Transformation of financial practices and flows

The coal value chain refers to the various activities involved in the coal mining process from extraction to marketing.

In addition to exclusionary strategies that aim to disinvest more or less gradually in the sector, the actor may decide to stop investing in new projects related to the coal chain. New projects are an area to be treated differently from other assets as they involve the financing of assets that have a life of more than 30 years. A coal mine planned today will continue to operate after 2050. This is the date often used to achieve "carbon neutrality". As a reminder, the use of carbon neutrality can only be made at the level of the planet, at the level of financial institutions and companies in general, we speak of a contribution to carbon neutrality, as ADEME underlines in its March 2021 note.

Engagement or exclusion strategies can be applied to one or more assets, or to the entire financial portfolio. In the case of management companies, this can be divided between open-ended funds, dedicated funds or mandates.

A management company chooses whether to apply its coal policy to its existing funds, to new funds or to all of its funds.

In order to comply with the Paris Agreement and maintain a trajectory aligned with a global warming limit of 1.5°, financial actors must divest from the coal sector with an exit timetable of 2030 in OECD countries and 2040 in the rest of the world. French asset management companies have therefore used these timetables to develop exit strategies and some have proposed more ambitious timetables than those recommended.

Thresholds are set and regularly reviewed to reach the exit target at the dates presented below.

Exclusion, or divestment, consists of both not investing in new coal projects, as well as stopping the financing already done in the sector according to thresholds and scope of activity defined by the actor.

Absolute thresholds are exclusion criteria that allow actors to make the transition away from coal. In a coal exclusion policy, a player stops doing business with companies whose coal-related activities represent more than X€ of turnover or which have a thermal coal power generation capacity of more than X GW. (X being the absolute threshold)

Relative thresholds are also exclusion criteria. In a coal exclusion policy, a player stops all activity in companies whose coal-related activities represent more than X% of their turnover or whose coal represents more than X% of their electricity generation capacity. (X being the relative threshold)

The coal exposure of the managed companies is calculated based on the amounts invested in coal mining companies and energy companies that produce electricity from coal, listed in the GCEL.. Funding to companies upstream or downstream of the value chain or that use coal-fired electricity is not included in this exposure calculation.

Shareholder engagement refers to the fact that an investor interacts with the companies it finances, whether with debt or equity, with the aim of influencing their practices in the sector concerned over the long term and/or improving their reporting on these issues. These requirements are formulated in the context of a structured approach that is followed over the long term.

Simply divesting from an oil and gas asset removes the investor's carbon liability, but does not reduce the absolute global carbon footprint.

Example: Economic agent A is an investor with an operating oil and gas plant, if it sells the plant to economic agent B it effectively reduces its exposure to coal in its portfolio, but the plant will continue to emit as much.

The aim of the commitment is to achieve a significant reduction in emissions by accompanying companies dependent on the oil and gas sector in an energy transition, thus enabling the closure of power plants. For example, if Agent A is able to replace the oil or gas plant with another low-carbon power plant, such as a hydroelectric plant, it will have reduced both its exposure and absolute emissions while maintaining access to electricity for local businesses and populations.

The oil and gas value chain refers to the various activities involved in the oil/gas process from extraction to marketing. For each type of hydrocarbon it is important to specify which part of the value chain is covered.

In addition to exclusionary strategies that aim to disinvest more or less gradually in the sector, the player may decide to stop investing in new projects related to the oil and gas sector chain of activity. Upstream expansion projects correspond to expansion in the exploration of new sources of oil and gas and in the production and exploitation of these sources. Midstream is the transportation, processing and storage of oil and gas.

Engagement or exclusion strategies can be applied to one or more assets, or to the entire financial portfolio. In the case of banks, the type of assets may be loans and credits, securities structuring (bonds or equities), dedicated financing, mergers and acquisitions or index-linked products.

In order to comply with the Paris Agreement and maintain a trajectory aligned with a global warming limit of 1.5°, financial actors must divest from the coal sector with an exit timetable of 2030 in OECD countries and 2040 in the rest of the world. French asset management companies have therefore used these timetables to develop exit strategies and some have proposed more ambitious timetables than those recommended.

