Executive Summary

Climate change has financial implications for investors – presenting significant portfolio risks as well as new market opportunities. However, this landscape of climate exposure for investors is often not well-understood, and its consequences are rarely reflected in how we assess the performance of companies and funds. The lack of common definitions and common taxonomies used to describe and orient climate-relevant concepts in the investment landscape often adds to the confusion. It can also be challenging to differentiate climate-related investment choices that are significant, from those that are marketed as “green” but lack substance.

This is problematic for two major reasons: First, investors and others are exposed to significant financial risks associated with climate change that are not being properly assessed or managed. These unaddressed risks can hurt investment portfolios as well as our overall financial system, and often mean that markets are not properly recognizing the cleanest or most efficient companies.

Second, much of the world’s long-term capital that is needed to put the world on a low-carbon, climate-resilient pathway has not been allocated to these types of investments. This means that investors are not able to take advantage of many opportunities associated with climate exposure that would also allocate significant capital towards the fight against climate change.

Environmental, social, and governance (ESG) data contains essential information to enable investors to manage climate-related risks, and a number of data tools and financial products have emerged that seek to help investors utilize it.

However, there are some inherent challenges. ESG data is often voluntarily disclosed through a patchwork of different organizations and actors. It varies significantly in the quality, quantity, and rigor of disclosed information. This variation in ESG data between companies in the same industry, across industries, and throughout the capital stack can make it difficult for investors to account for climate exposure across entire portfolios.

This paper explores the landscape of climate exposure and examines the strengths as well as some of the current limitations of ESG data, tools, and financial products.

ESG data toolsaggregate ESG data, research, and analysis for investors, allowing them to identify climate exposure in their portfolios today. However, these tools emphasize climate risks over climate opportunities, and are limited by the quality of the underlying ESG data. Nonetheless, these tools represent an important start.

ESG index productshelp investors actually manage these risks or pursue opportunities; however, these have their own challenges. Exclusionary (or “divestment”) indexes are often more effective as political or moral statements than as a means of managing complex climate risk or attempting to influence the cost of capital for fossil fuels. Non-exclusionary indexes (which underweight low-ESG performers) and thematic indexes (which emphasize “green” investments) may be slightly more nuanced tools. However, they often don’t provide the levels of transparency needed for investors who are serious about either managing climate risk or pursuing opportunities in areas like renewable energy or alternative fuels.

Emerging green financial productslike green bonds and YieldCos have the potential to be important vehicles for climate-related investments in the future. However, green bonds today lack a universal definition of “green” criteria and aren’t necessarily raising new financing for climate action. Current YieldCos, in turn, are often focused on growth and may not meet the needs of institutional investors.

The landscape of climate exposure consists of a number of actors, ranging from companies and investors to regulators, disclosure advocates, ESG tool providers and others. All will continue to play important roles in improving this space. To achieve improvement, we suggest the following:

• Standard-setting organizations, disclosure initiatives, and investors can lead the way on greater disclosure from companies. Ultimately, standardized ESG disclosure within corporate reporting processes needs to become a necessary underpinning for standard investment analysis. Mandatory disclosure for public companies – through financial regulators, exchanges, or intermediaries, and covering a range of asset classes – would afford investors more comprehensive information and greater comparability across industries, improving the added value of tools and products to manage climate exposure.
• Investors and regulators can continue mainstreaming ESG investment. Integrating ESG metrics into investment decisions can add portfolio value today, while also helping the ESG investment sphere to grow and mature.
• Financial product and service providers can work with investors to create new financial vehicles for green investments and improve existing ones. ESG-inclined indexes, green bonds, and YieldCos remain a promising start, and all are increasing in their sophistication, disclosure, and investment oversight. Nonetheless, additional green investment vehicles that improve upon current limitations are likely to be important assets for investors managing increasingly complex climate-related risks and pursuing greater climate opportunities, over time.
• Investors can share best practices for minimizing climate risks and maximizing climate opportunities. Effective management of climate exposure will require knowledge-sharing on the best ways to minimize climate risks and maximize climate-related opportunities, across asset classes, investors, and geographies. A dialogue of like-minded investors who are willing to engage in an interactive process of evaluating portfolios on a regular basis could provide an important start.