Climate change is a risk to your retirement savings, so we have to factor it into our decision-making about investments. According to the Reserve Bank of Australia in June 2023:
“… climate risks will affect financial institutions via a number of channels. Physical risks from increased variability and extremity of climatic conditions will reduce the value of certain assets and income streams. This could result in increased claims on insurers, unexpected credit losses for banks and write-downs to the value of financial investments. Policy and technological changes that address climate change will moderate these physical risks; however, they may increase the transition risks associated with the move to a lower emissions global economy. Sudden or unexpected changes in regulations, technology or consumer preferences, or uncertainty about prospective policy settings, could quickly lower the value of assets or businesses in emissions-intensive industries, some of which may become economically unviable or ‘stranded’.” [1]
We communicated the evolution in our approach to addressing climate change risk to members via the Quarterly newsletter in May 2023, and updated the website with information about the approach when it went live on 1 July 2023. A year in, we thought you might be interested in some more detailed information about the approach and an overview of how it’s working.
There are different views on the best way to address these financial risks of climate change – some organisations use engagement, some use divestment, some use other approaches and some use a combination – it is a complex area that involves bringing together elements of climate science, economics, finance and regulation.
We use a number of external asset managers in each of these asset classes and some were constrained to operate within carbon budgets, which are described in more detail below. We also engaged with companies and used our voting rights to encourage them to improve their ESG performance where possible.
Since July 2023, Vision Super’s main method of addressing carbon risks in the Australian and International equities asset classes is by applying a carbon budget approach. We evolved towards a predominantly carbon budget approach because we believe it provides a better framework for addressing the financial risks from climate change. This framework seeks to better cover the range of carbon risks faced across the portfolio, rather than just focussing on fossil fuel producers. A carbon budget looks at both supply and demand, whereas divestment from fossil fuel extraction is aimed only at supply. We also considered that this approach could be effectively applied across all of our listed equities managers, improving consistency of how we address this risk. We also continue to engage with companies and use our voting rights.
The aim of the carbon budget approach is to constrain our Australian and International equities asset classes to be meaningfully less carbon-intensive than the respective benchmark. Carbon intensity is a measure of carbon emissions relative to its sales. This is a simple proxy for how exposed a company’s own operations are to carbon risk and is most useful when comparing across companies. When we constrain portfolios to a carbon intensity level lower than the benchmark, we are reducing the carbon risk relative to the benchmark using that measure of carbon risk.
Moving to a carbon budget approach meant that more companies exposed to carbon risk were better captured, rather than the suppliers alone. For example, fossil fuel companies have high carbon intensity scores but their customers such as utilities and airlines are also captured as are other emitters such as cement companies.
We have defined carbon intensity based on scope 1 and 2 carbon emissions [2] We note that scope 3 emissions data is limited, inaccurate and unreliable at the current time and varies materially across data vendors and hence, we do not utilise scope 3 emissions in our carbon budget approach at this stage [3]
Some of our managers apply their judgement to build portfolios based on analysis of company fundamentals. For these managers, the carbon budget approach constrains them overall, however, it also allows for relative assessment to continue to occur while operating within this carbon intensity constraint. For example, if a manager considered there to be compelling value in a company with high carbon intensity the manager can buy the stock, but it may have to sell other high or medium carbon intensity companies to ensure the portfolio overall remains within the budget.
Under our current carbon budget approach, our Australian and International listed equity portfolios’ weighted average carbon intensity for scope 1 & 2 emissions is 47% below the benchmark using data provided by independent data provider ISS as at 31 March 2024 [4]
As we said – it’s a complex area! We appreciate that there’s level of detail in this article that may be more than some members need. However, we also want to be as transparent as possible, and give the detail for those who do want it. If this is a topic you find interesting, you may also want to read our ESG policy here
This is a very dynamic area. As the available data continue to improve, more thinking and collaboration occurs, and legislative requirements change, we believe that new ways of addressing these risks will be established. We expect that our approach and other approaches in the market will continue to evolve.
[1] Reserve Bank of Australia news bulletin: Climate change and financial Risk
[2] Scope 1 are the direct emissions produced by a business, eg from the fuels they use, air-conditioning, direct electricity production, etc. Scope 2 are indirect emissions but still related to the business’s direct production – for example electricity the business uses but hasn’t generated themselves. For a more detailed explanation please see this page on the Australian Government’s Clean Energy Regulator’s website
[3] Scope 3 refers to broader indirect emissions, not covered by Scope 1 or 2. These include Scope 1 or other emissions of other companies. A company’s Scope 3 emissions are the scope 1 or other emissions of other companies. For example, if a business sells goods and these are subsequently transported by another party then the emissions associated with this transportation are the business’s scope 3 emissions.
[4] The Trustee does not independently verify the data provided by ISS.