By Hamlin Lovell, NordicInvestor
Lars Erik Mangset is the Chief Advisor, Climate Change for KLP, the largest occupational pension fund in Norway, which serves workers in municipalities and public health. Mangset has had an eclectic career. His background is in applied science and he has worked as a consultant and economist in various industries, including conservation charity WWF, before joining the asset management and asset owner industry, working within the economics and finance division of KLP, which includes strategic asset allocation, risk and compliance.
Mangset has a broad mandate: “my key priorities are firstly, climate stewardship within KLP, which is a strategic ambition to have a positive and impact on emissions and financial returns, in line with the Paris agreement. Secondly, considering financial risks from physical and transition climate risk. Thirdly, increasing green investments and maintaining quality assurance for them. And fourthly, data in general on sustainability and financial risks”.
Exclusions
KLP follows the Norges Bank exclusion list, but can potentially exclude more companies due to concerns about climate change impact because it has set a lower thresholds for two activities in terms of production. The Norges Bank threshold for coal mining and coal power generation is 30%, whereas KLP has set a threshold of 5%. In addition, KLP has also sat a threshold on 5% revenue from tar sand extraction, which results in a more stringent exclusion criteria considering the most carbon intensive forms of fossil energy extraction and production. (Some Danish pension funds have also set a 5% threshold).
KLP also has behavioural exclusions, based on violation of fundamental norms, which could include mineral extraction in disputed territories such as Western Sahara. “We are very concerned about international norms and practices, and we construct a norms-based framework,” says Mangset.
Engagement
But KLP wants to encourage positive change. “However, we would prefer to proactively engage, in order to avoid exclusions. We might develop a dialogue with companies based on unreasonable risk taking, and we could escalate the process if necessary. We engage both directly, typically with companies in Norway, and also in collaboration with other investors, typically for companies outside Norway. We engage collaboratively through groups such as Climate Action 100 Plus, the portfolio decarbonization initiative, and UNPRI working groups, such as one covering deforestation in the Amazon and palm oil in South East Asia,” he continues.
Expanding climate reporting coverage
“We have been reporting emissions for at least 10 years, based on TCFD indicators for the past 5 years. Most emissions come from our investments, rather than our own operations. We started reporting for listed equities and bonds and real estate and we are currently working to expand coverage to unlisted assets including infrastructure”.
“For sovereign debt, we have also started looking at countries’ emissions and Paris agreement pledges, but have not yet published this”.
Data challenges
“In listed equities our ESG data supplier MSCI has expanded its scope 3 data from upstream emissions to also include downstream emissions. There can be gaps in public data for unlisted bonds, but service providers can help us to fill the gaps. We started reporting scope 1 and scope 2 emissions on our real estate portfolio, and last year acquired a database to start reporting scope 3 emissions. A local company, Asplan Viak, is providing comprehensive life cycle analysis, which is different for real estate compared with listed equities”.
“Even in renewable energy where emissions could be near zero, we are still keen to get data on any emissions coming from operations and maintenance activity. The reason for this is that we are establishing a Paris-alignment framework which require us to establish an emission inventory for all our investment. While scope 1 emission data from renewable energy is not the highest quality data, it is a good start given the complexity”.
Reporting changes
As well as expanding the scope of coverage, KLP has been refining the way in which emissions are measured and allocated. “Historically we only looked at equities, but now we consider the whole capital structure of the company, including equity, debt and cash, and allocate on the basis of overall enterprise value. This is also in line with the development we see in upcoming EU regulation, such as the reporting directive and EU rules on benchmarking”.
“We are measuring carbon emissions both relative to millions of revenues, and relative to physical volumes of output, such as tonnes of steel or kilowatt hours of electricity”.
Forward looking climate metrics
Of course, most emissions data is backward looking, and the TCFD has a consultation on forward looking measures. “A forward-looking approach is important because even some of the heaviest emitters, such as cement or oil and gas companies, may have credible transition plans. We could look at their capital spending plans to assess how their future production mix could follow particular emissions trajectories. While KLP support the 1,5 degree trajectory, it is not always possible to find industry sector emission pathways for this global warming target. Where it is not, we apply to emission trajectory with the highest ambition. For instance for oil and gas a 2 degree trajectory is used”.
