27 July 2021
Just two words – 'net zero' – will likely move trillions of investment dollars over coming decades. Knowing how best to get a portfolio, and an insurance business, to zero greenhouse gas emissions will be a skill CIOs need to hone, as David Walker hears from AXA Investment Managers.
AXA's chief executive officer Thomas Buberl has made little secret that the fight against climate change is personal. It is hardly surprising therefore that AXA Investment Managers is trying to angle itself at the forefront of the battle to help insurance clients.
The affiliated asset manager is itself aiming for net zero on aggregate assets by 2050, as part of the $9trn Net Zero Asset Managers initiative.
But when Andrew Douglas, director, institutional business, and Bruno Bamberger, solutions strategist at the asset manager explain how insurers can achieve the same goal, they surprisingly do not cite divestments, rotations or shareholder engagements – at least as a first step.
But initially, they suggest to look at an insurer holistically. Yes, their parent has a €526bn ($627bn) general account, but it also has €83.9bn of insurance premiums to cover, including €34.8bn non-life exposures. Both parts of the balance sheet carry CO2 implications, and each influences how the other can be structured.
"So it's important to start with the holistic exposure of the insurer's balance sheet, and identify some of the long-term targets to manage the [climate] risk. The asset management community tends to focus on the investment portfolio, but it can also support its insurance clients to define a holistic ESG framework at firm level," Douglas says.
Working for AXA has already given the affiliate immense insight into how an insurer's assets and liabilities interplay on the path to net zero, and the real-life considerations, and no doubt challenges, of an underwriter pledged to getting there.
A cuppa with the CIO
Europe's larger insurers might have led the way on net zero ambitions, but Douglas says AXA IM's conversations with mid-sized and smaller insurers over the past 12 to 18 months have "dramatically changed. Previously climate was not particularly on the agenda, and ESG was not a leading topic, but now sustainability is one of the top two or three topics we discuss with all insurers, and particularly with small- and mid-sized ones".
That change makes sense, he adds, after all "mid-sized and smaller insurers have similar policy holders and similar pressures from regulators - although that is proportionate."
But Douglas acknowledges the constraints on resources facing smaller underwriters, and says experienced asset manager partners can bring "data and expertise that can support your understanding as an insurer".
Scope 1, or 'direct', greenhouse gas (GHG) emissions occur from sources that are owned or controlled by the company.
Scope 2 GHG emissions occur from the generation of purchased electricity, steam, or heat, consumed by the company.
Scope 3 GHG emissions are a consequence of the activities of the company, but occur from sources not owned or controlled by the company.
Source: UNEP FI Investor Briefing, 2013
AXA IM's early-stage discussions with CIOs may involve identifying the most appropriate metrics to base actions on, ensuring "achievable emission reduction goals" to target over scope 1-3 and how, and by what date, to aim to get there.
Bamberger emphasises here the difference between achieving portfolio-net-zero, and being part of a societal-net-zero.
"It is relatively easy to get to a low-carbon current portfolio by removing a fairly small tail of high-emitting issuers. But doing this does not drive the whole-of-market transition required to get the world to net zero. And if you do not drive that transition, [an insurer's] assets and liabilities will still be impacted by the physical risks of climate change."
Financials still key
CIOs have acclimatised to triangulating investment returns, volatility and Solvency II risk charges – and then along come net zero-related measures.
Douglas says: "In the same way an insurer's strategic asset allocation creates an efficient frontier for return versus solvency capital, or return versus volatility, the strategic asset allocation can also take into account carbon intensity and assess the warming potential across the whole portfolio."
But he emphasises, "the focus still remains on financials - one must not forget them as a key driver, and the main focus, for any CIO. Although assessing warming or carbon intensity is important... insurers still have commitments to shareholders, policyholders and other stakeholders...to make a decent return."
AXA IM's early-stage conversations with CIOs will also discuss Pillar 3 reporting and monitoring requirements.
"CIOs need to...demonstrate the metrics of their investments, and show that they're on the right trajectory. That is something that can sometimes be overlooked," Douglas explains.
Investors should consider a range of metrics when considering climate, Bamberger says. "You can increase your 'green bond share' to boost climate solutions and aid towards a low-carbon economy. But that does not give the whole picture, because companies can issue and self-certify [green bonds] without a set standard. A thorough review of an issuer's climate strategy is required due to this. Absolute carbon emissions or carbon intensity could be more pertinent metrics to consider," Bamberger says.
On the positive side...
Net zero can be painted, wrongly, only as a task of avoidance, engagement and divestment for CIOs.
It is not, and harbours winning technologies and business models, some evident already.
As Douglas says: "Of course, it is important to manage the downside well, but there are also opportunities to be found."
AXA IM's equities strategies and alternatives offerings seek to identify, and buy into, them.
