CPP Investments' Pathway Agnostic Approach to Net Zero
CPP Investments has adopted a “pathway agnostic” approach to its net zero commitment which does not pre-suppose how the transition to net-zero carbon emissions will take place, its managing director of portfolio design explained.
In a fireside chat at Conexus Financial’s Sustainability in Practice forum held at Harvard University, Derek Walker, managing director, head of portfolio design and construction at CPP Investments, said after making a net-zero commitment CPP did not want to take a specific view on how the transition would occur, arguing “a blanket divestment approach really for us was pre-supposing a pathway, and we didn’t want to do that”.
Walker said the C$525 billion fund’s net-zero commitment considers that the whole economy will transition to net zero, and this will involve a range of elements including regulations, consumer and corporate behaviour changes and technological innovation.
“We know that will involve some combination of those things and we don’t know what,” Walker said. “So we want to be fairly open to those different pathways.”
At the end of the fiscal year last March, the fund had about C$66 billion of what it called “green and transition assets” and has committed to grow that to C$130 billion by 2030.
Green assets are assets where 95 per cent of their revenues are derived from green sources. Transition assets are looked at in several ways, such as credible commitments validated through the SBTi framework, or companies in green sectors that have not yet achieved the 95 per cent target but have a credible plan to get there.
“We’re invested in Ørsted which is a Danish power producer and one of the first energy companies to have a science-based net zero target,” Walker said. “So that would be an example of a transition asset. And on the green asset side, we would have an investment like Pattern Energy, which is involved in renewables in North America and Japan.”
Outside of these green and transition assets, the fund takes a range of approaches to navigating this space, Walker said.
From a bottom-up perspective, CPP has been integrating climate considerations in any deals that come through in investment opportunities, and working to establish a consistent approach across teams, which is not a trivial undertaking for such a large organisation, Walker said.
From a top-down approach, CPP began by estimating the physical and transition risk of assets and how it would impact growth across different economies in the world. “We would then–within our return framework–translate that into return impact, and that was something that we could use to inform our long-term strategic allocation,” Walker said.
The fund is now working out a better transition risk factor “that is forward-looking but relatively robust so that we can understand where those climate leaders and laggards will be,” Walker said.
“In turn, that will help us understand what’s the correlation structure, and the relationship of that climate risk to some of the other risks that we’re trying to manage in the fund. So that, for us, is really the target.”
More broadly, the fund is evolving its portfolio construction process by bringing together a range of disparate functions under new CIO Ed Cass, including management of leverage and liquidity “so that it was all under one roof under the CIO’s direction,” Walker said.
This was an opportunity to step back and re-imagine portfolio design, Walker said, warning that “reimagining…is not for the faint of heart when you’re willing to go that far.”
“But we’ve also tried to be pragmatic and say that the objective is to come up with a framework that is more transparent, that’s more attributable and is more efficient in terms of simplifying our overall processes,” Walker said.
This is an interesting article going over how CPP Investments is incorporating climate change into its portfolio construction.
Clearly, it is pathway agnostic which is why they're not divesting out of oil & gas but very focused on increasing their green and transition assets.
Also, this part is worth noting:
Outside of these green and transition assets, the fund takes a range of approaches to navigating this space, Walker said.
From a bottom-up perspective, CPP has been integrating climate considerations in any deals that come through in investment opportunities, and working to establish a consistent approach across teams, which is not a trivial undertaking for such a large organisation, Walker said.
From a top-down approach, CPP began by estimating the physical and transition risk of assets and how it would impact growth across different economies in the world. “We would then–within our return framework–translate that into return impact, and that was something that we could use to inform our long-term strategic allocation,” Walker said.
The fund is now working out a better transition risk factor “that is forward-looking but relatively robust so that we can understand where those climate leaders and laggards will be,” Walker said.
It's still early on but at least CPP Investments is incorporating climate considerations in its portfolio construction using bottom-up and top-down approaches to better understand transition risk factors and their effects on the overall portfolio.
Derek Walker also states the Fund is evolving its portfolio construction process by bringing together a range of disparate functions under new CIO Ed Cass, including management of leverage and liquidity “so that it was all under one roof under the CIO’s direction.”:
This was an opportunity to step back and re-imagine portfolio design, Walker said, warning that “reimagining…is not for the faint of heart when you’re willing to go that far.”
“But we’ve also tried to be pragmatic and say that the objective is to come up with a framework that is more transparent, that’s more attributable and is more efficient in terms of simplifying our overall processes,” Walker said.
That too makes sense since the CIO, Ed Cass, works closely with the CEO, the Chief Financial and Risk Officer and Investment Department leaders to strengthen the organization’s investment governance with the aim of generating greater performance gains.
In other related news, today, CPP Investments launched The Decarbonization Imperative, an updated proposal for helping corporate boards and management develop transparent and credible plans to achieve net-zero goals and, in turn, create long-term value.
You can learn more about it here.
Below is the Executive Summary:
You can read the full report here.With global temperatures climbing and the impacts of climate change growing more extreme every year, the need to combat planetary warming is urgent and clear. Emissions of carbon dioxide and other greenhouse gases (GHGs) must be rapidly and drastically cut, with overall global emissions approaching net zero by 2050, to prevent the potentially catastrophic impacts of climate change.
This rapid decarbonization will require sweeping changes, transforming every sector in every country. Industrial processes that can’t be decarbonized may disappear. Business models will evolve across the whole economy, not just within energy systems. Everything from industrial processes, buildings, transportation, food and consumer goods will be impacted. Without dramatic improvements in solutions to deliver low- or no-carbon hydrocarbons or reduction in the cost of carbon capture technologies that can offset GHG emissions, fossil fuel reserves risk becoming stranded and potentially requiring a write down in value. At the same time, the need to decarbonize is already creating a myriad of new opportunities, stimulating a powerful new wave of innovation that is rapidly bringing down the costs of many low-carbon technologies, while creating new technologies and business.
