In its September Quarterly Review, the Bank of International Settlements (BIS) published a much-needed article that analysed the impact of fighting the climate crisis at the firm-level from corporate projects funded by green bonds[i]. In their own words the authors conclude, “…green bond projects have not necessarily translated into comparatively low or falling carbon emission at the firm level.” As a complement to the existing suite of labels for green bonds, the authors suggest that a firm-level, green rating system predicated on carbon emission intensity would incentivise companies to decarbonise in alignment with the Paris climate goals. Considering the rapid expansion of the green bond market, its conclusions are, to put it mildly, controversial.
Decarbonisation of the economy is security-agnostic
While we are not convinced about some aspects of the paper, we are in unequivocal agreement that climate assessments at the security level are insufficient to assess companies’ decarbonisation pathways at the firm level. Moreover, as we have said in the past, we most certainly agree with the tone of the paper: green bond-financed projects are necessary to solve the climate crisis, but not sufficient. While we encourage further development of the green bond market, the decarbonisation of the economy cannot happen unless companies find ways to continue to create economic value whilst simultaneously decarbonising in alignment with the goals of Paris. As such, we believe the authors are correct to shift the focus of the corporate world’s contribution in the fight in the climate crisis to corporate activities in general and away from projects specifically.
Scoring a firm’s carbon-intensity: An possible input, but not a panacea
The firm-level, green-rating system that the authors propose—the distribution of companies in deciles predicated on carbon intensity–has certain attractive elements to it as well as some challenges.
If employed, this rating should only serve as one contribution to the investment process and not be relied upon in its entirety as an ESG assessment. The creation of the score is based on slow-moving, historical data. Yet we want to invest in a company’s future, not in its past. As such, its ex-post character must be placed in the context of a more complete ex-ante assessment. For example, a company now managing the physical and transition risks of climate change through M&A, capital expenditures or technological advances could score poorly given its green credentials would be based on historic data. However, assuming we can find value in their debt securities, it is in these such companies we would choose to invest and with whom we would want to engage.
While we agree with the authors on the benefits a standardised scoring system would bring, calculating emissions intensity for comparative purposes can be more easily done now than in the past. We have seen rapid improvements in environmental disclosures and growth in data providers (e.g, Trucost). In addition, Carbon Disclosure Project (CDP) scores offer a comparable level of insight to the scores that the authors seek.
We are very encouraged by the principal message of this paper: We must find incentives to accelerate the decarbonisation of economic activities if we are to reach the goals of Paris. In so doing, we must focus on changing behaviour at the firm level as well as the green-project level.