IFSWF Santiago Principles

IFSWF Direct | SWFs Decarbonisation vs Net Zero

Next month, IFSWF will publish its fourth survey of our members on their attitudes to climate change and the actions they are taking in their portfolios to mitigate the effects of climate change in partnership with the One Planet Sovereign Wealth Fund Network.

Since the inaugural survey in 2020, the respondents have reported impressive progress in integrating climate change considerations into the investment process. Our 2023 report notes another surge of progress in sovereign wealth funds’ implementation of climate change tools and an uptick in their transparency on their actions.

As we collect more data, we are beginning to observe some nuances in the approaches that sovereign wealth funds are taking to climate change. As long-term investors, sovereign wealth funds are predisposed to taking a long-term view of the energy transition – in the words of one of our members, it is “a process, not a switch”. As such, we are seeing them adopt an approach emphasising decarbonisation rather than a hard “net-zero” approach, which has been embraced in many developed countries and investor groups such as the Net-Zero Asset Owner Alliance or by politicians, for example, the EU Taxonomy Climate Delegated Act.

So, what evidence do we have for this claim?

In our 2023 climate change survey, we found the following data points:

  • Over three-quarters of sovereign wealth funds that responded to the survey engage with portfolio companies on climate issues. Almost half are assessing or have assessed the decarbonisation pathways for their portfolio companies.
  • Two-thirds of them would divest either if there was a major ecological crisis at the company’s operations or if their engagement had failed to yield results. At the same time, almost half have some form of ethical screening (i.e. exclusion of particular sectors) in their portfolio. However, only 16% of respondents had divested from a company on climate-related grounds.
  • Over half of respondents engage with portfolio companies on climate issues with their asset managers, and half require them to provide specific environmental metrics on their assets under management.
  • 76% of respondents have either carbon footprinted their entire portfolio or are currently in the process of doing so.
  • Although a third of respondents currently have a net-zero target, 30% have no plans to adopt such a goal. That said, 90% of respondents stated that they aligned with their national net-zero goals.

Judging from our conversations with our members and dialogues with them at COP28, the emphasis on decarbonisation rather than net-zero targets appears to be due to three factors.

First – which many commentators may say is a soft get-out clause – are concerns about the quality of climate change data and the challenge of measuring scope two and three emissions in particular. Currently, our members believe datasets are not uniformly accurate enough for them to make a firm commitment to a net-zero emissions target. As government-owned institutions, they cannot afford to find themselves in a position whereby they have committed to a target only for revised data to show that less progress has been made than they thought or that the goalposts have moved due to better data becoming available. Unlike banks or asset managers, such as those that recently left Climate 100+, it would be exceedingly damaging for them from a reputational perspective to withdraw from a commitment once it had been made, which is why signing up to absolute targets is challenging. Many prefer to use voluntary frameworks such as those developed by OPSWF. However, just because they have not formally signed up to a quantitative target, to quote one IFSWF member, “doesn’t mean we’re not doing anything and doesn’t mean that we’re not taking climate change seriously.” Reputational risk in this area is key, as it is in many others for sovereign wealth funds.

Second, many sovereign wealth funds come from emerging markets and have an economic development mandate. As such, they are sensible to the fact that the energy transition needs to be equitable and help develop their economies. As such, the prohibition on greenfield gas power plants, as set out by the Net Zero Asset Owners Alliance Framework, for example, seems anathema. Many countries in Africa and South East Asia remain reliant on coal for power. However, according to the International Monetary Fund, South East Asia will be providing two-thirds of global economic growth in 2024; thus, achieving the region’s energy transition will be essential for reducing global carbon emissions. The International Energy Agency calculates that a transition to low-emission fuels, including natural gas as well as carbon capture, utilisation and storage, will close 30% of the emissions gap between the region’s current energy policy stance and meeting the Paris Agreement targets in 2050. Therefore, eschewing prescriptive frameworks and instead investing in reducing energy systems’ carbon intensity by replacing coal-fired electricity with gas alongside more renewable energy generation capacity can substantially contribute to reducing global emissions. This will also have attendant social benefits by increasing electrification for end-users, which will help reduce deforestation for fuel, improve children’s education by giving them access to electric light to study at night, and have health benefits to enable them to cook on electric stoves rather than breathe in toxins from solid or fossil fuels.

That said, such investments depend on strong, actionable policy frameworks, which currently need to be improved in Southeast Asia. In particular, our survey respondents rated this geography as the least attractive for climate change investments in 2023. Other investors with greater risk appetites than sovereign wealth funds will need to lead the way and prepare the market for these large, relatively conservative, investors.

Finally, as we see from the number of sovereign wealth funds that engage with their portfolio companies on climate issues, these long-term investors can play a vital role in moving companies from “grey to green” industries. Admittedly, our survey shows that more sovereign wealth funds could engage more with their listed portfolio companies on climate change issues – only 40% of our survey respondents said they voted at listed companies’ AGMs on this topic – but these investors are high-profile and, therefore, wield outsized influence. Funding oil majors to move towards lower-carbon energy generation or to fund research into technologies such as carbon capture and storage or green hydrogen, for example, can be important. They might also help fund coal companies to move from thermal coal used in power plants to less-polluting metallurgical coal to power steel production, which we need for the wind turbine or electric vehicle industries, which will play a key role in the energy transition. If such influential, long-term investors do not urge companies to reduce their carbon emissions, then the question must be, who will?

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