Portfolio alignment metrics will be a crucial catalyst of the transition to net zero

David Blood, head of the portfolio alignment team and co-founder of Generation Investment Management argues that portfolio alignment metrics will be crucial catalyst of the transition to net zero. Here he argues, with Dominic Tighe and Tanguy Séné who are members of the portfolio alignment team, COP26 private finance hub that by establishing standards of best practice, the Portfolio Alignment Report helps these metrics to reach their potential.

The costs of inaction on climate change are catastrophic. With the last five years the warmest on record, the impact on our planet’s ecosystems is accelerating. To hold back this tide, the next eight years are critical. The IPPC’s ‘report on 1.5C’ indicates that the world needs to cut annual global emissions in half by 2030 to limit warming to 1.5C.

To rise to the challenge of climate change, financial institutions and the companies that they finance, need clear pathways to net zero, illustrating the efforts they need to make. Investors need to be able to differentiate from those sticking with the high carbon business model of the past and those delivering the low carbon solutions of the future.

Different sectors of the economy and regions of the world have different decarbonisation options open to them, and so the shape of their pathways to net zero are different. It’s also key that finance doesn’t just shift from today’s high emitters if they have a credible plan to transition to net zero: the success story from Orsted’s rapid reconversion – from an oil driller to offshore wind leader – wouldn’t have been possible without sustained financial backing.

While critical, knowing the pathways to net zero is only the first step. Financial institutions need tools to assess the performance of specific companies against these pathways. These tools, known as portfolio alignment metrics, enable us to distinguish the leaders from the laggards as our economies adjust to a net zero future. That way, financial institutions can both direct capital to the leaders and stimulate the laggards to raise their game with credible transition strategies.

One approach for metrics is to translate a degree of misalignment between a company’s emissions projected over time and its net zero pathway, into a temperature score. This answers the question: “If every company acted with the same level of ambition as my company, what could the resulting level of global warming be?”, giving an intuitive sense of alignment with the aim to limit warming to 1.5C.

Our ambition is that portfolio alignment metrics become for climate finance as mainstream as credit ratings are in the bond market.

The new TCFD-commissioned Portfolio Alignment Report, published on October 14, should strengthen the quality and usability of portfolio alignment metrics. In setting out best practice recommendations for constructing these tools, it improves comparability and consistency. Our ambition is that portfolio alignment metrics become for climate finance as mainstream as credit ratings are in the bond market. Different methodologies exist but there is broad agreement on the status of an individual asset. We are not there yet, and challenges remain to mainstreaming.

One of the workstreams under the Glasgow Financial Alliance for Net Zero (GFANZ), that brings together over 300 net zero committed financial institutions, will focus on developing the potential of portfolio alignment metrics further, driving consistency and adoption across the financial sector.

Our hope is that this ongoing work can unlock the full potential of portfolio alignment metrics, as a catalyst of the transition to net zero. Once mainstreamed, these metrics will reflect and drive real world decarbonisation and help us to avert catastrophic climate change.

David Blood (Head of the Portfolio Alignment Team, Generation IM), Dominic Tighe and Tanguy Séné (Members of the Portfolio Alignment Team, COP26 Private Finance Hub)