Back in the spring of 2021, a hedge fund called Engine Number 1 was able to elect three of its candidates to the ExxonMobil Board of Directors, making news headlines. IMAP-funded faculty, Nalin Kulatilaka and Robert Kaufmann, delved into the motives behind Engine Number 1’s goals and the ultimate impact the activism had on ExxonMobil’s stock returns. Read their analysis and paper here. (Please note, this link will expire on October 25.)
The summer flew by and now the IGS Grad Student Summer Fellows have wrapped up their projects. IMAP supported the work of Claudia Diezmartínez and Sakshi Sharma.
Claudia conducted independent research on how cities across the United States are financing climate action and incorporating climate justice into their municipal budgets. She performed a deep dive into the inner workings of municipal finance for three cities that have explicitly incorporated justice into their climate action planning: Portland, OR; Dallas; and San Diego, by doing a content analysis of their municipal budgets and capital finance plans. Long-term, this project will provide actionable information for urban decision-makers on how best to fund and finance climate action across cities of different sizes and the implications of these financial decisions on the implementation of just urban transitions.
Sakshi built a comprehensive database system in MongoDB, complemented by a user-friendly web application, developed using Flask. The system consolidates diverse company data, incorporates web scraping from Yahoo Finance, and is seamlessly deployed on AWS for convenient access and future scalability. The database will allow IMAP’s Corporate Carbon Risk project to better analyze carbon reduction data within and across industry sectors, which will in turn help the project to develop a reliable methodology for predicting the likelihood of companies achieving their future carbon reduction targets.
Recently, all of the IGS Graduate Student Summer Fellows presented their work. Pastries from the North End were enjoyed by all.
IMAP is hosting two summer fellows as part of the IGS Graduate Student Summer Fellows program. Sakshi Sharma will be building a database for the Corporate Carbon Risk project and Claudia Diezmartínez will be piloting a method to assess and compare climate finance across US cities.
Sakshi Sharma
One of the most important goals of the Corporate Carbon Risk project is to develop a reliable methodology for predicting the likelihood of companies achieving their future carbon targets. As companies and investment firms commit to targets for reducing their carbon emissions, there is a growing desire to understand the risk associated with these future target statements.
Sakshi, a master’s student in BU’s Department of Computer Science, will be building a database in MongoDB for the Corporate Carbon Risk project, enabling the project to efficiently grow both its data and analyses. To do this, she’ll import and analyze historical data on carbon emissions, future carbon target statements, progress on capital investment projects, emissions reduction initiatives, and other unique circumstances of each corporation and industry sector.
Claudia Diezmartínez
New research is needed to identify the finance strategies that are either being piloted or proven to be successful to address climate change in cities and to understand how climate finance shapes the implementation of urban climate action.
Claudia, a PhD student in BU’s Department of Earth and the Environment, will be conducting a content analysis of municipal budgets and capital finance plans of ten selected cities in the United States that have explicitly incorporated justice into their climate action planning. She’ll pilot a method to systematically assess and compare climate finance across those cities. By analyzing how these cities are funding and financing climate action, whether and how they incorporate justice into budgeting planning, and the types of climate programs and policies to which investments are being directed, this research will explore the role that climate finance plays in the implementation of just urban transitions.
Find out more about both research projects here.
IMAP affiliated faculty Michelle Amazeen and Chris Wells shared their research findings on misleading “native advertising,” at the May 16, 2023 research symposium hosted by the Institute for Global Sustainability. Fossil fuel companies pay for native advertising, which is hard to distinguish from regular news content, to sway public perception around their sustainability efforts and involvement in greenhouse gas emissions. Check out The Brink article here.
Thank you for your interest. This position has been filled.
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Jan 10, 2023
Peter Fox-Penner,
Senior fellow, Boston University IMAP and Institute for Global Sustainability,
Chief Impact Officer of Energy Impact Partners,
and advisor to the Brattle Group.
