ESG Viewpoint: Five challenges for net zero investing

The Intergovernmental Panel on Climate Change gave the world a stark warning in 2018 of the dangers of failing to limit the global temperature rise from climate change to 1.5 degrees. This year has seen some of the physical impacts of climate change emerge even sooner than many scientists had predicted – including deadly flooding in Europe and China, and the North American ‘heat dome’ that triggered widespread wildfires.

In the run-up to the rescheduled COP26 climate negotiations, we have seen momentum gather behind the ambition of ‘net zero’ greenhouse gas emissions by 2050, consistent with a 1.5 degree trajectory. The investment community has joined the push, and at BMO Global Asset Management, we’ve been working on how to fulfil our commitment. We’ve also been contributing to industry knowledge on net zero investing, particularly through co-chairing the Implementation Working Group for the Net Zero Investment Framework. We have also been discussing our progress with clients, as the net zero journey needs to be a partnership between asset owners and managers.

Through our own work and our collaboration, we have identified five of the challenges faced by us and other investors:

1. Selecting a methodology

There is no single ‘net zero investing’ methodology. Several approaches have been developed by different groups. In our view, this is a healthy reflection of innovative activity on an issue that has emerged incredibly rapidly, almost from a standing start barely a year ago – but it does create the potential for confusion.

2. Avoiding perverse incentives

A concern with emissions targets of any kind is that they can encourage decisions that are aimed just at meeting the target, rather than achieving real-world emissions reductions. This risk exists both for companies and for investors.

3. Dealing with data gaps

The use of forward-looking, company-specific data points helps provide a more meaningful analysis of net zero alignment in terms of addressing the challenge above…but the approach carries significant challenges in terms of patchy data.

4. Account for solutions providers

Many companies involved in the manufacture of emissions-savings technologies may have a significant carbon footprint of their own, as compared with some other sectors – but looking just at these direct emissions does not capture the emissions savings they create though their products.

5. Expanding to all asset classes

The commitments made by investors, including BMO GAM, under the Net Zero Asset Managers Initiative mean transitioning all our assets under management to net zero emissions by 2050. However, whilst methodologies are becoming increasingly available for some asset classes, notably equities, credit and direct real estate, they are significantly less mature for others, such as sovereign debt, private equity, and multi-manager funds.