against the pandemic. But we do know that the path of decarbonisation is unlikely to run smoothly.
Moreover, we believe that investors who position appropriately for the ensuing disruption, and the shifting regulatory environment, can benefit materially from it.