Sustainable Finance Report #2

Article 5:

Climate risk, financial stability and the transformation of China

The potential investment implications

At the end of last year 195 countries covering 96% of global emissions agreed to take action to tackle climate change. This marks a significant improvement in the plans and

measures national governments are adopting to curb greenhouse gas emissions since the last climate agreement was signed in Kyoto 18 years ago, which covered just 11% of global emissions.

The implementation of these plans will aim to shape the approximately USD 90 trillion that is likely to be invested in infrastructure in the world’s urban, land use and energy systems. According to the New Climate Economy report, the nature of these investments will shape future patterns of growth, productivity, living standards and global emissions, as well as representing new business opportunities for companies
and investors.

The path towards emission reduction has been made somewhat easier over the past decade by the decoupling of economic growth in the OECD to greenhouse gas emissions, since historically these two factors have been positively correlated. This decoupling has been confirmed recently by an International Energy Agency study that showed that global emissions stagnated last year while global GDP rose by 3.4%.

However, the history of non-OECD CO2 emissions is less encouraging. We find that since 2000 global emissions from the consumption of energy have risen by approximately 40%, of which just over a half is attributable to China, Figure 1. Even here, there is room for optimism since China is now on a path of transforming its industrial base and energy mix. 

However, estimates suggest that current individual country pledges still imply global temperatures rising by 2.7 °C compared to preindustrial levels by the end of the century. As a result, this goes beyond the 2 °C level, which is widely believed to pose risks to the global economy and hence asset price valuations.

These risks and specifically the linkages between climate change and financial stability have been brought to the forefront of investors’ minds recently following the “Breaking the Tragedy of the Horizon” speech given by the Governor of the Bank of England to Lloyds of London at the end of September. 

An examination of Munich Re data reveals not only that the number of weather-related natural disasters has trebled over the past three decades, but that inflation-adjusted losses have increased fourfold over the same period, Figures 2 and 3.
While the insurance industry has been able to manage these risks, other sectors of the economy are less prepared, particularly in the event of legislation to tackle climate change that encourages the transition to a low-carbon economy.

Article 4:

A guide to benchmark sustainable equity indexes

Investor demand has led to a growing number of sustainable equity indexes to be launched in the marketplace. These deploy various selection techniques from exclusionary to best-in-class to thematic approaches. The major providers across the ESG index marketplace are MSCI, FTSE and S&P Dow Jones. 

In September 2010, the FTSE KLD Indexes transitioned into the MSCI ESG Indexes. The MSCI KLD Indexes, such as the FTSE KLD 400 Social Index, were originally launched in May 1990 and so MSCI can claim to provide the longest track record of sustainable indexes in the marketplace. Among their various indexes, the MSCI World SRI is the benchmark index.

In 2001, the FTSE created the family of FTSE4Good Indexes. These not only pursue similar investment styles as the DJSI family, but also included indexes with specific theme or impact investment solutions. Within the FTSE family, the FTSE4Good Global Index is the benchmark index. 

S&P Dow Jones launched a suite of sustainable equity index products in 1999. Among the DJSI family, the Dow Jones Sustainability World Index is the benchmark. This has been complemented by a range of positive exclusion and best-inclass index strategies.

Within the Deutsche Asset Management ESG family, the CROCI World ESG strategy was one of the first to be launched. This is a 75-stock, region-neutral, globally developed market equity strategy and has been run on a live basis since July
2014. Many of Deutsche Asset Management’s ESG strategies deploy the ESG Engine filter to ensure compliance with leading standards for environmental, social and governance criteria. 

In this article, we examine the sustainable index providers of MSCI, FTSE and S&P Dow Jones. In future reports we will expand our coverage to include other providers such as Stoxx/Deutsche Börse. For the indexes under investigation, these can be classified according to three investment styles, which are outlined on the next page and in Figure 1.