Investment Perspectives on a Carbon-Constrained Economy

Climate Risk ManagementInvestment Perspectives on a Carbon-Constrained

Economy

May 27 2010

Emily McAteer

[email protected]

TBLI Asia

www.riskmetrics.com 2

ESG is a Core Business for RiskMetrics

Sustainable investing is at the tipping pointAn emergent driver of asset growth and retention

ESG factors have a material impact on the economy, earnings and people’s lives.

RiskMetrics is at the heart of this transformationAcquisitions of established leaders in ESG research: KLD and Innovest

The most comprehensive and reliable product suite in the industry

A dedicated staff of 99 people worldwide, including 75 analysts

Pioneering research to measure the ESG impact of companies and industries

More than 30 years of sustainability expertise

ESG analysis that sees past green-washing

RiskMetrics ESG Analytics enables investors to monitor corporate management of ESG issues before they affect the bottom line.

Accounting Research

Legal

Proxy Analysis

Proxy Voting

RiskManager

RiskMetrics Group


Goals for Today

Addressing two key challenges in evaluating corporate climate change

performance

Discuss some of our solutions to these challenges

Measuring risk and management

New methodology for the financial sector


Climate change is reconfiguring the financial landscape

Climate risks and opportunities:

Regulatory

Legal

Physical

Competitive

Reputation

Measurable impacts:

CAPEX

Operating Costs

Cash Flow

Credit ratings

Cost of Capital

Why Climate Risk Management?


Climate Risk Management

Key Challenge Understanding who will win and lose from climate

change… Who will benefit from being first movers in technology development

and investment?

Who is effectively managing climate-related regulatory, physical, reputational risk?

Who is well-positioned to reduce operational GHG emissions or even sell surplus credits?

Who is integrating climate change into core business strategies?

Who is prepared for a carbon-constrained economy?


Evaluating Corporate Climate Change Performance:Key challenges, (some) solutions

Net carbon rating defined as function of four key variables at company level

Ability to manage and

reduce climate risk exposure

Carbon footprint and potential risk

exposure

Asdfasdfa

Asdf

Rate

of

imp

rove

men

t or

regre

ssio

n

Carbon Beta

Ability to take advantage of opportunities

Rate of improvement or regression

Balancing GHG footprint and management of climate risk/opportunity

Footprint alone doesn’t tell the whole story – ignores:

1. Companies’ ability to manage or reduce climate risk

2. Companies’ regulatory risk exposure

3. Company and sector improvement over time

Challenge 1:


Carbon Beta Rating

Climate Change

Governance

Carbon Risk

Exposure

Strategic Profit

Opportunity

Management

Risk

All ratings derived from risk exposure v. risk management analysis



Electric Power North America

Key challenges, (some) solutions

Evaluating Corporate Climate Change Performance:

2008 Absolute Scope 1 GHG Emissions

Constellation Energy

Entergy Corp.

Exelon Corporation

FPL Group

Pinnacle West

Calpine

Pepco Holdings

PPL Corp. Progress Energy

Southern Company

American Electric Power Co.

Duke Energy

TransAlta Corp.

NRG Energy

Fortis Inc.

AES Corp.

Allegheny Energy

Edison Intl.

FirstEnergy Corp

Northeast Utilities

Top Quartile

Second Quartile

Third Quartile

Bottom Quartile

Average Regulatory Risk Exposure

Risk Exposure

Risk

Man

agem

ent

Poor Carbon Management

Low Regulatory Risk Exposure

Strong CarbonManagement

Average Carbon Management

High Regulatory Risk Exposure


Carbon Beta Rating

Climate Change

Governance

Carbon Risk

Exposure

Strategic Profit

Opportunity

Carbon Footprint

Data

Measuring risk:



RiskMetrics WACCRT: Calculates the cost of compliance with carbon regulations as a percentage of EBITDA and market cap, based on:

a) company-specific carbon footprintsb) distribution of emissions across jurisdictionc) level of regulation in each country/region

Evaluating Corporate Climate Change Performance:Measuring Risk


1% 1% 0% 0% 0% 0% 0%8%

3%

14%

3% 6% 5%

16%

6%

11%9%

1%

23%

0%

31%

18% 17% 17% 17% 17% 16%

23%

15%

25%

14% 15% 13%

24%

14% 16%12%

4%

26%

1%0%

5%

10%

15%

20%

25%

30%

35%

Weighted Average Reduction Target - Present Scenario Weighted Average Reduction Target - Future Scenario

Significant change:

US and Canada: 17% reduction by 2020

Extensive downstream operations in Europe (more than half of current emissions) – currently exposed• Exposure will grow with tightening of EU regs• Increased exposure with Canadian oil sands investment

Greatest potential change:

Brazil 39% below BAU scenarios by 2020: roughly 32% below

2005

Integrated Oil and Gas

Evaluating Corporate Climate Change Performance:Carbon-Intensive Sectors


Moving beyond carbon-intensive sectors…

Non-intensive:• Indirect risk; • Various points of impact: supply chain, products, energy use

Oil and Gas Financials

Carbon-intensive: • Direct regulatory risk• Impact primarily in operations

v.