"There is a lot of climate-aware capital on the sidelines, so if you can identify good value within some of the best-in-class firms, and firms that can potentially innovate within areas of cleantech, for example, you can pick some strong winners over the next few years.
"As much as [net zero] is about tail risk and downside, there are opportunities in it, too."
He counsels to look at "the future path of your carbon emissions," as well as the current measure.
Analysing the targets and projections over 10-20 years, and updates, from investee companies may help avert CIOs ditching out of energy, utilities and basic materials holdings, whose scope 1 and 2 emissions represent about 85% of all the GHGs of these sectors.
Selling them with no regard to the financial impact would be painful for many CIOs' cashflows, Bamberger reasons.
"Utilities are great providers of long-term stable cashflows, so we do not want to exclude those sectors outright. We would prefer to stay invested with them, to make sure they set and meet climate targets."
Seeking out the companies in these sectors "most dedicated to making change is important from a financial perspective, [because] those that will change and adopt sustainable business models will give you your cashflows in future," Bamberger says. He adds, though, that AXA IM has a revenue-based 30% ceiling exclusion for coal extractors, so some miners are entirely off the table.
CIOs taking a forward-looking view on emissions is also important in regards scope 3 GHG emissions. Relatively few companies report them now, and figures are often estimated, but that will change.
And some sectors relatively harmless by scope 1-2 emissions - insurers, banks and tech, for instance - could spring significant 'scope 3 surprises' on share/bond holders when coverage broadens.
AXA IM typically aims for sector-neutral allocating "so there are no surprises down the line, when it comes to scope 3".
It is not just a matter of 'investees getting to net zero', but also 'getting [some] investees to net zero' - using engagement.
Bamberger says: "When we engage, we find businesses are more receptive when [they] know we are not forced buyers [of their issues, unlike passive investors] and that we are longer-term investors. We will not flip their bonds, and we could be holding them for 30 or 40 years."
But this does not allow CIOs to become forever complacent. "When you get to the stage of [having] less than one year to [a bond's] maturity, you have greater leverage with a company, with the threat that you'll not finance them, if they do not make necessary changes, leading to their cost of capital increasing," Bamberger says.
At present the world is awash with so much pandemic stimulus that borrowers might readily find other, less 'active' lenders.
"What will be most interesting is when all the [stimulus] starts to unwind," Bamberger says. "And there is not so much 'free money' and [lenders] can be more selective."
Investors deploying spare capital has squashed spreads between sectors, between high and low GHG emitters, and even ratings bands. That spells a good time for CIOs to organise and implement net zero plans, "because the cost of [shifting from] a high to a low emitter now is minimal and you do not really have to give up any financial considerations."
Another reason to act sooner rather than later is "the trillions of pounds, across all asset owners - governments, pension funds, insurers – moving towards climate-aware investing, and they're all looking at similar metrics."
Don't go near the edge
Of course, different investors have different trigger-points, and even though there is one common set of fundamental data, allocators may look at warming potential, or carbon intensity, absolute emissions or Climate value at risk. "If investors focus more towards one metric, then that will calculate their strategic asset allocation in a different way."
Bamberger does not see "a cliff-edge drop in certain assets" as investors react, and companies can take management actions on early signs. Just the same, AXA IM does not want its clients to be anywhere near an edge. "The laggard companies are the ones we want to avoid, and not to see that adverse price movement."
Government bonds have potential, at €2.5trn for directly-held alone, to be a significant influence on CIOs net zero plans – and their GHG emissions are measurable.
"You can see the carbon emissions of sovereigns relatively easily, and we do not assume they're net-zero. We can integrate them into our framework with the reporting on what they're producing."
Some countries - the UK, for instance, installing "some of the most ambitious carbon reduction targets" – allow investors to allocate "on the understanding they're on a zero-path to 2050". Carbon-heavy economies may keep CIOs awake at night.
For debt, Bamberger says, "the threat of divestment is lower, but there are still other aspects of driving change such as engagement, responding to consultations, and industry bodies.
"And if it works within your framework, you can replace a portion of government bonds with similar assets. You could tilt a portfolio towards quasi-sovereign or corporate bonds if a government does not meet its targets - that will send a strong signal on climate change."
He does note, however, that debt will maintain its place in the general account, not least for liability-matching abilities.
Insurance Asset Risk net-zero webinar series
Insurance Asset Risk is hosting a webinar series on insurers' net-zero journey, the challenges they face and the solutions they find.
Here is the full list of webinars, now open for registration:
Tuesday 21 Sep | First considerations before embarking on the Net-Zero journey
Tuesday 28 Sep | What is a Net-Zero investment portfolio?
Tuesday 5 October | Policy and regulatory response
Tuesday 12 October | Data and net zero
Wednesday 20 October | Rules of engagement for Net-Zero
Tuesday 26 October | The role of third parties