Investors can decarbonise with ease, says BIS paper

January 5, 2022|Written by David Clarke|Bank of International Settlements, European Central Bank, Federal Reserve, People's Bank of China

Investors can “massively” reduce their carbon footprint using a simple and easy strategy that has a minimal impact on returns, says a new paper from the Bank for International Settlements (BIS).

The researchers outline a method by which the emissions associated with an otherwise passive portfolio could be cut by 64% over a 10-year period. This merely involves excluding firms above a certain level of carbon intensity, and reinvesting the proceeds in the same sector and region.

The fact that this approach is so effective could have important implications for public policy, say the authors.

“The method we propose also has the advantage to provide an intuitive path of a gradual decarbonisation that can be used by regulators to guide the reallocation of capital and limit the risks of sudden Minsky moments,” the paper states.

Minsky moments refers to instances of a market collapse, during which investors rapidly try to offload certain types of assets. Climate advocates have said that the threat of such an event necessitates precautionary measures to limit the build-up of climate-related risks.

The researchers say the effectiveness of their approach can be explained by the fact that a small number of firms contribute so disproportionately to overall emissions. In the case of a worldwide passive portfolio, they found that excluding firms with the highest carbon intensity, representing just 10% of the market value, would cut the resulting portfolio’s emissions in half.

Reinvesting the divested funds in the same sectors and regions is preferable to a policy of pure exclusion, the paper says. The most polluting companies tend to be concentrated in energy, utilities and materials, and in emerging market economies. The proposed approach ensures a consistent level of diversification, and ensures that capital flows towards emerging markets are maintained.

There is a long-running and lively debate among climate-conscious investors over whether divestment of high-carbon assets is more effective than retaining a stake in those companies and using it to influence their direction. The BIS staffers say that if implemented at a large scale, their proposed approach would move funding from the most polluting to the least polluting firms in the same region and sector, and therefore reduce the cost of the transition.

The paper is likely to be of interest to the huge cohort of global investors who have made recent commitments to decarbonise their portfolios in line with the Paris climate agreement, most notably under the Glasgow Financial Alliance for Net Zero (GFANZ). It was revealed at the Cop26 summit in November that GFANZ’s membership now includes over 450 financial firms responsible for assets in excess of $130 trillion.

This page was last updated January 5, 2022

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