Thresholds are set and regularly reviewed to reach the exit target at the dates presented below.

Exclusion (or divestment) consists of both not investing in new oil and gas projects, as well as stopping existing financing in the sector according to thresholds and scope of activity defined by the actor.

Absolute thresholds (in units) are exclusion criteria that allow actors to transition away from oil and gas. In an oil and gas exclusion policy, a player stops doing business with companies whose oil and gas activities represent more than X€ of turnover or who have an oil and gas production capacity of more than X mmboe. (X being the absolute threshold)

Relative (percentage) thresholds are also exclusion criteria. In an oil and gas exclusion policy, a player stops all activity in companies whose oil and gas activities represent more than X% of their turnover. ( X being the relative threshold)

Urgewald has developed, in the framework of the Global Oil and Gas Exit List, 6 thresholds for oil and gas, which cover both Upstream (production, expansion, exploration) and Midstream (expansion and development of LNG terminals) and which can be used as a benchmark for financial institutions' policies.

Methodologies have been developed to assess the compatibility of a loan portfolio with environmental objectives such as the Paris Agreement. Many methodologies exist with different approaches and different baseline scenarios, and there is currently no scientific or regulatory consensus to favour one. The calculation of the alignment of a loan portfolio makes it possible to assess whether the activities financed are following a rate of transformation, of decarbonisation, in relation to a reference scenario.

The calculation of the carbon intensity of a portfolio makes it possible to relate its CO2 emissions to its size.

The scientific and expert committee has issued recommendations for a good definition of an alignment strategy.

A management company may choose to include climate indicators in its responsible investment policy.

The two main indicators used to measure the impact of investment decisions are carbon intensity or emissions and implied temperature calculations.

The Net zero asset managers initiative is a programme launched in December 2019 under the United Nations Environment Programme Finance Initiative (UNEP-FI). By joining the alliance, signatory asset managers commit to aligning their investments and portfolios with net zero emissions targets by 2050.

The carbon footprint corresponds to the carbon emissions generated directly or indirectly by an entity. Generally, it is expressed in CO² equivalent, i.e. it presents the emissions of all the greenhouse gases of the entity expressed in CO². These emissions can be divided into 3 scopes.

• Scope 1 corresponds to direct emissions.
• Scope 2 corresponds to indirect emissions linked to energy consumption.
• Scope 3 covers other indirect emissions. For financial institutions in particular, it is important to divide this scope 3 into two parts.
  • The first part corresponds to the indirect operational emissions of financial institutions (waste emissions, employee travel, etc.). In the GHG protocol, this corresponds to scope 3.1 to 3.14.
  • The second part corresponds to the indirect financed emissions. This means calculating the scope 1, 2 and 3 of the companies financed by the financial institution up to the level of the share it finances. In the GHG protocol this corresponds to scope 3.15.

The majority of the emissions generated by a financial institution correspond to its financed indirect emissions.

This metric is used to measure the objective of contributing to carbon neutrality. As a reminder, carbon neutrality can only be used at the level of the planet; at the level of financial institutions and companies in general, we speak of a contribution to carbon neutrality, as ADEME points out in its March 2021 note. In order to monitor this contribution, the institution must calculate its carbon footprint on the one hand and its carbon compensation on the other, corresponding to the carbon sinks it will generate to compensate for greenhouse gas emissions.

The carbon intensity amounts to presenting the calculations of carbon emissions in relation to the entity's production. Depending on the methodology, some institutions or associations present this figure as the carbon footprint per euro invested, putting the money injected by the bank into the economy (through loans, investments and real estate) in the denominator.

An organisation's emissions reductions from its activities, products and/or services, where these reductions are achieved outside the scope of its operations, are referred to as 'avoided emissions'. In recent years, more and more companies are claiming avoided emissions to highlight their contributions to the global decarbonisation effort. Read the explanatory note of ACT, a Finance Climact project, on the subject.

The temperature calculations are based on the carbon emission calculations and climate strategies of the financial institutions, which allow the climate performance of an entity to be defined. One or more climate scenarios are then defined. The climate performance is then compared to these scenarios to give the temperature of the portfolio. These calculations can be performed on the whole portfolio or by sector.

