Managing Climate Risk in Institutional Investment Portfolios: Case Studies

As the climate crisis with its physical impacts accelerates, along with the transition to a net-zero emissions economy, Canadian investors increasingly recognize the material and financial risks to their portfolios posed by climate risk. Increasingly large institutional investors know they must assess and manage climate-related risks if they are to meet their fiduciary duties to clients and beneficiaries.

In steps that align with The Investor Agenda, an initiative to accelerate and scale up the actions that are critical to keeping global warming to no more than 1.5 degrees Celsius, some Canadian pension plans have developed climate action plans involving low-carbon investment strategies, corporate engagement, disclosure and policy advocacy. This article explores how three Canadian pension plans, the Caisse des Depots et Placement du Quebec (CDPQ), OP Trust; and the Ontario Teachers’ Pension Plan (OTPP) are addressing climate risk in their investment portfolios.

Each of these Plans has developed a range of approaches to assess and manage two fundamental climate change risks: physical risk (e.g., the impacts of heat waves, droughts, wildfires, sea level rise, floods and stronger storms) and transition risk (e.g., the impacts of government climate policies like carbon pricing and the technology transition to renewable energy, electric vehicles, and energy and resource-efficient technologies). One strategy is to “decarbonize” portfolios by reducing the carbon intensity of entire portfolios or of particular asset classes. Another common strategy is to align their portfolios with the “well-below 2 degrees Celsius” Paris Agreement goal. Some have set time-bound targets for emission reductions. Others have set quantitative goals to scale up their low carbon, climate positive investments, and are reporting their strategies and progress in line with the Task Force for Climate-Related Financial Disclosure (TCFD) framework.

CDPQ

CDPQ adopted its Climate Action Plan in 2017 with four pillars: integrating climate risks and opportunities into all investment decisions, reducing the portfolio’s carbon intensity, increasing low carbon investments, engaging companies, and participating in industry leadership initiatives. It aims to reduce the carbon intensity of its portfolio by 25% by 2025 via carbon budgets for each asset class. CDPQ also plans to increase its low carbon investments across asset classes by 80% to USD $32 billion by the end of 2020.[1] If a climate-related risk is deemed material to a particular investment, CDPQ performs a rigorous qualitative analysis of the risk and its impact, employing specialized consultants as necessary. The fund prefers engagement to exclusion, but will reduce its exposure where engagement does not produce satisfactory results. They align their investment staff compensation with achieving these carbon reduction goals.

CDPQ’s Climate Plan is based on four principles: (1) achievable targets, (2) measurable performance, (3) transparent disclosure of process and results, and (4) collaboration. The Plan is ahead of schedule, with CDPQ having added $16 billion in low carbon assets for a total of $34 billion by year-end 2019 and reduced its portfolio carbon intensity of its portfolio by 21% in this same period.[2]

OPTrust

Similarly, OPTrust published its Climate Action Plan in 2018 with eight pillars designed to enhance the Fund’s resilience to climate change. OPTrust undertook several studies as part of its climate change analysis. The first, in 2017, was with Mercer Consulting who conducted a climate change scenario analysis of the total fund to evaluate the likely resiliency of its portfolio to a 2degree Celsius world, the goal of the Paris Climate Agreement. The second, in partnership with Ortec Finance, was an asset liability management/strategic asset allocation project that integrated physical and transition risks and opportunities associated with climate change into several multi-horizon time scenarios. A third, currently underway, is a bottom-up study to establish a baseline assessment of climate-related risks to the total fund, including carbon footprint, stranded assets and energy transition analyses.

The fund conducted a survey to identify their external managers’ considerations of ESG and climate in their investment processes. Subsequently, the OPTrust team created a clear set of expectations for integrating ESG and climate factors into the investment process for use in its manager meetings. Because the global scale of climate-related risks requires collective action, OPTrust is collaborating with organizations including Ceres’ Investor Network, CDP, and the Investor Leadership Network, and is a participant in the Climate Action 100+ initiative to engage the highest emitters of greenhouse gas emissions.

OPTrust is currently in discussion with data providers to help devise bottom-up climate change risk metrics for physical risk and transition risk for all asset classes. It also continues to look for risk models that provide actionable information on such key issues as carbon value at risk that will allow the portfolio managers to confidently and fully integrate climate change into portfolio construction and the investment process.

OTPP

Ontario Teachers’ Pension Plan (OTPP) fully integrates climate risk in the organization’s investment processes and across all its investment professionals. The Plan’s overall approach is to integrate climate change consideration in its investments, engage with companies, industry, regulators and policymakers to effect positive change, and to seek the investment opportunities that arise. In 2017 OTPP developed its Low Carbon Economy Transition (LCE) Framework. The LCE Framework identified and monitors twelve signposts that are indicators of the direction and pace of change of the economy towards a low carbon future, which helps the organization to assess the long-term merits and resiliency of investments.

