global perspectives

    Lombard Odier publishes an open letter to the TCFD and its Portfolio Alignment Team

    Lombard Odier publishes an open letter to the TCFD and its Portfolio Alignment Team
    Thomas Höhne-Sparborth, PhD - Head of Sustainability Research

    Thomas Höhne-Sparborth, PhD

    Head of Sustainability Research
    Michael Urban, PhD - Deputy Head of Sustainability Research

    Michael Urban, PhD

    Deputy Head of Sustainability Research
    Christopher Kaminker, PhD - Group Head of Sustainable Investment Research, Strategy & Stewardship

    Christopher Kaminker, PhD

    Group Head of Sustainable Investment Research, Strategy & Stewardship

    Our detailed letter offers a commentary supporting the work of the Task Force on Climate-Related Financial Disclosures (TCFD) on forward-looking metrics, and analyses responses by the Transition Pathway Initiative (TPI) and the 2° Investing Initiative that, we believe, risk misrepresenting the nature of these metrics.

    In November 2020, the TCFD-affiliated Portfolio Alignment Team (PAT) published an initial report exploring forward-looking metrics aimed at assessing the alignment of portfolios to the climate transition. In June 2021, the TCFD published two further reports, providing guidance on climate metrics and offering technical recommendations surrounding the adoption of so-called Implied Temperature Rise (ITR) metrics.

    ITR metrics, or temperature alignment metrics, seek to assess whether investments align to the emission reductions needed to meet decarbonisation goals. For example, ITR metrics might classify an investment as “1.5°C aligned” if it meets objectives to keep global warming to the level pursued by the Paris Agreement. It follows that investments aligned to 3°C, 4°C, or 5°C would be lagging behind in their climate ambition.

    At Lombard Odier, we have been an early advocate of more forward-looking metrics. Recognising the rapid evolution of forward-looking methodologies, our team undertook a review of early efforts in this space prior to developing an internal temperature alignment methodology. This review led us to similar conclusions as the TCFD and our own metric closely aligns with the TCFD’s recommendations.

    Temperature alignment metrics, as opposed to traditional carbon footprint analysis, evaluate not only the emissions of a company today, but also whether the company’s emissions are falling in line with sector-specific benchmarks. These ITR metrics recognise that a company in high-emitting, climate-relevant sectors such as steel, cement, or chemicals may absolutely form part of the solution, provided it is rapidly decarbonising or has set credible targets to reduce emissions. Conversely, companies in lower carbon sectors may be more poorly aligned if their emissions are increasing and their management is taking inadequate further action.

     

    Figure 1: Schematic illustration of Lombard Odier’s implied temperature rise (ITR) metric

    Company-X-climate-trajectory.png
    Source: Lombard Odier. For illustrative purposes only
     

    The reports of the TCFD provide practical guidance as to the development of these metrics, and encourage their adoption by financial institutions. However, two responses published by selected supporters of the Transition Pathway Initiative (TPI) and the 2° Investing Initiative (2DII, the lead developer of alternative PACTA methodology) called into question the reports’ conclusions.

    The TPI response – signed by a selection of the TPI’s supporters – raises as its most fundamental concern that “[i]t would become increasingly difficult to hold a portfolio of transitioning assets in high carbon intensive sectors, even if those very same companies had been responsive to investor engagement and made credible and independently verified net zero aligned targets that were consistent with the transition.”

    We believe that the above statement is an incorrect representation of nature and objective of ITR metrics. ITR metrics first define sector-specific benchmarks detailing the specific rate of decarbonisation that companies in the sector need to achieve, before comparing a company’s own historical and projected emissions to that benchmark. For example, a company in a sector such as steel might have a higher carbon footprint than a manufacturer of furniture. Well-designed ITR metrics, however, would compare the steel company against a benchmark specific to the steel industry. As opposed to what the TPI’s response implies, a company in this industry with credible net zero targets would indeed be assessed to be very well aligned to the transition, at least by ITR metrics aligned to the TCFD’s recommendations, such as our own.  

    TPI also argues that adoption of portfolio alignment metrics “will have a series of undesirable consequences for asset owners potentially forcing them to breach their fiduciary duties, imposing significant additional costs on asset owners.” In contrast, at Lombard Odier we believe that, given how the climate transition creates significant market and regulatory shifts, it is very much the fiduciary duty of asset managers and asset owners to identify how well their portfolios align to the transition. It agrees with the TCFD that ITR metrics, used alongside other tools, are an essential starting point for investors to understand that alignment.

    In similar fashion, our open letter addresses a number of misconceptions in the response from 2DII. 2DII is the lead developer of PACTA, which offers sector-by-sector assessments of investments in key sectors such as real estate, power, and transport. 2DII argues that such sectoral analysis offers more actionable insights, but they provide only the most basic ITR metrics. This sector based analysis does not offer sufficient  granularity, with the TCFD specifically recommending the use of more granular approaches – with   Lombard Odier’s being an example of these. These approaches offer similar ability to steer action, but – in contrast to the PACTA approach – also provide a common language, allowing a direct comparison between a “2°C aligned” company in one sector and a “1.5°C aligned” in a different sector. Crucially, we note,ITR approaches also allow for the aggregation of scores at a portfolio level.

    As ITR metrics draw on various climate scenarios, the approach requires specific analytical capabilities. Our letter addresses key issues raised by 2DII on a variety of technical topics from the use of emission- and production-based metrics, to the analysis of indirect emissions, relationships between emissions and global warming, and approaches to portfolio-level analysis. We observe that ITR metrics specifically support the analysis of real emission reductions and, for this reason, should be welcomed by investors.

    Our letter concludes by agreeing that different approaches to these forward-looking assessments can lead to divergent results, an issue that also applies to assessments by TPI and PACTA. It argues, that to promote convergence and standardisation, common guidelines are needed – which, it highlights, the TCFD reports specifically seek to provide – and therefore calls for the recommendations of these reports to be embraced by market participants.

    To read the letter in full, please use the button provided.

    important information.

    This document is issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the “FCA”), and entered on the FCA register with registration number 515393.
    Lombard Odier Investment Managers (“LOIM”) is a trade name.
    This document is provided for information purposes only and does not constitute an offer or a recommendation to purchase or sell any security or service. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful. This material does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investment in financial products. Before entering into any transaction, an investor should consider carefully the suitability of a transaction to his/her particular circumstances and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. This document is the property of LOIM and is addressed to its recipient exclusively for their personal use. It may not be reproduced (in whole or in part), transmitted, modified, or used for any other purpose without the prior written permission of LOIM. This material contains the opinions of LOIM, as at the date of issue.
    Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term "United States Person" shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
    Source of the figures: Unless otherwise stated, figures are prepared by LOIM.
    Although certain information has been obtained from public sources believed to be reliable, without independent verification, we cannot guarantee its accuracy or the completeness of all information available from public sources.
    Views and opinions expressed are for informational purposes only and do not constitute a recommendation by LOIM to buy, sell or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change. They should not be construed as investment advice.
    No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient, without Lombard Odier Asset Management (Europe) Limited prior consent. In the United Kingdom, this material is a marketing material and has been approved by Lombard Odier Asset Management (Europe) Limited  which is authorized and regulated by the FCA. ©2021 Lombard Odier IM. All rights reserved.