Altius Quarterly Sustainability Report - September 2022
Altius Asset Management
We specialise in Australian and New Zealand cash and fixed interest with recognised expertise in ESG risk management
The Albanese Government’s landmark Climate Change Bills passed the Senate during the quarter, enshrining Australia’s emissions reduction target of 43% by 2030 (from 2005 levels) and net zero emissions by 2050 in legislation. This provides energy policy, boosting investment certainty that is more in line with other developed countries. At the same time, the Government has also released a consultation paper on changes to the safeguard mechanism that it intends to introduce next July. It would involve new emissions baselines, or limits for 215 major polluting facilities, that would be gradually reduced over time. Companies will have to either cut emissions or buy carbon credits to stay within their baseline. The legislation also resurrects the Climate Change Authority, charging it with the task of giving annual advice on progress towards meeting existing targets and advice on new targets. The government will have to release the advice and publicly explain deviations from that advice. Government agencies must also consider the targets when making investment and the climate change minister must give an annual statement to parliament on progress towards the targets.
The Bill clearly represents a move in the right direction, but many would like to see a more ambitious target (minimum 50% reduction) as supported by most state governments, the Business Council of Australia, and the Australian Industry Group. The independent scientific consortium, Climate Action Tracker (which tracks and contrasts government climate action against the globally agreed Paris Agreement aim) notes that even with the new target, Australia still ranks amongst those governments rated “insufficient” in action, although previously the target was regarded as “highly insufficient”. In this regard, the ratchet mechanism that treats the current target as a floor is an important addition to the Act.
In the US, the far-reaching Inflation Reduction Act will see an unprecedented $370bn invested in cutting United States emissions 40 percent by 2030, providing a launch pad for green investment and the transition towards renewable energy for the world’s largest greenhouse gas emitter. The independent Rhodium Group think-tank assessed the measure would reduce US emissions by at least 31% by 2040, compared with 2005 levels, but noted that current favourable macroeconomic drivers such as increasingly high fossil fuel prices and cheap renewables could result in a 44% reduction. The bill includes numerous investments in climate protection, including tax credits for households to offset energy costs, investments in clean energy production and tax credits aimed at reducing carbon emissions and is impressive in terms of scope and the integration of the measures in the policy. This video primer is an excellent pacy download of detail[1].
Australia’s energy system needs urgent investment in new wind, solar and storage capacity, and new transmission lines to cope with electricity supply shortfalls projected to affect NSW in 2025, followed by other states shortly thereafter. In its latest annual report, AEMO said the acceleration in coal and gas plant closures, delays in new transmission projects and expectations of rising demand meant that reliability standards for electricity will be breached 7 years earlier than it foresaw last year[2].
The AEMO has adjusted its assumptions for electricity demand and supply in accordance with the “step change” scenario for transition, which assumes closure of 5 coal plants over the next decade taking out 8.3GW or 14% of the national energy market’s total capacity. Furthermore, demand is expected to rise more than previously assumed with greater electrification across households and industry. New generation in the pipeline is not sufficiently advanced to give much comfort to the regulator. Holding back project commitments has been lack of clarity for market rules, although the new government’s commitment to 82% renewables by 2030, and the injection of environment and emissions into the national electricity objective, should smooth the path. Sufficient labour and supply of materials are also constraining new projects.
Of some assistance regarding energy demand management, energy-efficiency standards for new residential buildings in Australia are being upgraded for the first time in a decade. New homes will be required to improve minimum performance from 6 stars to 7 stars under the Nationwide House Energy Rating Scheme (NatHERS), with the new provisions will be reflected in the 2022 National Construction Code. The rating will also use a whole-of-home energy “budget”. This will allow homes to meet the new standard wholistically after consideration of the efficiency of appliances and self-generation from roof top solar and batteries. The changes apply from May 2023, and all new homes will have to comply by October 2023. The new code is expected to reduce emissions by 1.64 million tonnes and would assist in Australia reaching its goal of net zero by 2050.