I especially thank Tom Gosling for his through and thoughtful comments. I also thank Dan Firger, Paul Bodnar, Patricia Hudson, Curtis Ravenel, Ken Pucker, Nalin Kulatilaka, Susan Murphy, Rebecca Francus, Albert Abaunza, Kevin Fitzgerald, Shayle Kann, Morgan Sheil, Gabriella Rocco, and Marianne Gray. All errors are my own.
On 7 August, London Business School’s Tom Gosling wrote an extremely thought-provoking blog post about the Global Financial Alliance for Net Zero (GFANZ), a voluntary association of financial firms who make commitments to transition their investments to net zero by 2050 (“NZ50”). Summarized briefly, Dr. Gosling (who I will take the liberty of calling Tom) argued that the pace of climate action by the nations of the world means that adhering to the GFANZ pledge creates a significant conflict with the fiduciary duty to maximize profits for most managers of listed firms’ securities.
Tom has unquestionably raised important points that are real and deserve further discussion. However, his analysis is a bit one-dimensional or static, for lack of a better term. When the problems he points out are unpacked a little the actions of some asset managers and GFANZ can be reconciled with fiduciary duties. This limited reconciliation goes to the heart of GFANZ’ raison d’etre — to accelerate the natural cycle between governmental policy shifts and business’ response to them. Seen in this light, GFANZ has a specific, catalytic role to play in the ongoing interplay between business activity and government policy. It may not be a broad-based club that includes the vast majority of financial actors, but it can advance climate progress without jeopardizing a wide swath of fiduciaries along the way.
In particular, Tom noted that current assessments such as the IPCC’s recent 1.5 degree report conclude that the world is not nearly on track to keep temperature rise to 1.5°C, meaning that high-carbon- emitting economic activity is continuing at a much higher pace than this target allows. (He followed up his first post with a second post suggesting changes to GFANZ, posted here.) Global investors, Tom noted, could not simultaneously be financing all of the economic activity associated with a much higher emissions path than 1.5°C– presumably most profitable under current policies — and be claiming that their investment actions were leading to net zero. Tom gives an especially compelling example of how actual economic activity could be inconsistent with projected activity in a 1.5°C scenario when he notes that the two-thirds of the oil and gas that could be burned in a 2° scenario could not be used without CCS in a 1.5°C future.
Tom is correct to note that the 1.5°C target, which is enshrined in the Paris agreement and UN Race-to-Zero guidance, is more stringent than 2° or (loosely) net-zero-by-2050. Nonetheless, while formally supporting the goals of the Paris agreement and requiring alignment to 1.5°C, GFANZ commitments are implemented via pledges to get to net zero emissions by 2050. Accordingly, in this post I will use net-zero-by-2050 as the key operational marker for GFANZ implementation
Tom also looked at several arguments asset managers might use to “reconcile the worsening climate outlook with their commitments under GFANZ.” For example, GFANZ’ guidance to financial institutions states, “Over 500 financial institutions have come together to form GFANZ, committing to achieving netzero greenhouse gas (GHG) emissions by 2050 in support of the global transition to a net-zero economy to limit global warming to 1.5 degrees C.” Governments could shift their policies to make 1.5°C most profitable, but this was “more an article of faith than a view consistent with the prudent person rule.”
The second rejected explanation is a redefinition of fiduciary duty. While the clients of fiduciaries are interested in “factors beyond financial returns,” the linkage between any one financial investor’s achievement of climate goals and global climate outcomes is so imprecise that one can neither guarantee nor measure any concrete climate benefits from a voluntary sacrifice of returns.
Finally, managers could assert that climate risks justified investing for net zero. However, Tom argues that climate risks for individual investments are not yet specific and large enough to warrant net zero shifts — and even if they were, the same inability to point to tangible payoffs would bedevil this strategy.
Suppose we could assemble the set of every current investable GHG-emitting enterprise in the world along with its carbon emissions intensity (GHGs emitted per dollar invested). We then measure all investments that can be made into this universe that meet the risk/return threshold consistent with each investor’s fiduciary duties as they are now understood. If we ordered these investments, starting from the highest GHG-intensity emitters and progressing to ones that are successively lower, we would probably start with coal-fired power plants and factories, moving through oil refineries and other high-GHG emitters on to successively cleaner economic enterprises. This range is used as the horizontal access in Figure 1.