Sector exposure determines how much investment / financing is present in a financial institution's stock based on the sector of activity of the issuer being financed.

Sustainable, applicable to all member countries. Launched at the initiative of the European Commission, the Taxonomy defines criteria by sector of activity to harmonise the definition of investments considered as sustainable.

To be considered environmentally sustainable, an activity must: i) meet one of the six objectives of the Taxonomy, ii) not cause collateral damage to one of the other five objectives (DNSH) and iii) comply with the minimum guarantees of social law, iv) respect the technical criteria and thresholds defined by activity.

In January 2022, the Taxonomy came into force for the first two objectives. The next four are to be implemented in early 2023.

Some management companies have decided to implement this calculation on a voluntary basis prior to its regulatory application.

Bonds are loans issued by companies on the financial markets. Extra-financial conditions can be attached to bonds when they are issued. This allows investors to choose to support companies and projects according to defined criteria, for example environmental or social.

The labelling of a fund allows a player to certify the management process and the selection of issuers in its portfolio according to the various criteria required by each label.

Labelling a fund is a guarantee of compliance with the specifications of each label and helps reassure clients in their selection of responsible products.

The Greenfin label allows investors to invest in funds that respect environmental criteria. One of the particularities of the Greenfin label is that it excludes funds that invest in fossil fuels or nuclear energy.

Through shareholder engagement, insurers can directly influence the ESG practices of the companies in which they hold shares or ensure that they are properly taken into account by management companies in the context of delegated management. This can be done by setting up a general engagement policy that can define the positions taken by the company during the various dialogues with the company, or more precisely by setting up a voting policy that can have a direct effect on the strategic choices of the companies whose shares are held.

A sector policy is a document through which a stakeholder commits to stop or reduce its activities with companies in controversial sectors for economic, social or governance reasons.

Each actor defines the criteria and thresholds of its policy for the sectors concerned.

The integration of environmental, social and governance criteria can be added to financial analysis.

Even if common methodologies are being developed in ESG analysis, the multiplicity of criteria, as well as their heterogeneity, makes it difficult to compare players.

The AMF doctrine (" Position-Recommandation AMF – DOC2020-03: Information to be provided by collective investments integrating extra-financial approaches"), proposes to structure and reinforce ESG approaches by means of a French classification that allows ESG products to be divided into three categories.

In order to present the integration of ESG criteria in the products of management companies, it was decided to present only the first category of assets. It covers products with a significant commitment to management.

This view makes it possible to observe the breakdown of ESG assets under management by dominant strategy.

The SFDR (Sustainable Finance Disclosure) is a European regulation that came into force in March 2021. It defines two categories of products.

Article 8 products correspond to products that promote environmental or social characteristics

Article 9 products aim at sustainable investment objectives.

The labelling of a fund allows a player to certify the management process and the selection of issuers in its portfolio according to the various criteria required by each label.

Labelling a fund guarantees compliance with the specifications of each label and reassures clients in their selection of responsible products.

Different French labels exist: they cover responsible investment products (label ISR, solidarity products (Finansol) or environmental products (Greenfin).

Bonds are loans issued by companies on the financial markets. Extra-financial conditions can be attached to bonds when they are issued. This allows investors to choose to support companies and projects according to defined criteria, for example environmental or social.

Impact finance is an investment or financing strategy that aims to accelerate the fair and sustainable transformation of the real economy, by providing evidence of its beneficial effects. (Read the definition by the Finance for Tomorrow Impact Group).

The implementation of common definitions and measurement methodologies should help structure these emerging investment methods.

Private actors must be part of a global effort, adopting a "systemic" perspective, to help respond to the challenges identified by citizens and public authorities, from the local to the international level. The Sustainable Development Goals are mentioned as an accepted and recognised reference framework and allow for the coverage of many topics. However, some actors prefer to use the Paris Agreement which provides a more specific framework on climate.

Using the SDGs as a framework, fund managers should select one or more of the 17 goals to frame and communicate the focus of their impact fund.

A fund can be oriented towards several Sustainable Development Goals at the same time.