“We are also converting climate targets into a forward-looking temperature score. There are 8 or 9 different methodologies that can be used. We have chosen the SBTI (Science Based Targets Initiative) one as it aligns with the Carbon Disclosure Project 1.5 degree Paris framework. We have broadly chosen the IPCC 1.5 degree report because it is a fairly standard trajectory of reducing emissions by 7% out to 2030, and zero by 2050, and it also fits in with the EU sustainable finance framework. However, we do not follow every single requirement of the SBTI, rather we cherry pick from SBTI and other provisions and standards to identify our preferred parts of it”
The objective is for the overall portfolio be aligned with the Paris target, based on weighted average temperature scores as well as a suit of other climate related metrics. Some companies could be above the threshold and others might be below it.
Value at risk is also in a sense a forward-looking measure, in that it stress tests for future scenarios in terms of stranded assets, physical risks and so on. “KLP calculated Climate Value at Risk (VaR) three years ago for all of its listed equities and bonds, in collaboration with several other Norwegian institutional investors and Aviva from the UK. We did this just after the G20 endorsed the TCFD. This was a very good learning process but there are uncertainties about how to measure physical and transition climate risks used to calculate VaR”.
Defining net zero and offsets
Indeed, there are also different ways to define the net zero goal.
“There are also different opinions over how to define net zero. If the metric is abused by “greenwashers”, it can lose credibility. We expect the SBTI could help to forge a consensus over the best ways to define net zero”.
Offsetting to hit a headline target may not be a defensible approach. “In our view, offsetting is contentious. We do not accept buying carbon credits as a way to achieve net zero targets. Companies need to actually decarbonize, through methods such as natural capture or carbon or activities with negative emissions. For our internal activities, we do carry out active forest planting but describe this as “compensating” rather than “offsetting” emissions”.
Regulatory oversight
Regulators will also help to define the acceptable measures and approaches. “The whole agenda is increasingly becoming a compliance issue since the Norwegian regulator considers climate risk. We have some analytical projects underway this year to figure out how to integrate climate risk into strategies and risk assessments across the organization. This will lead to some kind of climate VaR, based on a mix of top-down and bottom-up modelling. The top down modelling will look at economic shocks and the bottom up modelling will consider individual companies’ data measurement and climate risk profiles”.
Nordic and EU ESG Product Labelling
The Nordic region is relatively unusual in having developed its own eco-labels many years before the EU Sustainable Finance rules that are being phased in between 2021 and 2023. KLP was the first firm in Norway to launch an eco-labelled funds, using the Nordic Swan Ecolabel, which is also used for consumer products such as soaps, washing powder, and toilet paper. It is described as “the official ecolabel of the Nordic countries”.
“KLP has five new funds, covering equities and bonds, including an ecolabel fund which tries to mimic an index fund – it has no fossil fuels or weapons, and changes weights based on ESG tilts: automatically excluding the bottom one third of companies and investing more in the top third. This strategy has performed very well with a low tracking error, below 1%, in a positive direction”.
Since the EU has not yet issued all of its “regulatory technical standards” it is probably too early to predict if the Nordic labels converge with, or diverge from, the EU ones. KLP is researching whether the Nordic Swan Ecolabel could be aligned with the EU Sustainable Finance agenda, and is not sure if it fits into the SFDR and EU taxonomy yet. “This is a fairly detailed process. We do expect some harmonization, but are not yet sure if this will be complete,” says Mangset.
Environmental factors beyond climate
Climate grabs the most headlines, but there are plenty of other important environmental issues. “We cannot only focus on emissions, green technology and green bonds that enable transition financing. We also need to be clear on companies’ land use, deforestation and biodiversity. In 2020 we issued a report with Storebrand and the rainforest alliance, looking especially at data on deforestation. This will be an increasingly important issue in future”.
Impact Investing:
Impact investing can also cover a variety of environmental and social goals. “We already have 8% in renewable energy globally, including hydro and wind, in Norway and overseas in developed markets and emerging markets. In Norway we are among few private owners of hydro power and wind power companies. We have also got involved in development financing, in collaboration with public partners and other institutions, to channel finance to more challenging markets such as sub-Saharan Africa. Here, blended finance can be useful with public entities providing first loss capital so that other investors can take less risk”.
“Elsewhere in environmental impact investments we are invested in forestry that meets the Forestry Stewardship Council standards”.
“Beyond environmental impact, we are exposed to microfinance, and banks in developing countries”.
Climate risk and financial responsibility
Mangset sums up by underscoring that ESG responsibility has to be combined with financial responsibility to deliver investment returns to savers. “We must distinguish climate risk from stewardship. There are big ambitions and society is not moving fast enough – but we must also balance the 1.5 degree goal with the primary goal of ensuring profitable, cost effective management of pensions”.