OTPP systematically integrates the risks and opportunities associated with climate change across asset classes and throughout all levels of the organization. The Fund is also active externally with companies, industry, and others to manage risks and invest in opportunities. Ontario Teachers’ starting premise is that we are transitioning to a low carbon economy; however, how smooth or disruptive that path is uncertain. The Low Carbon Economy Transition Framework identifies three different scenarios or pathways that require the organization’s ongoing attention: 1) an orderly transition to a low carbon economy; 2) a transition consistent with current policies and practices; and 3) a period of sustained dependence on fossil fuels that ultimately leads to drastic and disruptive actions to curb further warming.

An important element of Ontario Teachers’ climate strategy is to exercise its influence as a major pension fund investor and to collaborate with peer organizations. In addition to representation on boards of companies in the portfolio, Ontario Teachers’ is a signatory to and participant in Climate Action 100+, the global investor initiative to engage companies having high carbon emissions; a founding member of the Investor Leadership Network, comprising fourteen global asset owners (six of them Canadian pension funds) advocating for stronger climate change disclosure; and a member of SASB’s Investor Advisory Group. OTPP also sits on the board of the Global Real Estate Sustainability Benchmark (GRESB), and helped found GRESB’s Infrastructure Assessment. As part of the Canadian financial ecosystem Ontario Teachers’ is a member of the Canadian Coalition for Good Governance and the Accounting for Sustainability CFO Leadership Network.

OTPP has not formally catalogued all its investments that support the transition to a low carbon economy, but its $30 billion real estate portfolio meets either LEED or BOMA BEST standards and its airports are all carbon neutral or working toward carbon neutral. The Fund also has direct investments in: renewables, climate-related technologies, sustainable agriculture and forestry, and water-related infrastructure. In November of 2020 OTPP launched a € 750 million Green Bond to advance its sustainable investing program.

Ontario Teachers’ Pension Plan is developing a sector specific ESG Maturity Framework that draws upon SASB’s standard setting work for 77 industries and uses data from Bloomberg and MSCI along with our proprietary assessment of the companies’ governance, policies and practices around the material sustainability factors. The framework enables OTPP to categorize companies’ ESG management as baseline, advanced or exceptional, and track company progress concerning such things as risk management practices, intensity of carbon emissions, and disclosure of climate risk consistent with the TCFD recommendations.

These three large Canadian pension plans are leaders in recognizing and managing climate-risk in their investment portfolios. Each has taken concrete and measurable steps to address the challenges posed by climate change. They have set timetables for their own organizational goals. They have drawn on internal and external expertise in developing their objectives. In addition to their internal structures, they also work within broader climate-related coalitions and frameworks. While each of the three have their own policies and procedures for managing climate-risk across their portfolios, they all recognize the economic materiality of climate change as investment risks, and have become early movers in taking comprehensive action to identify, evaluate and manage climate-related risks in their portfolios.

This article is drawn from “Portfolio Climate Risk Management: Case Studies on Evolving Best Practices” a Ceres report published in July 2020.

Sources:

[1] CDPQ (2020) https://www.cdpq.com/en/investments/stewardship-investing/climate-change, accessed Jan. 13, 2021.

[2] Ibid.

RIA Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.

Author

Dr. Tessa Hebb

Distinguished Research Fellow

Ceres, Carleton Centre for Community Innovation Carleton University

Dr. Hebb is a Distinguished Research Fellow and past Director of the Carleton Centre for Community Innovation, Carleton University, Canada. She is working with Ceres to expand its footprint in Canada. She is also an Adjunct Professor in the School of Public Policy and Administration and the Sprott School of Business at Carleton University. She has published many books and articles on responsible investing and impact investing including the volumes the Routledge Handbook of Responsible Investment and SRI in the 21st Century: Does it make a Difference to Society.

Peter Ellsworth

Senior Director

Ceres Investor Program

Peter manages key relationships with the asset owners and investment managers that comprise the Ceres Investor Network, an investor group committed to sustainable investment policies and practices. He co-authored The 21^st Century Investor: Ceres Blueprint for Sustainable Investing and leads the Ceres work on green bonds. Peter brings to Ceres more than twenty years in the Capital Markets working with investors, asset managers and corporations designing investment structures and risk management solutions. Prior to Ceres he was Managing Director with KLD and the FTSE KLD index partnership, Managing Director of Foreign Exchange at BankBoston, head of Deutsche Bank’s Special Products Group, and founded the foreign exchange business at Kidder, Peabody. He was educated at Franklin & Marshall College, the University of Brussels and the University of Chicago.