The ‘why’ of climate action investing

The following blog is an extract from our latest Climate Solutions paper: Climate change: Inaction is not an option

Depending on how it is calculated, listed companies make up between 40% and 50% of the global emissions stack[1]. What listed companies do with their own emissions has the potential to materially affect the climate outcome the world realises.

While also difficult to calculate, particularly given the need to strip out double-counting effects, integrating Scope 3 emissions into this calculation would significantly increase their share. This means that in aggregate it is highly likely that listed companies have a significant influence in well over half of all emissions globally. Unfortunately, when we look at these emissions over time, we can see that listed companies in aggregate have not been decarbonising, once we adjust for the effects of COVID (see chart below).

An objective analysis of listed companies’ climate targets would also suggest that future expectations for listed emissions should be little different – with around 80% of the emissions from listed companies coming from those that are not aligned (according to LGIM’s proprietary models) with ‘below 2 degree’ climate outcomes. Unless listed companies significantly accelerate both their ambition and their actions, their lack of action risks significantly impairing the world’s climate goals.

In our view, inertia also risks a significant misallocation of capital, with potentially significant financial consequences for investors. The emissions that are not aligned with ‘below 2 degree’ climate outcomes are also likely to sit towards the bottom end of the global abatement cost curve – and which should be decarbonising at least as fast, if not faster, than the pace associated with net-zero-2050-consistent scenarios.

According to our analysis[2], the direct financial costs of this lack of ambition for companies in MSCI ACWI alone could be around $290b USD cumulatively between now and 2030. The longer-term financial implications are – from a systemic perspective – just as serious. LGIM’s analysis also suggests that delaying climate action by 10 years might put as much as an incremental 8% of global GDP at risk between now and 2050. Unlike corporate emissions, there is no ‘unit of measurement’ that investors can use to measure capital allocation towards opportunities (beyond tracking the dollars themselves on a case-by-case basis), which necessitates demonstrating this underallocation by anecdote rather than systematically.

In this vein, we believe two anecdotes are useful. First, the allocation of capital towards the renewable industry – where we estimate that capital allocation is currently running at approximately one third the level required for a net-zero world. Second, the development of new critical mineral resources is still in its early stages. For instance, the IEA estimates that achieving net-zero globally by 2050 would require six times more mineral inputs in 2040 than today.[3]

So not only are companies not decarbonising their own balance sheets sufficiently quickly, we see little evidence that they are allocating enough capital towards the opportunities that the energy transition is likely to create. Both of these failures could carry significant costs for investors. Yet we believe they offer potentially significant opportunities if they can be addressed.

The above blog is an extract from our latest Climate Solutions paper: Climate change: Inaction is not an option. This paper is jointly authored by LGIM’s Climate Solutions team and AP7. The views and approach expressed within this paper relate specifically to their mutual investment strategy.

 
[1] Source: CO2 emissions – Our World in Data and LGIM analysis, as at August 2023. Scope 2 emissions have been adjusted to avoid double-counting. Assumptions, opinions and estimates are provided for illustrative purposes only. There is no guarantee that any forecasts made will come to pass.

[2] Source: LGIM. Destination@risk.

[3] Source: IEA (2021) The Role of Critical Minerals in Clean Energy Transitions Assumptions, opinions and estimates are provided for illustrative purposes only. There is no guarantee that any forecasts made will come to pass.