Decarbonisation engagement: How third-party managers are responding
Climate change is the defining issue of our time, and we are at a pivotal moment. The growing impacts of climate change on the global economy are increasingly unavoidable.
The landmark Paris Agreement reaches its ten-year anniversary in 2025, and governments and corporations continue to shift course to try to limit climate change. Despite recent backpedalling fuelled by divisive politicking and a concerted ‘anti-ESG’ campaign, financial services businesses are expected to set net zero targets in line with global efforts to decarbonise, with the Net Zero Asset Managers Initiative (NZAM) being the most widely adopted platform used to set these targets.
The announcement by NZAM on 13 January that it is reviewing the initiative “to ensure that NZAM remains fit for purpose in the new global context” is a perplexing, although sadly not altogether surprising development. We have seen asset managers with a significant US presence exit the Climate Action 100+ collaborative engagement, and also NZAM citing a number of different factors. Most obviously, pressure from the anti-ESG lobby in the US. It is perplexing as in order to move to a 1.5 degree world we need a global framework to hold asset managers to account and also to help the industry develop its approach to climate transition.
For asset managers, the majority of emissions are those they have financed through investments, termed ‘financed emissions.’ We are aiming to set decarbonisation targets for our financed emissions, to complement our operational emissions targets. Led by Margaret Schmitt, we recently embarked on the first phase of our engagement with third party managers to assess what degree of alignment is feasible, and how aligned (or unaligned) our fund holdings currently are with a net zero trajectory. We hoped this exercise would also provide helpful insight into how other firms – both similar and dissimilar from Quilter Cheviot – have approached setting net-zero targets.
Over half of the firms that manage the third-party funds we invest in have set targets through NZAM, making it an ideal starting point in this assessment. We selected our top 20 firms, accounting for over two thirds of our third-party fund-invested AUM, to discuss the detail of their NZAM commitments and determine to what degree the funds we invest in are linked to specific firm-level net zero commitments.
Following our engagements, we assessed firms’ responses against our climate alignment criteria, and assigned scores accordingly. We deliberately weighted the criteria towards rewarding the strategy and engagement components of firms’ NZAM commitments, and were interested in understanding:
- How thoroughly a firm interrogated alignment feasibility before setting targets;
- Whether they had a clear strategy for achieving their targets; and
- How integrated this target was in the management of individual funds Quilter Cheviot is invested in.
When comparing scores across the firms we assessed, there were a number of trends which emerged. Some of our key findings included:
Size was not a limitation on scoring well in our matrix:
- Of the top five firms, two were classified as small, two were large and one was extra large
Firm ‘type’ showed differences (‘asset owners’, ‘wealth managers’ and ‘asset managers’):
- We found that firms with asset owner parent companies (banks or insurance) scored lower on average, with those owned by banks scoring the lowest. This may in part reflect the restrictions of managing owned assets or the slight variation in approach for asset owners setting targets through the Net Zero Asset Owner Alliance.
- Within the smaller firms, the wealth managers category of smaller boutique firms outperformed the other two considerably, which is likely a reflection of their ability to concentrate on restricted subsets of investments and more readily adopt a ‘whole of firm’ approach to setting climate targets.
Smaller firms made larger commitments:
- This is often a reflection of boutique firms’ more limited investment universes, such as not investing in harder to align assets such as index trackers, and particular investment theses such as extensive exclusions to screen out heavy emitting sectors. Nonetheless, we still had exceptions to this, where larger asset managers were comfortable committing sizeable portions of their AuM in their NZAM commitments.
Many firms are still reticent to include Scope 3 emissions in targets:
- Industry view of Scope 3 emissions has shifted in recent years, so this is likely due in part to the age of some targets. However, some firms expressed a clear disdain for Scope 3 emissions.
- Some of this reluctance was linked to concerns about data quality and availability, but more troublingly, some argued these emissions were beyond their scope of climate responsibility. While we acknowledge there are complexities to including them, they nonetheless remain critical given current climate efforts are proving insufficient, and they often make up the majority of an issuer’s carbon impact. Firms wilfully ignoring these emissions is a profoundly irresponsible view.
US-based firms scored slightly worse than UK/EU firms:
- American firms scored an average of 18% lower overall than the UK firms we engaged with. Poor targets and corresponding weakness in accompanying engagement framework was common in US firms, although three were included in the top half of overall raking which indicates there remain firms with relatively robust climate targets despite the challenging geopolitical context in the US.
Following our engagement, we developed criteria to inform our view of what best practice looks like for a firm-level net zero target made through the NZAM framework. These include having:
- Comprehensive targets
- Appropriate alignment metrics
- A balanced methodology
- Useful tools and resources
- Net-zero aligned activities
- Integrated strategy
Setting climate targets for investments is no simple feat. It is challenging to balance setting a rigorous strategy with communicating the details and nuances of targets clearly. While there are many examples of what we would consider to be best practice, there are also three general principles that apply to our expectations of firms’ climate-related targets.
- Transparency above all else – While setting climate-related targets is understandably complex, we encourage all to prioritise transparency in disclosures. All too often, this information is either challenging to obtain or is absent.
2. Engagement is key – This can take many forms and can adapt to a firm’s resources, but engaging and subsequently reporting on that engagement is a critical element of stewardship.
3. Be a part of the conversation – Evidence that your firm is proactively working on this today, and not delaying until peers demonstrate a way forward. Commit where it is possible to and take other measures in the harder to align areas. Where setting explicit targets is not possible, scale proactive engagement activities to compensate.