The NSW government is also introducing a new state environmental policy (SEPP) with new standards for energy, water, and thermal performance, while also extending Building Sustainability Index (BASIX) standards to some non-residential buildings for the first time[3]. Under the BASIX, new homes and renovations will have to reach a 7-star rating from the current 5.5 stars minimum and a range of large commercial developments will also have to submit “net-zero statements” showing their buildings are either all-electric or can fully convert to renewable energy by 2035. Residual scope one emissions can be offset through Climate Active Carbon Neutral certified credits. Under consideration is how to change building standards to facilitate EVs in new buildings. In a welcome innovation for sustainable finance, the New South Wales government is also proposing a series of energy auctions designed to overcome some of the obstacles to clean energy investment in the task of transforming the country’s most coal dependent state grid. The auctions will provide a pricing floor to generation and storage projects to lower the cost of equity and finance and to attract more that were previously fearful of the market volatility and curtailment/connection risk. Access rights to the renewable energy zones will be auctioned to limit on the number of projects within a renewable zone and will award a maximum output capacity to each project.
Global investment in renewable energy increased 11% in the past year (H1 on H1), according to data published by Bloomberg NEF. Investment in solar projects hit US$120 billion (an increase of 33%) and US$84 billion for wind projects (an increase of 16%). However, accreditation body Bureau Veritas has warned of heightened pressure on renewables’ supply chains due to a shortage of key materials, which risks slowing down the upscaling of solar and wind projects[4].
The Science Based Targets initiative (SBTi) announced the launch of the Forest, Land and Agriculture (FLAG) Science Based Target Setting Guidance, providing a standard method for companies with material land-related emissions (20% or more) to set targets aligned with global climate goals[5].
Land-intensive sectors represent nearly a quarter of global GHG emissions – second only to the energy sector. A key requirement is for companies to commit to zero deforestation by 2025. Companies are also required to set near term (5–10 year) emission reduction targets in line with 1.5°C and long-term targets to reduce at least 74% of emissions by no later than 2050.
The SBTi guidance also noted a role for GHG removal, like soil carbon sequestration and improved forest management but clarified that nature-based carbon removals are not offsets and are not a substitute for deep emissions cuts.
Following the lead of the European Central Bank (ECB) and Bank of England (BoE), the US Federal Reserve Board announced it will launch a pilot climate risk study with six of US’s largest banks, starting early next year and conclude by the end of 2023.
Against scenarios of climate, economic, and financial variables, the Fed will review the banks’ analyses, engage on climate risk management capacity, and publish aggregate-level insights from the pilot.
The RBA has also flagged that climate change will likely have a significant impact on the structure of our economy, the pricing and return on assets, with clear implications for the efficiency and stability of the financial system. The RBA warned banks, insurers, and other businesses to act now to manage the financial threats from global warming, with directors and trustees likely to face increasing litigation risks if they don’t take “appropriate actions”. A key concern is that climate change can significantly affect asset prices and reduce the stability of future cashflows. At the same time, climate change may also reduce the ability of households and businesses to meet their repayments, by impacting incomes and houses will likely become harder to insure. The RBA also called for the development of an Australian taxonomy for sustainable finance to provide consistency of definitions for what is appropriate in the context of the local high emission economy. A taxonomy would assist those making and interpreting disclosures to make informed investment decisions that will drive the adaptation and mitigation actions needed to manage the risks of climate change[6].
APRA released an information paper on the Climate risk self-assessment survey conducted with medium-to-large financial institutions, with key findings including 40% of institutions said climate-related events could have a material or moderate impact on their direct operations, 90% of institutions are overseeing climate risk and managing it in line with the recommendations of the TCFD. However, they noted 23% do not have any metrics to measure and monitor climate risks. Only a small portion have fully embedded climate risk across their risk management framework, and integration of climate risk into strategic planning is work in progress. Advanced quantitative risk metrics such as scope 3 and financed emissions, and forward-looking exposure to physical and transition risk, was not yet widespread with 50% of banks reporting they do not assess emissions arising from wholesale lending. Climate-related scenario analysis (including IPCC, NGFS, STEPS and SDS) is conducted by 72% of institutions and majority consider they have moderate vulnerability to both physical and transition risks under a high-risk scenario. 22% were unsure of their vulnerability to physical and transition risks[7].
