FINANCIAL STATEMENTS
STRATEGIC REPORT
GOVERNANCE
A range of assessments for the liquid corporate bond portfolio, where public data is available, are shown in the table below. These illustrate the additional costs as a result of climate physical and transition risks that may be incurred in our existing bond portfolio if it were to remain unchanged to 2080.
WHICH METRICS AND TARGETS DO WE USE FOR CLIMATE RISK? The metrics below are used for our liquid corporate bond portfolio:
CLIMATE VALUE-AT-RISK A risk metric which is an estimation of scenario-specific valuation impact for transition and physical impacts, at both an issuer and portfolio level. WARMING POTENTIAL An impact metric which gives a portfolio’s alignment with future climate goals based on projected business activities of invested companies. CARBON FOOTPRINT An impact metric that gives the GHG emissions at an issuer and portfolio level.
CLIMATE VALUE AT RISK BY 2080 ON LIQUID CORPORATE BOND PORTFOLIO OF COMBINED RISK SCENARIOS
Transition 1.5°C rise
Transition 2°C rise
Transition 3°C rise
Scenario
Physical – base case
-6.0%CVaR -£404m -7.0%CVaR -£470m
-4.8%CVaR -£321m -5.8%CVaR -£387m
-3.4%CVaR -£225m -4.4%CVaR -£296m
Physical – worst case
Results as of 31 December 2021.
All our investments are assessed using the following BRAYG scale, which includes ESG factors more generally, with climate risk often a strong driver of the score: • Black – excluded: divestment and no new investment. • Red – restricted: no new investment. • Amber – watchlist: invest but monitoring required. • Yellow – no concerns: investment permitted. • Green – positive impact: investment encouraged. WHAT ARE OUR FUTURE PLANS FOR THE CLIMATE RISK MANAGEMENT OF THE CREDIT INVESTMENT PORTFOLIO? • Identify a suitable data provider for the assessment of climate risks on our illiquid portfolio. • Introduce a more detailed climate assessment for potential investments to supplement our BRAYG scoring. LIQUID INVESTMENT BOND PORTFOLIO SCENARIOS Measurement of climate risk in our liquid corporate bond portfolio, is well advanced. We have partnered with MSCI Carbon Delta to carry out scenario analysis on these assets, for which quantifiable climate data is readily available (public developed market and emerging market corporate bond issuers – about 70% of our liquid investment bond portfolio). The scenario analysis carried out on the portfolio uses projected energy pathways, broadly following a 1.5°C, 2°C or 3°C temperature rise. It is the borrower’s ability to repay their debt that affects us as fixed income investors. Any increased costs to the borrower, through the physical impacts of climate change or transition risks, may affect their ability to meet their debt repayment obligations increasing the risk of default. Physical climate risk scenarios estimate the costs for businesses from asset damage and business interruption due to impacts from a range of nine weather hazards, including extreme heat, tropical cyclones and heavy snowfall, based on the location of the company’s headquarters. Transition risk scenarios estimate the potential cost impact from the transition to a low carbon economy under the three scenarios using emission reduction targets for the main countries of operation of the investee company. CLIMATE VALUE-AT-RISK The CVaR for the debt investment derived using this approach is the aggregate of the CVaR for physical risk and transition risk over the period to 2080. The approach has limitations: the transition risk exposures are estimated without taking account of all the company- specific risk factors; the location of the company headquarters alone is used to assess the physical risk exposure rather than the location of any other business operations; the CVaR numbers are a present value of future costs estimated over a timeframe of nearly 60 years, while our holding period for the bonds is much shorter, and so overestimate the financial costs.
This modelling suggests that transition risk may be a more material risk to our liquid bond portfolio issuers than physical risk. A 1.5°C temperature rise produces higher cost impacts because the rate of decarbonisation is the greatest under this scenario. A slower rate of decarbonisation has a lower cost impact even though the assumed rise in temperature is higher. WARMING POTENTIAL The potential impact of our liquid corporate bond portfolio, where public data is available, on the climate is illustrated using a warming potential metric over the period to 2100. The purpose of this metric is to guide the portfolio’s alignment with future climate goals based on the projected business activities of invested companies. The result for our existing portfolio suggests the bond issuers’ emissions are aligned to warming the planet by 3.1°C by 2100 in a scenario aimed at limiting global warming to 2°C. CARBON FOOTPRINT The carbon emissions of our liquid corporate bond portfolio (where public data is available) are shown below:
Bond issuers’ financed carbon emissions Scope 1 + 2 emissions Scope 3 emissions
Carbon emissions (000s CO 2 e/$m invested)
100 317 111
Downstream
Upstream
Results as of 31 December 2021.
The issuer’s carbon emissions are apportioned across their shares and bonds (enterprise value including cash). This metric allocates emissions to the investor for each million US dollar of their investment. The CVaR and warming potential metrics are purely illustrative as they are projecting far into the future based on assumptions about our existing investment portfolio. The longer the time period that data is projected into the future, the more the uncertainty in the results. The carbon footprint metric reflects the emissions of our current portfolio. We expect each of these metrics to improve as the composition of our investment portfolio changes with time through the application of our Responsible Investment Framework, reducing our exposure to higher carbon companies.
ILLIQUID INVESTMENTS (COMMERCIAL MORTGAGES, INFRASTRUCTURE LOANS, OTHER PRIVATE DEBT)
Assessing the risks to our illiquid investments is particularly challenging due to the difficulty in obtaining specific data as the borrowers are not subject to disclosure requirements. We are engaging with data providers to help us quantify the physical and transition risks to our illiquid investments such as commercial mortgages, infrastructure debt and
27
Powered by FlippingBook