New signposts for green finance

Every year, Al Gore’s 2006 film “An inconvenient truth”, resonates more loudly. Faced with the growing environmental and climate crisis, the world of finance has in recent years thrown itself headlong into integrating environment, social and governance (ESG) criteria. We have a greater need for direction than ever before.

In finance, there are a great many environmental ratings systems, as each data and service provider has its own, which in most cases is a relatively opaque proprietary model. Comparative studies generally reveal no clear correlation between them, nor with environmental impacts. As for the most popular metric, the carbon footprint, it produces figures which are useful for energy producers, but not for all other activities. Moreover, it is by nature blind to the environmental externalities, which affect ecosystem resilience, water, air quality and biodiversity. It is over simplistic. So what can be done?

Simplify (but not too much)

When dealing with this challenge, science and common sense are good guides. Over the decades, we have accumulated information on the environmental impacts of products and services through life cycle assessment and numerous independent studies. This wealth of information is widely available to everyone through third-party certified labels, even on the goods we buy, and under the watchful eye of NGOs. As a result, we know that our air travel sends our carbon footprint sky high, that it is better to cycle or take public transport, that it is better to eat lentils than steak, and so on. Common sense dictates that it should be possible to produce signposts to help investors distinguish green from grey or brown, and any of the “50 shades of green” called for by the very emblematic Bank of England governor, Mark Carney.

Our contribution to this approach is the NEC, or Net Environmental Contribution, which we have been developing since 2015. It aggregates the information available on the main environmental impacts of an economic activity in order to produce an indicator for measuring the extent to which a particular activity is aligned to the environmental transition, according to a single scale ranging from -100% to +100%.

At the upper end, +100% corresponds to activities with a high environmental impact that are aligned with the transition and with international objectives for the fight against climate change: reuse and recycling, a substantial share of renewable energies, organic vegetables, rail travel, cycling, public transport, car-pooling, well-insulated wooden houses, etc. A 0% measure corresponds to the average solutions offered by the global economy and to economic activities, which have a limited environmental impact, such as healthcare and communication. But at the lower end, -100% corresponds to activities with a high environmental impact: coal extraction and its use for energy, the use of oil sands and shale oil, intensive cattle farming, short-haul air travel, etc. Between the two are ranked the shades of green for positive NECs and shades of brown for negative NECs.

If it isn’t measured it can’t be managed

The NEC measures the net environmental contribution at a given point in time for a given economic activity, though in a more comprehensive way than a mere carbon footprint. It is a tool offering transparency and compliance. It has several applications, which investors in the financial sector will find particularly valuable: firstly, it assesses transition risks and opportunities, which is one of the basic tasks of an investor. It also has a reporting function, publishing the NECs of financial products and their reference indexes, specifically within the framework of the international recommendations of the TCFD (Taskforce for Climate-related Financial Disclosures) and Article 173 of France’s Energy Transition for Green Growth Act.

The NEC also provides a structure for dialogue with the businesses involved by challenging their strategic positioning and their trajectory. Lastly, the NEC also acts as a base for responsible investment strategies and impact investing, by sorting selected assets, as in the Sycomore Eco Solutions equity fund, which was the first in France to qualify for the Greenfin label, and which only admits businesses with completely positive NECs. At Sycomore AM, the NEC has been systematically integrated into both financial valuation and reporting.

Deciding to open co-operation to everyone

 

  • To develop our tool, alongside our partners Quantis and I Care & Consult, we took the decision in 2018 to open our initiative to all pioneers by launching the NEC Initiative. It is a pre-competitive platform freely accessible at www.nec-initiative.org since September 2019, allowing users to share and pool publication, R&D, instruction, training and maintenance. It is open to all financial players, institutions such as the OECD, academics, NGOs and businesses who want to establish their current and future NECs. The more compact the business model, the easier the NEC is to calculate, which makes it suitable to use for small and medium-sized enterprises (SMEs), which make up the lion’s share of the economy and are key players in the environmental transition. We believe that such a metric has no future if it is not transparent, global and open source, and that co-operation is no longer an option, but a necessity.

References

Arnault, P. et al. (2018), Is the transition risk material? Testing the Net Environmental Contribution™ metric on a universe of listed European equities, https://nec-initiative.org/publications-2/

Carney, M. (2019), Remarks given during the UN Secretary General’s Climate Action Summit 2019, https://www.bankofengland.co.uk/-/media/boe/files/speech/2019/remarks-given-during-the-un-secretary-generals-climate-actions-summit-2019-mark-carney.pdf

Hawley, J. (2017), ESG Ratings and Rankings: All over the Map. What Does it Mean?, https://www.truvaluelabs.com/wp-content/uploads/2017/12/ESG-Ratings-and-Rankings-All-Over-the-Map.pdf

Le reporting extra-financier des investisseurs : Le cadre réglementaire français, https://www.ecologique-solidaire.gouv.fr/reporting-extra-financier-des-investisseurs

Sustainable finance for investing in a low-carbon European electricity sector, http://www.ceem-dauphine.org/assets/dropbox/CEEM_Conference_Sustainable_Finance_in_the_Electricity_Sector%2C_Dauphine%2C_230919.pdf

Task force on climate-related financial disclosures, https://www.unepfi.org/climate-change/tcfd/

mate-change/tcfd/

©OECD Observer November 2019




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