We lead with “E”. ESG has become a household acronym, evidencing the view that sustainable businesses are better businesses. But we still have a long way to go in further developing the concepts. ESG, sustainability, Sustainable Development Goals (the “SDGs”), green, impact are often terms used interchangeably. That should not be the case. We need to be precise in what we mean. We think all investment products with a sustainable goal need to have a truly clear purpose and a specific tangible metric as a proxy for impact.
iClima’s vision is to use CO2 equivalent avoidance as a key metric for decarbonization impact. CO2 avoidance is part of the GHG emissions reduction strategy. CO2 is the common unit for measuring global warming impact and GHG impact is measured as CO2 equivalent (the amount of CO2 that would have the equivalent global warming impact).
The global goal is to reach net-zero by 2050 to limit the rise of global temperatures by 1.5 to 2 degrees Celsius above pre-industrial levels. Data on total emissions in 2019 helps us know if we are on target in terms of the CO2 reduction needed. The CO2 avoidance from 2019 gives us more of an indicator of a company’s potential impact today. We believe we need to track our progress on a yearly basis, as you check your balance when going on a diet.
Viewing the global emissions problem from an emissions reduction standpoint is only part of the solution. As advocated by the Avoided Emission Framework, a shift to low-carbon will require “new approaches driven by companies delivering innovative and disruptive solutions that will bring significant changes in societal behaviour and overall reduction in emissions”. It will also require new robust ways to measure climate impact which is not possible with the static and backward-looking carbon footprint methodology that the majority are using today (Vontobel, 2018).
This is the gap in the market that iClima Earth aims to fill, by taking a solution-oriented route to navigate investors towards the enablers of the transition to a net zero emissions world. iClima focuses on the “climate champions”, the companies that provide real solutions to climate change and have a significant impact measured by GHG emissions avoided as a result of their use.
A fundamental shift can happen if more capital flows into the segments that support the transition to a low carbon economy, accelerating the uptake of existing individual and system solutions, and encouraging the development of new solutions. We believe the assessment of GHG emissions avoidance (CO2e avoidance) will provide a quantitative measurement of the climate impact, or decarbonisation potential, of the “climate champion” companies.
iClima’s approach allows a shift in narrative, helping investors to identify who is “doing more good” rather than who is “doing less bad”. We believe that very relevant investment products can be built by focusing on the companies enabling CO2e avoidance through their products.
We disclose, open source, our ranges of CO2e avoidance per company, but not the exact potential CO2e avoidance. There are complex assumptions that need to be made when calculating CO2 avoidance. It is in nature a conceptual exercise as you compare a green solution to what would have happened otherwise (e.g., a EV car displacing an internal combustion engine vehicle). We think it is extremely important that CO2e avoidance becomes a key metric used by all stakeholders and we will be sharing the raw data with research institutions as we want to contribute to the improvement of these figures. As the saying goes, if it gets measured it gets managed.
At iClima, we are attempting to quantify the potential CO2 avoided by each company in our universe. This differs slightly from Project Drawdown (where they estimate avoided emissions for whole industries out into the future). It is for companies, per year.
Environment, Social & Governance indicators are a core part of responsible investment. However, ESG methodologies are not standardised. We applaud the idea of holding companies accountable for higher sustainable standards, but it will take a long time for consensus to be created around the different rating systems. The lack of a unified approach can make it difficult for an investor to discern an impactful investment. We think that focusing on CO2e avoidance is a robust approach that has not yet been done. You end up with a very different portfolio if you focus on companies that are scoring high on ESG (whatever the methodology to grade them on E, S & G) or if you actually focus on the companies that can enable the decarbonisation of the planet, quantifying that by calculating CO2 avoidance.
It is imperative that companies reduce Scope 1 and 2, but also Scope 3. Many companies have focused on Scope 1 and Scope 2 emission reducing activities, and that has been a phenomenal development. By the same token, many companies have started to report emission figures under Scope 1 and Scope 2. That has set us on the right path towards climate action reporting. However, we need further development in terms of Scope 3 activities as a next step towards a holistic climate response.
As a reminder, Scope 1 and Scope 2 measure emissions from a company’s operation and energy use. Scope 3 emissions cover the gap – all other emissions that are not directly attributed to a company’s process or energy consumption. Scope 3 encompasses 15 activity types, including supply chain emissions as well as emissions from the use of the sold products (for example the diesel used by the ICE vehicles that Shell sells at their petrol stations).
We think that equity benchmarks and ETFs that focus only on companies reporting reduced Scope 1 & Scope 2 emissions are not necessarily impactful. Why? Because they are missing Scope 3. Moreover, if you build a portfolio with companies that are reducing their carbon footprint you are gaining exposure to shares of companies doing “less harm”.
Companies with high ESG scores and/or lowering emissions are in theory more sustainable, better corporate citizens, likely to obtain lower cost of capital. We applaud that, but we are proposing a different focus: to focus on the companies that directly enable the decarbonisation of the planet.
We followed the guidelines of Project Drawdown and triangulated their mapping of climate change solutions with the recommended list of economic activities and technical screening criteria prepared by the Technical expert group on sustainable finance (supported by Principles for Responsible Investment (PRI), of which we are a signatory). The Taxonomy identifies activities that are environmentally sustainable. We took the liberty of adding solutions that we deem material and not part of Drawdown and/or PRI’s recommendations, like Green Financing. It is important to highlight that with the current information disclosed by companies it can be quite challenging to follow the guidelines of the Taxonomy.
Project Drawdown’s top-down approach identifies key sectors and technologies that could help reduce GHG emissions and avoid catastrophic climate change. They describe 100 existing solutions that can bring the world to net zero by 2050. It is a solid roadmap and reference to how to get to net zero. We attempted to bring that approach to a more granular level: companies that are active in these 100 spaces, quantifying their contribution on a yearly basis.
The expression from the Californian Gold Rush conveys the idea that it is extremely hard to know who will strike gold, but one can make a more certain profit by selling shovels. We do not know who will strike gold (in our case what companies can really reduce emissions in a material way or what companies indeed command stellar ESG scores), but if we focus on the companies selling shovels (enabling CO2 avoidance through their products and services) we can gain exposure to the companies more likely to benefit from the transition to a low carbon economy.
We believe that our approach of looking at the companies that can enable the transition to a low carbon economy is a very robust one.
iClima’s co-founders are finance professionals with decades of experience in equity capital markets, project financing and infrastructure investments. They all went to the Wharton School in the USA and currently live in London, UK. The team directly working on the sustainability analysis all hold a MSc in Climate Change, Management & Finance from Imperial College, also in London. The work has been done under the guidance of our Climate Change advisor that has two decades of experience in carbon market. Please check our LinkedIn Company Page for more information on the team.