Some sources of carbon come from entities that can’t be invested in by third parties, which creates a source of leakage in the GFANZ mechanism but does not render it invalid. This includes state-owned enterprises, which Gosling has reminded me account for perhaps one quarter of all global GHGs based on a Columbia Center for Global Energy Policy report. However, the report notes that 69% of all SOE emissions come from China, which is a unique actor in climate diplomacy in any case, and 85% of all SOE emissions are from the power sector, which is influenced through many channels other than GFANZ. With respect to privately-held assets, there is not yet a GFANZ commitment mechanism but several are under development right now, including a Net Zero Venture Capital Alliance (NZVCA). Once these commitment mechanisms are in place the mechanism I discuss below will work just as it does for other assets already under GFANZ pledges.
Even though we can’t invest in everything that generates carbon, all investable entities exist somewhere along the spectrum in Figure 1. When an investor invests in one, they should be allocated their share of the emissions from the entity they are financing. The simplest assumption to make about these allocations is that the investor’s share of the emissions footprint of the entity they are investing in equals the current average emissions intensity times the amount invested. For example, if Acme manufacturing is now emitting 10 lbs of carbon equivalent emissions per dollar of capital, and I invest $5 new dollars in Acme, my Scope 3 financed emissions from this transaction is $5 x 10 lbs./$ or 50 lbs. of CO2e. If as an investment manager I’ve made a pledge to GFANZ, this 50 lbs. is now part of the footprint I need to transition to net zero by 2050.
This new investment may be used by the company to lower its current or future emissions, in which case it should not be viewed solely as having a footprint equal to the current average emissions intensity of the firm times the size of the investment. However, under current carbon accounting treatment and in the absence of a more sophisticated analysis, the effect of the investment would be to increase the financed emissions component of footprint at current intensity levels. One of the issues we are wrestling with in the formation of the NZVCA is the treatment of emissions impact – i.e., how our investment changes the footprint of our investee now or in the future, versus their current footprint.
As you proceed through the investments from left to right in Figure 1 you come to a key transition point where GHG intensity is at the current average level of about 283 mTCO2e/million dollars invested.
If you invest in entities to the left of this point you will be raising the average global carbon intensity and total carbon emissions, at least as measured by the increase in the emissions allocated to your footprint Conversely, all investments to the right of this point act to reduce total global average GHGs intensity per dollar invested (again gauged by footprint changes) — though not necessarily on course for NZ50.
As we continued rightward we’d come to a second point where investments reduced current emissions on a path that reaches NZ50. Beyond this point, all investments are already at a net-zero-consistent intensity. It is worth noting that this is a key point of disagreement between Tom and myself. Tom argues that portfolio manager who allocates investment to a firm whose intensity is on the right-hand side will have no effect on that firm’s actual emissions trajectory, “particularly with secondary markets activity.” In my view, greater market-rate capital available to low-carbon firms, even through secondary market trading, encourages them to grow faster, in turn signaling policymakers that policies promoting this type of investment are advantageous.
Incidentally, if the rules for creating this sample are relaxed to allow for nonprofit and government investment funds, concessionary returns, or multi-objective B-corp investors there is a larger pool of investments with lower-than-average GHG intensity that can now be accessed. This is because there are many low-GHG investments that are not yet profitable at going market rates, but do earn enough money to qualify for concessionary or public financing.
In this framework, one way to express Gosling’s point about the conflict between current investment opportunities and a net zero path is this: under current policies affecting investment profitability, the aggregate size of the investments to the left of the NZ50 point on this chart are demonstrably much larger than the investments to its right. Otherwise, GHG intensity would not be declining too slowly for the world to achieve net zero by 2050. In Gosling’s construct, governments have created an overall playing field where too much of the universe of now-profitable emits too much carbon and too little of the total aligns with net zero.
