The key areas of risk when transitioning to a net-zero investment goal are sometimes surprising, and many insurance companies are still struggling to understand the best process to achieve their goals.
In the new Insurance Asset Management Europe 2023 report, industry experts discussed the topic in a panel discussion: “From risk to opportunity: Aligning investment strategies with net-zero goals against a backdrop of evolving regulation and standards”.
In the conversation, Anand Rajagopal, Private Markets Sustainability Lead, Phoenix Group, as well as representatives from Legal & General and the Standards Boards for Alternative Investments (SBAI) discussed the key risks and challenges that investors are facing when transitioning towards net zero deadlines, and how can these risks be overcome.
Rajagopal explored ideas around how investing in a diversified portfolio can mean being dependent on the world. He also talked about transitioning to support business objectives, asking how an insurance company can properly judge the pace and scope of these changes. Fear around the net-zero transition is palpably felt. In 2022, Zurich and the Financial Times asked if “a disorderly transition [was] inevitable?”
“The fear is that late and rapid policy shifts will leave businesses and societies with little time to adapt and could cause deep disruption,” said the analysis. "It will also provide less time to develop and finance the necessary green infrastructure and technologies.”
These concerns pose the question of how one can become a leader without misjudging the direction of the industry - and how it can be achieved alongside the deadlines set by regulatory bodies.
Anand Rajagopal: It starts with being humble and acknowledging that we are not trying to create a perfect solution on all things net zero as a lot of this is evolving as we speak. So, we need to be able to make certain tactical manoeuvres as we work towards net zero milestones and see how the overall portfolio emissions trajectory is evolving.
There has been a lot of focus today on prior panels on ESG embedding and integration in the investment process, and it is a very important element that we focus on within Phoenix, Phoenix Asset Management, and our external partners.
"Within our net zero strategy, we have a milestone to reduce our carbon emission intensity of the portfolio in scope by 25% by 2025 and our peers are no different."
In terms of risks and challenges, obtaining the net zero goals and interim milestones begins with our ability as an institution and asset owner or manager to be able to confidently footprint and talk, on a portfolio-and exposure-level, to what is the economic carbon emissions intensity – which, is the tonnes of CO2 equivalent per sterling million of EVIC (Enterprise Value) invested. This is different from physical emissions intensity, which is grams of CO2 emissions per kilowatt hour of electricity generated – also a measure more applicable for electricity generation assets.
When you look at our various milestones, us, Aviva, L&G, along with many others, have their own target years and milestones with related commitments. We manage almost £270 billion in AUM on behalf of more than 12 million customers. Within our net zero strategy, we have a clear milestone to reduce our carbon emission intensity of the portfolio in scope by 25% by 2025 and our peers are no different. We have a 50% emissions reduction target by 2030 in the assets that we exercise control and have influence over.
"There are not enough market opportunities with low or zero carbon emissions intensity to invest in, especially once you apply all the investment constraints."
For this 2030 milestone, there is a bit of a subjectivity with the assets under scope but, make no mistake, we do need to think about decarbonisation while focusing on achieving investment volumes and profitability and, at the same time, supporting the economy by investing in sustainable – and in our case, transitional and productive assets as well. We have the ambition to invest up to £40 billion in such assets over a long-term timeframe. Last but not least, I believe we are one of the few insurers (if not the only one in the UK) to have published our sustainable classification framework on how we define these assets and eligibility with quite a lot of granularities.
In terms of risks and challenges, there are not enough market opportunities with low or zero carbon emissions intensity to invest in, especially once you apply all the other investment constraints, such as MA Eligibility, etc. If you have a starting point that you define in 2019 or 2021, you are trying to bring down that number by 50% in 2030, which means that you have to do quite a few things here: you have to be able to support areas that are still transitioning, which are probably not with the low intensity going in. They may be at a medium to high clip; yet, these are often the assets that could offer good risk-adjusted returns – all else equal – and are indeed the areas that badly need private capital to play a role in (for example, emerging economies, developed market corporates in hard to abate sectors, etc., in the process of transitioning, etc.) In my view, a direct way you offset the (going in) higher intensity with such origination is by being able to invest in very low or near zero-intensity assets, because, on average, you still want to be able to bring that emissions intensity curve down for net zero.
"The commonly acknowledged challenge would be with a lack of data across asset classes; so, we need to come up with reasonable proxies when needed."
Herein lies the problem, because as an asset owner or investor, we are very passionate about investing with purpose. At the same time, to ensure we invest in low or zero-intensity assets to manage the portfolio build vis-à-vis net-zero trajectory, we need to develop the ability to pay up if need be in certain instances and perhaps compromise on economics. The other obvious and commonly acknowledged challenge would be with a lack of data across asset classes; so, we need to come up with reasonable proxies when needed.