Resilience Dispatch #28: Net Zero Investing

Nov 1, 2022
 > This edition | When net zero investing meets the “value-carbon frontier”    
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Carbon is a new global currency. If we’re serious about stopping climate change, every economic decision that society takes in the future will have to consider not just financial value, but climate value: is this action compatible with a stable climate, or does it add to the problem?

This special series of the Resilience Dispatch will explore how we can put more “money in the carbon bank.” That is, how do we invest to build up our natural carbon sinks? We’ll look at where demand comes from, how we design investments to be more effective, fair, and durable, and how we deliver real results.

We’re beginning on the demand side – where can we tap into additional climate ambition? In this Dispatch, we cover recent signs of trouble for financial institutions’ commitments to a transition to net zero portfolios, and our Senior Advisor Rupert Edwards offers a practical solution.

In this edition:


Just under a year ago, the Glasgow Financial Alliance for Net Zero (GFANZ), co-chaired by Mark Carney and Michael Bloomberg, announced that it had secured commitments from financial sector institutions representing more than $130 trillion in private capital to achieve net zero emissions by 2050 at the latest. This was great news.

A few things then happened.

First, eighteen US states have threatened or enacted laws punishing financial institutions using environmental, social, and governance factors to guide investment decisions. The latest is the state of Missouri, which last week said it was pulling $500m out of pension funds managed by BlackRock over its “prioritizing” environmental, social, and governance factors over financial  returns. Under pressure, firms including BlackRock and Vanguard are saying that they will continue to invest in fossil fuels. (To be clear, the International Energy Agency has said that any further oil, gas, or coal development is incompatible with holding global warming to 1.5 degrees Celsius.)

GFANZ signatories also started worrying about their legal exposure from net zero commitments. Bloomberg reported last month that banks including JPMorgan Chase & Co. and Morgan Stanley were thinking about leaving the GFANZ coalition.

Third, fossil fuel companies – especially coal – are having a very good year. Banks earned more than $1 billion lending to the fossil fuel sector in the first three quarters of 2022. Glasglow commitments notwithstanding, lending to the sector is actually up 15% over the same period in 2021.

Meanwhile ESG-aligned investments aren’t faring so well. Clean energy indexes have underperformed dramatically compared to the traditional energy sector this year.

Altogether, GFANZ commitments are looking a little shaky.

Rupert Edwards argued that this could happen, back in 2021 in a Forest Trends paper. Rupert is our Senior Finance and Carbon Advisor, and a forming Managing Director of Climate Change Capital and Head of European Government Bond trading for JPMorgan. In a recent thoughtpiece, he talks about the tightrope financial institutions are walking. Institutional investors’ efforts to decarbonize portfolios are inevitably constrained by fiduciary duty to maximize financial returns. Nor do they have direct control over companies’ emissions: they can engage with companies, but they can’t enforce a 1.5 degree pathway. This leaves the ball in the court of public policy, to drive the signals in the real economy that will enable finance to flow toward lower carbon pathways, or to better value nature.

So when ESG is under fire (and in some cases under-delivering), and low-carbon funds are over-valued versus the traditional energy and other sectors, investors find themselves with few good options to achieve both financial returns and climate impact. Investment firm Robeco has called this the “value-carbon frontier.” Companies can decarbonize up to the reach of current policy ambition, and probably no further. Beyond that edge, “the reducing the carbon footprint sacrifices financial returns in a broad-based investment portfolio.”

Rupert suggests high-integrity carbon credits as a ready-to-go strategy for financial institutions to manage carbon impact for those clients willing to sacrifice some return. High integrity carbon credits can optimise the financial performance of carbon constrained investment strategies, representing a more efficient and impactful use of capital if low carbon portfolios are overvalued or if ESG strategies are failing to deliver meaningful climate change mitigation versus non-ESG benchmarks.

Carbon markets can help the economy reach net zero before 2050. And should be an important mechanism  to quickly deliver finance to emissions mitigation projects around the world, including nature-based climate solutions like forest protection and restoration.

Of course, carbon credits were never meant to be a permanent solution; the idea is to use them as a supplement to ambitious efforts to decarbonise businesses and supply chains, and to draw down our reliance on offsets as we complete the transition to a low-carbon economy. In the medium to long term, policy needs to change. Market forces may shift back in favor of ESG and low-carbon investments, but only public policy can move the value-carbon frontier outward. (Trying to change the definition of fiduciary responsibility would be a messy cop out on the part of politicians, expecting pension funds and other investors to solve public policy problems.) Financial institutions can chase value – but it’s in the public sphere that we decide what’s valuable. That includes whether climate risk and return deserve equal weight to financial return, for the sale of the planet and all of us. 

– Michael


Rupert Edwards

The Paris Agreement’s Article 2.1(c) describes “making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.” However, efforts by Financial Institutions to decarbonize portfolios are hamstrung by their inability to exercise direct control over the greenhouse gas emissions of companies to which they provide finance.

The fiduciary responsibility to maximise returns means that institutional investors inevitably struggle to decarbonize investments beyond a level implied by the efforts of public policy and the real economy.

ESG funds (as opposed to low carbon funds) have faced a barrage of criticism in recent months, from the mild: that the acronym ESG jams together disparate and sometimes contradictory objectives; to the damning: that the sector is rife with greenwashing and at risk of a miss-selling scandal, or that funds offer little if any environmental benefit and cause actual harm by misleading investors into thinking they are addressing climate change when they are not.(8)

Genuinely low carbon strategies and investing directly in climate solutions are, of course, an effective way to reduce carbon footprints and to allocate capital to climate change mitigation. They do, however, concentrate risk in a small number of sectors, thus risking financial underperformance.

Both investment managers and retail investors need the flexibility to switch out of green assets if they perceive them to be overvalued. Moreover, the sectors where emissions are hard to abate remain critical to economic growth and the transition to a carbon neutral economy. Investments in some carbon-intensive companies represent both an opportunity to finance businesses leading the way to net zero and at the same time achieve superior returns. In these scenarios investors can hold more carbon intensive portfolios and pay for credits to maintain the same carbon footprint or pay extra to achieve net zero today. [Keep reading]

Try Quiet Quitting on Net Zero (Bloomberg)

Missing the Target: Why Asset Managers Have Not Committed to Net Zero (Universal Owner)

How retail investors can achieve net zero long before 2050, help end tropical deforestation and save the Paris Agreement (Forest Trends)

The Secret Diary of a ‘Sustainable Investor’ (Tariq Fancy)