There is room for discussion around this point because we are assuming that each new investment into entities with a current carbon intensity of, say, 50 lbs. of CO2e per dollar causes 50 more pounds of CO2e per new dollar invested. Many companies on the left as well as the right side of Figure 1 have made commitments to cut emissions from current levels, and some of the financing going to these companies will be used for this purpose. A snapshot like Figure 1 could say that we are not on track for net-zero, but can’t factor in future, but real, decarbonization plans. This idea has been gaining traction lately in ESG investment circles by labelling some companies and their stocks “ESG improvers.”
Another wrinkle in Figure 1 is the ultra-important role of investment in new GHG-reducing innovations by governments, venture capitalists, and others. These investments are typically not yet producing marketed products, so the companies are causing emissions at some rate per dollar invested as they build and test prototypes and head towards product launch, but aren’t yet saving substantial amounts of carbon with their products . These companies’ emissions are adding to current global GHGs and quite possibly to Gosling’s key emissions observation. However, if these innovations yield improved ways to cut emissions not yet factored into the IPCC’s trajectory they will soon be in the rightmost block even if their present emissions profile puts them on the left. We see this phenomenon in my firm’s venture investments, and in addition to our own reporting the newly-forming Net Zero Venture Capital Alliance and Project Frame are trying to improve transparency on this mechanism as well.
These points notwithstanding, Gosling is correct that the sum total of investing activity in Figure 1 is not yet reducing global GHG emissions — after all, atmospheric carbon concentrations increased by 2.6 ppm in 2021. This must mean that more investment is going into the left block of the figure, increasing total global GHGs, than is going into decarbonizing investments across the entire spectrum.
While this may be so, there is most assuredly a portion of Figure 1 where NZ50-consistent investments reach market levels of return and where many investments are being made. Some investments fully compatible with NZ50 are profitable in many markets now, either in specific niches or even widespread use. PV solar, wind energy, storage, and many other parts of the clean energy system are clearly technologies that can be profitable investments today. Other NZ50 investments are not yet first-cost- cheapest, but in some cases consumers who value green products will pay more to create equal or better profitability for investors. In other cases, NZ50 products provide added services that allow market profitability even without green preferences. In still other cases, the likelihood of future government mandates, declining cost curves, and the time required to tool up to meet mandates indicates that investment oriented towards net zero is now prudent. This describes the electric vehicle market in much of the world today. All this is within the investable universe that my firm, Energy Impact Partners, primarily focuses on, as do many other climatech investors.
In sum, when Tom’s argument is unpacked it does not follow that there are few opportunities consistent with net zero and market returns. It may well be the case that, under current worldwide government policies, there aren’t enough of these opportunities to put the world on course to net zero by 2050, or more strongly 1.5°C, and still too many opportunities to invest in high-emissions enterprises. In my view, that’s right where GFANZ comes in.
Obviously, the investment spectrum we’re discussing is anything but static. At every point in time, government policies play a pivotal role in determining how many investments reach market return thresholds within each of the three blocks in Figure 1. Policies that provide public subsidies for building coal-fired power in a country would expand the size of the left-hand, high-emissions investment opportunity block. Policies that tax carbon significantly in that same country would have the opposite effect. The aggregate size of each of these blocks is the result of thousands of government policies, regulations, court rulings, subsidies, taxes, and fees, all creating the complex playing field on which investors assess the expected return on of an investment. One way to describe the global climate policy framework is to say that the role of the Paris Accord and its surrounding commitment ecosystem is to steadily reduce profitable investments in the left-hand block and increase them on the right-hand side so as to shift the entire aggregate emissions profile down to NZ50.
We’re all familiar with the many constraints governments face in adopting emissions-reducing policies. Almost all climate policy shifts disadvantage some legacy businesses and their investors and often also create other just transition issues. Of course, each policy shift also creates more investment opportunities on the right side, along with more jobs and healthier and often more equitable economic development. For any government responsive to its citizens – including its businesspeople – its ability to shift policies towards decarbonization depends on its citizens’ and investors’ willingness to bear the transition costs. This is influenced enormously by the size and visibility of the businesses and investors who are in the part of the economy where they are making highly profitable investments and creating good jobs while substantially reducing GHGs.