Meanwhile, reinsurance giant Munich Re has announced that it will no longer insure or finance projects “exclusively covering the planning, financing, construction or operation of new oil and gas fields”. From April 2023, the German-based insurer will also cease to make new direct investments in “pure-play” oil and gas.
ANZ provided an ESG briefing where it reiterated its commitment to a $50bn sustainable finance target by 2025, of which approx. 60% had been completed earlier this year. ANZ said it is on track to set emission targets for 9 priority sectors (by 2024) and will announce targets for oil and gas, as well as the building products sectors by end-2022. Thermal coal mining is currently the only sector ANZ has pledged to stop financing. Adding to the task, Lending to oil and gas extraction increased from $5.9bn to $6.4bn in the 6 months to March. ANZ also said it is not keen to exit whole sectors based on emissions but would rather “skew capital towards those that have robust transition plans”.
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ANZ’s top emitting customers belong to manufacturing (30%) and resources (20%) sectors, with 60% based in NZ and/or offshore. Most customers had not publicly disclosed plans to transition to net zero or were just starting to develop plans as of a year ago. Investors and analysts on the call pushed for more disclosures around customer conversations, specifically criteria used to assess plans, and consequences for lack of progress. The bank made no mention about scope 3 targets.?
Global Green, Social, Sustainability, and Sustainability-Linked (GSSS) bond issuance has surpassed $600 billion at the end of Q3 this year, although this is down 30% on last year reflecting worsening credit conditions and less Covid related spending. On the investor side, the ECB is expected to favour corporate bonds of companies that emit less carbon incorporating into security selection a scoring system which will be based on emission performance, goals and climate disclosures. During the quarter, China also published new Green Bond Principles (GBP) which are broadly in line with ICMA’s in requiring 100% of the proceeds from green bond issues to be invested in green projects (70% previously) and mandatory for exchange traded bonds. Singapore issued its inaugural Green Bond, a S$2.4 billion 50-year issue, their first ever 50-year bond and well oversubscribed. Switzerland is expected to issue its first green bond later this year having identified CHF 4.5 billion in eligible green expenditures.
In the ongoing debate on green taxonomy, several environmental groups are legally challenging the inclusion of natural gas and nuclear power as eligible sustainable activities by the European Union. They have requested for an internal review and asked for a response within the next 22 weeks from the EU failing which they will be taking action reaching the court of justice of the EU.
According to Environmental Finance data, total sustainable debt issuance has now surpassed $3 trillion, mostly in green bonds, social and sustainability bonds. Sustainability-linked bonds (SLBs) have been roughly 5%. The latter have provoked some concerns due to gaming by issuers. Bloomberg News noted they had “analyzed more than 100 SLBs worth almost €70 billion that were sold by global companies to investors in Europe—the most mature market for sustainable finance products—and found that the majority are tied to climate targets that are weak, irrelevant, or even already achieved”. Krista Tukiainen, head of market intelligence at the Climate Bonds Initiative went so far as to say the SLB market “is broken,” and not “moving the needle on climate”[8].
In contrast, in the latest politically charged anti-ESG move, Louisiana has announced that the state will divest around $800 million from BlackRock in response to the asset manager’s sustainable invest approach. The decision follows action by other conservative states across the US with boycotts from Arkansas ($125 million), Utah ($100 million), and West Virginia ($20 million). A report, commissioned by the PRI, noted that global asset managers and banks are being forced to choose between ESG or fossil fuel energy strategies. Banks and pension funds that control assets in a state where investment laws are changing could also face legal liability risks.
Lastly, Altius is about to release its inaugural Impact report, the first of its kind for bond portfolios in Australia. The report covers measuring and tracking carbon within a portfolio and measuring against Benchmarks, comparing the carbon risk exposure of individual portfolio holdings and how to get bang for buck in portfolio construction as well as forward looking assessment of portfolios under accepted climate scenarios and the role of engagement with ESG issues and how advocacy can advance action on issues that matter most to investors/members. For access to the report please contact us through our website @altiusam.com[9]???
[2] https://aemo.com.au/newsroom/media-release/critical-investment-needed-to-manage-reliability-gaps
[7] https://www.apra.gov.au/sites/default/files/2022-08/Information%20paper%20-%20Climate%20risk%20self-assessment%20survey.pdf