2016 ET CARBON RANKINGS REPORT

FOREWORD
5
The international Financial Stability
Board recognises the issue of carbon risk
and has set up a Task Force on Climate
Related Financial Disclosures to make
recommendations on how companies
should disclose climate-related financial
information so that investors and other
capital market participants can “understand
the concentrations of carbon-related assets
in the financial sector and their exposures to
climate-related risk”. 4
For investors to get a full picture of
carbon risk they need to go beyond
direct emissions from a company’s own
activities (Scope 1 and 2) and understand
indirect emissions from the activities in
its value chain (Scope 3), from production
of the raw materials it uses to the use of the
goods it sells. Scope 3 emissions are typically
the largest source of emissions within a
company’s total footprint, and a major
source of its carbon and climate-related risk.
These value chain carbon costs can affect
a company’s suppliers and customers, and
the viability of a company’s core business.
Costs linked to increased regulation and
explicit emissions pricing cannot always
be passed through the supply chain or
to the final consumer. The materiality of
Scope 3 emissions has been most strongly
demonstrated in the US coal industry,
where tightening emissions regulation has
combined with other factors to decimate
shareholder value. 5
The financial importance of Scope
3 emissions data has been revealed
by ET Index Research analysis of the
performance of high-carbon and lowcarbon
intensity companies. 6 Over the
2010-2016 period, low-Scope 3 intensity and
low-Scope 1 and 2 intensity portfolios both
outperformed high-intensity portfolios, by
7.2% and 4.8%, respectively. The greater
performance difference between portfolios
sorted on Scope 3 intensity further confirms
the financial materiality of Scope 3 emissions,
in addition to basic Scope 1 and 2 emissions.
At present, not every country enforces
mandatory corporate greenhouse gas
emissions reporting across Scope 1, 2 and
3. 7 Therefore, one of the key functions of the
ET Carbon Rankings is to shine a light on
companies around the world that are failing
to place this information into the public
domain in a clear, comparable, and complete
format; and to encourage them to disclose.
Corporate emissions reporting will be a
central metric in tracking the transition
to a low-carbon economy and managing
transition risk. The central function of the
Paris Climate Agreement is to guide a global
response to the threat of climate change
by keeping global temperature rises to well
below 2 °C. This requires a rapid transition to
net zero emissions across all sectors of the
economy. 7 Market pricing of carbon and
climate-related risk, whether it be direct
or indirect, will necessarily be focused on
greenhouse gas emissions.
For the prudent investor, following a lowcarbon
investment strategy is a logical
imperative. However, not all low-carbon
strategies are created equal. According to
Martin Skancke, Chair of the UN PRI, investors
“need to differentiate between products that
reduce individual exposure to carbon risk
versus those that reduce collective aggregate
climate change risk.” An investor who merely
shifts the weights in their portfolio to lowcarbon
stocks, without engaging with other
market participants or investee companies,
reduces their own exposure to carbon risk
but does nothing to reduce systemic risk.
An investor who not only reduces their own
exposure but also engages with other market
participants and investee companies to
encourage the flow of capital to low-carbon
investments, benefits both themselves and
the market.
2016 CARBON RANKINGS REPORT
ET INDEX RESEARCH