I think this is the role of GFANZ and its alliance members. Through their commitments, members express confidence that they will find portfolio companies that reside primarily in the right-hand block of investments. They pledge to reduce their footprint of allocated financed emissions from its current level to steadily lower levels in the future, in effect notifying governments in advance that they accept this deal: if governments enable more low-GHG investments to be profitable they will invest it them. Some may already have investments with intensities consistent with NZ50 or they may be investing on track to hit the target even if current emissions put them on the left.
By expressing this willingness to invest via their pledge, policymakers are reassured that there is enough opportunity in decarbonization to ratchet policies further in this direction “It’s a lot easier to turn into law that which hundreds of your largest businesses are already doing,” Carbon Disclosure Project president Paul Dickinson recently remarked. For every policy ratchet they achieve, they open up a larger investable space for new and expanded GFANZ members who have pre-pledged to fill it. The Paris Accord envisions progressively higher ambition in each NDC; the cycle between GFANZ investors and policymakers should promote higher ambition through its complementary process.
There are certainly challenges for GFANZ if this description of its overall role is correct. Most powerfully, Gosling’s critique reminds us that GFANZ membership likely cannot extend to all investments, only that fraction consistent with a net zero path. That includes many but not all companies in the right-hand block and the left-side investments that will take the investee’s operations to NZ50. To maintain its credibility, GFANZ commitments must ensure that the investments of those who commit meet these criteria. This assessment has to allow for rapidly-changing shifts in technologies, costs, energy prices, and other factors. In my role with Energy Impact Partners, we are constantly watching many climatech sectors where new innovations combine with the evolving policy landscape to make formerly-uninvestable opportunities now attractive.
Tom Gosling is right that there are substantial tensions between the fiduciary duty of some asset managers and the ability to commit an investment portfolio (or another similar financial activity) to a net zero path. These tensions suggest that the size of the GFANZ universe isn’t all financial investors, and that acknowledging these limits is part of the credibility establishment that pulls national ambition forward. While it is indeed tragic that all global economic activity is not yet on a 1.5°C path, this does not rule out significant investment that satisfies both fiduciary duty and a pathway to NZ50. GFANZ’ role is to demonstrate the economic opportunities arising from the clean energy transition and thereby contribute to virtuous cycle of improved policies and greater net-zero-aligned investment.
Our first in-person workshop was a great success!
On October 7, 2022, researchers, academics, investors, and corporate leaders gathered on Boston University’s campus for the IMAP Fall 2022 Workshop to discuss how we can make corporate carbon targets more effective.
Calvert Research and Management President John Streur is a member of the IMAP’s Advisory Board and participated in the IMAP’s fall workshop on corporate carbon targets. He shares his key takeaways from participating in the event on the Calvert blog.
Alicia Zhang, PhD Candidate in Earth & Environment at Boston University
In July 2022, I attended the inaugural ESG conference held at Cornell University. The conference highlighted the hopefulness and optimism surrounding ESG investments to foster a ‘green’ transition, but also emphasized concerns in the ESG practice due to systematic bias. ESG information may provide useful insights to investors on firms’ performances. However, it has long been understood that, due to its infancy, the current ESG practice has flaws and inconsistencies. The various and diverse methodologies used by rating firms, as well as the incompleteness of raw ESG data to construct ESG scores has drawn questions to the integrity of such scores by researchers and practitioners. The metrics and scores are currently challenging to trust and interpret, and some ESG practitioners are successfully misleading investors to construct a false narrative.