It is not enough for companies to identify their capacity to economically abate emissions. Doing so must be among their most urgent priorities.
Companies face the same increasingly severe physical impacts of climate change, such as more extreme floods, droughts, and heatwaves, as their stakeholders. In addition, they are under growing pressure from investors, regulators, suppliers, customers, and competitors to reduce their emissions, to disclose their climate and financial risks, and to create viable plans to transition to a low-carbon economy. They are grappling with technological uncertainties, including future changes in regulation, carbon prices and cost of alternative technologies, and the challenge of acting when data are incomplete or lacking. That lack of data is hobbling efforts to accelerate the transition to a low-carbon economy.
Until companies make detailed disclosures and develop decarbonization plans based on clear and objective data, investors and markets will find it difficult to accurately value companies or predict their future performance. Equally important, companies that do not have decarbonization plans are likely to miss key opportunities to maximize long-term returns and gain competitive advantages by finding efficient transition paths ahead of the competition. Thousands of companies globally have already committed to net zero, but in many cases, it is unclear whether these companies have credible plans for achieving their commitments.
Many companies have already taken constructive action, backing up their pledges to cut emissions with investments in renewable energy, cuts in operational emissions, and other vital steps. During recent discussions at the CPP Investments Insights Institute, which brought together other asset owners, asset managers, accountants, academics, consultants, and index providers, we found widespread agreement on a fundamental issue: there is insufficient information available to determine the ability of most companies to transition to a low-carbon future.
Some companies have made commitments to net-zero emissions without clear pathways to achieve those goals, putting them at risk of negative market reactions when investors realize the goals are not achievable. Others have yet to even create a governance framework to address the issue or assess their current GHG emissions, the essential first steps to decarbonization and sustainability according to the Task Force on Climate-related Financial Disclosures (TCFD).
These failures expose companies to a number of risks, including higher energy costs, higher costs of capital, and market share losses to more climate-aware competitors. They also risk impaired future competitiveness as the transition to a low-carbon future progresses, greater potential for being burdened with stranded assets, failure to spot new business opportunities, and potential litigation if their climate guidance is discovered to have been made without an appropriate basis.
To address these issues and to encourage more companies to take action, last year CPP Investments proposed a broad Abatement Capacity Assessment Framework (‘Framework’) and standardized template for assessing a company’s potential for reducing emissions. The idea is conceptually simple. First, determine a company’s current baseline emissions. Second, identify actions that can cost-effectively cut emissions now (the current “abatement capacity”). And third, assess steps and strategies that can cost-effectively reduce emissions in the future under different carbon price assumptions (the “projected abatement capacity”).
The Framework serves as a starting point for the development of transition plans and determining their economic feasibility. Additionally, the Framework would enable companies to comply with the sustainability reporting standards currently being developed based on recommendations from the TCFD, while also meeting the demands of shareholders and other investors for climate-related disclosures.
Meanwhile, the regulatory landscape is changing. Both the United States Securities and Exchange Commission (SEC) and the Canadian Securities Administrators (CSA) have proposed mandatory reporting requirements for GHG emissions, emissions-reduction targets, exposure to climate hazards and financial risks, and transition plans. In addition, the International Sustainability Standards Board is developing climate standards that are expected to become a global baseline for reporting on climate-related issues.
This confirms the role we see for the proposed Framework. In June 2022, we provided comments to the SEC in response to its proposed rules to enhance and standardize Climate-Related Disclosures for Investors. In our comments, we note that rather than needing to be used as a standalone separate exercise, the Framework can complement and support the coming regulations by offering a roadmap for the work needed to meet those requirements.
In particular, the Framework provides an approach for reporting on the economic feasibility of delivering on companies’ emissions reduction commitments without giving away any competitive secrets. Supporters of the Framework also believe it can elicit information that the market can utilize to drive fundamental changes in the economy across industries and countries, and perhaps help guide the regulations themselves. We believe that market actors, especially capital providers, will want to advocate for the kind of rigor and transparency this Framework represents. As regulators put rules in place, it is in the best interest of investors and their beneficiaries that these rules provide decision-useful insights both to price risk and to ensure capital is allocated to support the transition.Our overall message remains clear as outlined in our original ‘The Future of Climate Change Transition Reporting’ report. Climate change—and the resulting need to rapidly cut emissions and prepare for the coming transition—is an urgent issue that requires immediate attention from corporate boards and senior executives. They will need to ensure they have the necessary resources to develop and share their transition plans. This includes increasing the company’s climate literacy, using the Framework to quantify the company’s decarbonization capacity, and prioritizing the removal of emissions where economically possible, while simultaneously developing strategies for abating those emissions that are currently more costly to abate. Failure to focus on decarbonization as a core function of management and business strategy means boards and management are not acting in the best interests of their companies, shareholders, and other stakeholders.
Developing and assessing the viability of decarbonization and transition plans should not be viewed as an onerous new exercise. Instead, companies should embrace the process as a key mechanism for identifying major opportunities and gaining competitive advantages. Assessing a company’s abatement capacity enables its management and board of directors to better understand how it can benefit from “greener” and more efficient technologies, and to accelerate the development of new low-carbon technologies. The Framework helps companies build businesses focused on the long term, gain market share over competitors with higher carbon intensities, prove to investors they can survive and thrive in a low-carbon world, maximize their own long-term returns, and help accelerate the economy-wide transition to net zero. In addition, the Framework enables companies to share the underlying assumptions for their net-zero commitments in a transparent manner without compromising commercially sensitive data
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