Challenge 2:


0.00% 3.00% 6.00% 9.00%

BG Group

BP

OMV

Repsol

Shell

Total

Chevron

Conoco

Hess

Occidental

Imperial

Suncor

Sasol

Exxon Mobil

Husky …

Marathon Oil

Murphy Oil

Statoil

ENI

Lukoil

Petrobras

Compliance costs as % EBITDA: Current Scenario Compliance costs as % EBITDA: Future Scenario

Murphy: 40% refining capacity currently exposed in United Kingdom, 60% in US – compliance costs increase to nearly 4% of EBITDA with US regulation and stringent UK targets

Hess: More than 75% of emissions in Malaysia, Algeria, Equatorial Guinea – no public targets and flaring of methane allowed. Only 20% of emissions are associated with operations in US and EU – low exposure

Carbon-Intensive Sectors

Evaluating Corporate Climate Change Performance:


Non-Intensive SectorsEvaluating Corporate Climate Change Performance:

Banks are exposed to climate risk through the activities and companies they finance, rather than through their operations

We map each bank’s syndicated loan portfolio to RiskMetrics’ in-house carbon data and analytics to build a picture of each bank’s carbon risk exposure, including:

Carbon emissions financed

Carbon performance ratings of borrowers

Carbon regulatory risk exposure and country reduction targets

Overlaps between climate and financial risk is particularly significant to banks


Methodology: Attributing Borrower’s Emissions to Bank

Borrower Bank

Carbon : 10% of borrower’s emissions

Loan : 10% of borrower’s total assets

100 tonnes CO2e

10 tonnes CO2e

Notes:

+ carbon emissions refer to Scope 1 emissions as disclosed by the borrowing firm

+ where necessary industry and regional averages supplemented missing data

+ 29,000 syndicated loans were analyzed through 2008 and 2009, representing USD 6.9 trillion in volume

+ bank’s cut of each loans is estimated according to bank’s role in the deal, whole loan split between participants


0

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

70,000,000

Tonnes CO2e

Total Scope 1 Emissions 2008 Emissions Through Syndicated Loan Activity 2008

Why Look at Carbon Exposure? Comparing Absolute Emissions Through Financing vs. Operations

Citi JPM RBS Barclays0

500,000

1,000,000

“Financed” Emissions of a Bank are 1000x Larger than Scope 1 Emissions


Footprint Analysis: Carbon-Intensity of Loan PortfolioTonnes CO2e per USD mm Financed, Contribution by Sector

Notes:



286 281 274 270 264

237 231 230 228 227 223

192

161 158 157 153

-

50

100

150

200

250

300

350

Tonnes CO2e per USD mm

Other

Heavy Industry

Materials

Metals, Mining & Forestry

Energy & Power


More Important than Footprint: Carbon PerformanceComposition of Portfolio by Carbon Rating

0%

10%

20%

30%

40%

50%

60%52% 52%

39% 38% 38% 36%

30% 29% 28% 27%

21% 20%18% 17% 17%

10%

BB B CCC

RiskMetrics carbon ratings (‘AAA’ through ‘CCC’):

% of Loans with Poor Climate Change Performances

(below BBB)

15%

13%

17%25%

19%

5%6%

Distribution of Carbon Rat-ings Across Sample

AAAAAABBBBBBCCC

Several banks lend to a disproportionately high proportion of companies with poor climate change

performance

+ High intensity industries in syndicated loan portfolio only

+ Syndicated loan activity over two years ending December 31, 2009


Footprint Analysis: Carbon-Intensity of Loan PortfolioTonnes CO2e per USD mm Financed, Contribution by Sector

Notes:



286 281 274 270 264

237 231 230 228 227 223

192

161 158 157 153

-

50

100

150

200

250

300

350

Tonnes CO2e per USD mm

Other

Heavy Industry

Materials

Metals, Mining & Forestry

Energy & Power


52% 52%

39% 38% 38% 36%

30% 29% 28% 27%

21% 20%18% 17% 17%

10%

0%

10%

20%

30%

40%

50%

60% BB B CCC

More Important than Footprint: Carbon PerformanceComposition of Portfolio by Carbon Rating

RiskMetrics carbon ratings (‘AAA’ through ‘CCC’):

% of Loans with Poor Climate Change Performances

(below BBB)

15%

13%

17%25%

19%

5%6%

Distribution of Carbon Rat-ings Across Sample

AAAAAABBBBBBCCC

Several banks lend to a disproportionately high proportion of companies with poor climate change

performance

+ High intensity industries in syndicated loan portfolio only

+ Syndicated loan activity over two years ending December 31, 2009


Key Takeaways and Next Steps

• 1. Most global banks have significant exposure to carbon risk through their financing activities, but risk management strategies remain underdeveloped

• Many climate risk management and due diligence strategies focused on reputational risks, limited to specific asset classes (e.g. Project Finance). Focus on a few high-profile loans.

• No global banks have robust systems in place to measure and manage aggregate carbon risk exposure across assets

2. This is just the first step

• Syndicated loan activity only a part of company’s total financing activities

• Exploring links between climate performance and credit quality

• Correlation between ESG risk management in core business and broader integrated risk management at the bank, room for quantitative studies


For More Information, Contact:

Emily McAteerClimate Risk [email protected](646) 778-4183www.riskmetrics.com

http://www.riskmetrics.com/


Regulatory Exposure: % of Portfolio Subject to Carbon Regulation, Present and Future Scenarios

Notes:

+ based on geographic operations of borrowers, measured by % of assets, revenues or operations in each geographic segment

Currently 47% of loans (USD 2.9 trillion) face carbon regulations

Expected to rise to 84% (USD 5.1 trillion) by 2013

16%

50%

40%36%

87%

61%

73%

58%

73%

63%

79%

50%

60%67%

60%64%

100% 98% 97% 96% 95% 94% 93% 93% 92% 91% 90% 89% 89% 88% 87%81%

0%

20%

40%

60%

80%

100%

% in Regulated Markets - Present Scenario % in Regulated Markets - Future Scenario

Investment Perspectives on a Carbon-Constrained Economy

Economy & Finance

Transcript of Investment Perspectives on a Carbon-Constrained Economy