Many investors utilize ESG ratings constructed by ESG data providers like MSCI, Refinitiv (formerly ASSET4), and Sustainalytics, to quantify a firm’s performance in relation to ESG criteria. Yet, research has not yet come to a consensus on whether there is an impact of ESG ratings on investment returns. This is a tough spot for ESG rating providers to be in, especially since the ESG industry follows an ‘investor pay’ model in which ESG data vendors compete based on how useful their ratings are for ESG-related investment strategies. Given this model, ESG rating providers often want to demonstrate a positive relationship between high ESG scores and high returns, even if such a relationship does not exist.
A paper (voted the most outstanding paper by conference attendees) presented at the Cornell ESG conference by Dr. Florian Berg, a research associate at the MIT Sloan School of Management, highlights issues with ESG scores due to systematic biases in the ex-post restatements of Refinitiv data and how ESG funds can manipulate scores as well as raw granular data to give some firms a better ranking or classification. ESG metrics were adjusted upwards after the fact for companies that have superior financial performance, retroactively introducing a positive link between ESG scores and returns. This was done without announcing the changes to the public; further data rewriting strengthened this relationship. The findings throw a cautionary caveat when using ESG ratings to make lofty aspirational statements with the goal of assuring shareholder profits. In effect, as the authors contend, this supposed positive relationship between Refinitiv ESG scores and returns on investments will draw in clients (and their money) to Refinitiv’s proprietary ESG score database, but also may mislead investors and their asset allocation decisions.
However, these findings should be taken with a grain of salt. Certainly, a major question is whether the restatement issue with Refinitiv data is applicable to other ESG rating providers, such as MSCI or Sustainalytics. This is a question that was brought up by the presentation’s discussant, Dr. Ryan Lewis, an Assistant Professor at University of Colorado Boulder’s Leeds School of Business. He assumes that there is pressure across rating providers to equate ‘green’ as ‘good,’ in terms of financial returns. Lewis also wonders how institutional investors respond to these restatements. Funds may be reallocated to firms that have a track record of being ‘green,’ i.e., have had ‘good’ ESG scores for a relatively long time. However, given that Refinitiv does not publicly disclose its restatements, I find it highly likely that investors and asset managers are unaware of the restatements and, by extension, their impacts on firms’ actual ESG performance. Further analyses on whether ESG data rewriting is occurring on a broader scale is necessary to understand what the impact of this bias is on decisions made by firms and ESG practitioners, as well as on academic research.
ESG rating providers are not the only actors that can mislead investors. Another paper presented by Dr. Filippos Papakonstantinou, a Reader in Finance at King’s College London, finds that mutual funds that discuss their ESG investment strategy in their prospectuses attract higher flows, especially if the prospectuses contain ESG-related ‘buzz’ words in their prospectuses, compared to prospectuses that contain information on fundamentals, such as disclosed fund holdings or realized fund returns (a finding that supports Lewis’ assumption). However, these buzzwords can mislead investors in terms of actual performance. ‘Greenwashing’ funds that represent their investment strategy in a manner that makes it appear as if they are more heavily tilted towards ESG than in reality attract flows similar to funds that are truthful about their commitment to ESG investing. Yet these funds perform worse than the funds that do follow through on their ESG commitments which, the authors argue, engender challenges for asset managers seeking firms that follow through on their ESG commitment and may hamper improvements in environmental and social outcomes.
These cases of mismanagement and successful manipulation of the ESG practice highlight the need for regulation and reorganization of the practice. As the two papers highlight, the traditional strive for optimal profits yields a system that may not produce actual environmental and social change, but instead continues to support the system in which public interests must step aside for private interests. To engender the change needed for a ‘green’ transition, incentives need to be put in place to better align private profit and social welfare. Further, outcome-based regulations, such as those proposed by the Securities and Exchange Commission (SEC), can improve the transparency of asset allocation and portfolio selection as well as can help investors make decisions that align with their own ESG goals.
The ESG practice is important and can work, but we must be wary of and address its flaws. In its current immature state, the ESG practice is vulnerable to exploitation and impacts investors’ asset allocation decisions. By being cautious of flaws within systems and working to fix them, we can improve the performance, sustainability, and resilience of a firm as the world moves towards a green and just economy.
