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Institutional investors trying to decarbonize their portfolios may feel as though they’ve come to a crossroads with a confusing set of signposts. Paris-aligned? Net zero? Carbon neutral? Which is the right way to go? In this Green Bond Bulletin, we describe how we navigate these terms when we choose companies and projects in our green bond strategy, and how our approach meets the Paris agreement criteria and even goes a step further.
What do we mean when we say “Paris-aligned”?
When we talk about a Paris-aligned green bond portfolio, we mean one comprising bonds that finance projects needed to meet the Paris Agreement goals, or bonds issued by companies that are on track to meet their Paris agreement targets. What are those goals? The main goal as stated is to limit global warming compared with preindustrial levels to well below 2°C, while pursuing efforts to limit warming to 1.5°C, with no or low overshoot. However, we think that any target is going to be accompanied by overshoot. That is why we say simply “1.5°C” and do not use “well below 2°C”.
What is “net zero”?
Many companies and governments are planning for the 1.5°C goal by using a “net zero by 2050” target as a more ambitious proxy for the “Paris-aligned” goal. To meet this target, a business needs an ambitious 1.5°C aligned science-based target for scope 1, 2 and 3 emission[1] reductions across its full value chain. The key concept here is that ”net zero” mainly refers to emissions reductions; the remaining emissions can be offset only by certified carbon removal projects, such as afforestation.
What are the differences between “Paris-aligned”, “net zero” and “carbon neutral”? Why are they often used interchangeably?
All the concepts are related, but have different meanings, so it is important that we specify exactly what we mean when we use the terms. There is no set guidance on how to achieve carbon neutrality. The term essentially refers to a balance between all greenhouse gases – not just carbon dioxide – emitted into and removed from the atmosphere. External carbon offsets should be used to cover the remaining emissions only. However, in reality, this carbon neutrality goal can be formulated as an offsetting programme that covers the entirety of the company’s emissions. Some companies can use this to continue emitting as they had been, while making sure that their carbon remains ‘’neutral’’ on balance. Net zero is more ambitious in this sense. A net zero by 2050 target can be used to meet the 1.5°C scenario in the Paris agreement, and the net zero by 2070 can be used to meet the agreement’s 2°C scenario.
What approach does NN Investment Partners take?
NN IP employs a methodology developed by NN Group and derived from the Institutional Investors Group on Climate Change[2] (IIGCC)’s Net Zero Investment Framework (NZIF) of March 2021. The NZIF provides a set of recommended actions, metrics and methodologies that investors can use to decarbonize their investment portfolios, increase investment in climate solutions, and maximize their contribution to achieving global net zero global emissions by 2050. Using this methodology, we assess companies according to their actual or potential alignment with a net zero pathway on the basis of the following considerations:
- Ambition: A long-term 2050 goal consistent with achieving global net zero.
- Targets: Short- and medium-term emissions reduction targets.
- Emissions performance: Current direct emissions intensity performance.
- Emissions disclosure: Disclosure of scope 1, 2 and 3 emissions.
- Decarbonization Strategy: A quantified plan setting out the measures that will be deployed to deliver GHG targets, proportions of revenues that are green and where relevant increases in green revenues.
- Capital allocation alignment: Evidence that the company’s capital expenditures are consistent with achieving net zero emissions by 2050.
Based on these assessments we can place companies in the following categories:
- Achieving net zero: Current emissions intensity performance is at, or close to, net zero emissions with an investment plan or business model expected to continue to achieve that goal over time;
- Aligned to a net zero pathway: Performance over time is sufficiently in line with targets set;
- Aligning towards a net zero pathway: Company has set a short or medium-term target, disclosure of scope 1, 2 and material scope 3 emissions data; a plan relating to how the company will achieve these targets;
- Committed to aligning: Company has set a clear goal to achieve net zero emissions by 2050;
- Not aligned: All other companies.
Sources used to gather data for these categorization criteria include CA100+ Net-Zero Company Benchmark, Science Based Targets initiative, ISS scenario tool, Transition Pathway Initiative, CDP and analyst research.
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