Carbon footprint – TCFD Report 2020
Etica Impatto Clima

This content is an extract of the Task Force on Climate-related Financial Disclosures (TCFD[1]) aligned Report released by the company ISS ESG. It details results for the analysis conducted, for the first year, on the Fund Etica Impatto Clima (Linea Futuri Responsabli) which investment strategy is focused on climate change related topics, among others environmental considerations.

All asset classes have been analyzed accordingly to the TCFD recommendations: Portfolio of Equity plus Corporate Bonds together, and Portfolio of Sovereign bonds.

The document discloses results achieved at the year-end 2019 in the four areas of interests in line with TCFD recommendations: Governance, Strategy, Risk Management, Metrics and targets.

The related carbon metrics used in the Equity and Corporate Bonds analysis are the following ones (please refer to Appendix for more details):

• Relative Carbon Footprint: a normalised measure, defined as the total carbon emissions of the Portfolio per million EUR invested. Any reference to relative carbon metrics in the Analysis refers to tCO₂e / EUR million Invested;
• The Weighted Average Carbon Intensity (WACI): is the metric explicitly recommended by the TCFD for asset managers. The WACI allocates Scope 1 & 2 GHG emissions based on Portfolio weights. and has among its positive aspects the fact that is simple to calculate and easy to communicate to investors and, most notably, it can be applied across asset classes as it does not rely on the ownership approach. Any reference to carbon intensity in the Analysis refers to tCO₂e / EUR million Revenue;

The Data Analysis goes beyond the sole carbon footprint assessment by providing various metrics used to assess climate-related risks and opportunities in forward-looking perspectives. Those metrics include^[2]: carbon risk rating, scenario analysis, transitional climate risk and physical risk exposure.

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GOVERNANCE

The Board of Directors (hereinafter the “BoD”) is Etica Sgr’s decision-making body and is final accountable for climate-related matters, which are incorporated into Etica Sgr’s overall investment strategy focused on issuers that adopt good practices from an ESG viewpoint. The BoD oversees climate risks and opportunities via three main channels:

1. the supervision of integration of climate-related considerations into the investment process by defining the final Countries and Companies investible universe;
2. the definition of climate-related issues for engagement in the form of dialogue with issuers and/or the exercise of voting and other shareholders’ rights;
3. the supervision of key initiatives in the climate change domain such as the annual carbon footprint of investments.

As the first Italian asset management company to have signed the Montreal Carbon Pledge in 2015, Etica Sgr is committed to measuring and reporting on the carbon footprint of its investments in line with the TCFD on an annual basis. Every year, the BoD of Etica Sgr oversees the results of the investment carbon footprint analysis with strategic objectives, such as:

• Positioning the Portfolio towards more sustainable companies in relation to environmental and climate change strategies (i.e. companies committed to keep global warming well below under 2°C in line with the Paris Agreement);
• Collecting climate-related data (e.g. GHG emissions reduction targets) that can be used as a basis for engagement with companies in the equity Portfolio.

STRATEGY

The investment strategy of the fund Etica Impatto Clima focuses on climate change and the selection of securities is implemented through an assessment of the climate profile of the issuers. Corporate issuers are excluded if involved in thermal coal mining and/or the revenue share from fossil fuel is larger than 33% of the total revenue and/or the revenue share from shale oil or oil sands is larger than 10% of the total revenue and/or the oil shale reserves are larger than 33% of the total revenue. Moreover, several industries are excluded also because of their climate impact. Those industries are oil exploration and production, integrated oil, oil and gas services and equipment, oil transportation, coal and coal mining, precious metal and other metal mining, mining services. Several climate-linked factors are included in the issuer-specific negative screening based on controversies (e.g. pollution, environmental and climate impact of value chain). It is also important to note that the Etica Impatto Clima fund does not invest in the Financial sector, but green bonds issued by financial institutions can be purchased after a careful analysis of the bond’s Prospectus by the ESG Analysis and Research Area.

RISK MANAGEMENT

The Etica Impatto Clima fund incorporate considerations on lower-carbon energy:

• By excluding the fossil fuel industry, for the majority, from the investible universe;
• By including criteria related to renewable energy in the sustainability assessment of issuers (e.g. revenue share from renewable energy power generation and/or from the production of turnkey solutions for the renewable energy industry etc.).

As a thematic fund focused on climate change, the Etica Impatto Clima fund includes additional criteria on fossil fuel involvement and lower-carbon energy. For instance, issuers that derive more than a given share of their revenue from certain fossil fuel activities are excluded. At the same time, green bonds, whose proceeds may be used to finance projects targeting renewable energy, energy efficiency, circular economy, sustainable water management, green buildings, and whose prospectus is in line with the Green Bond Principles outlined by the International Capital Market Association (ICMA)[3], can be purchased.

Etica Sgr’s consideration for lower-carbon energy is also reflected in its engagement activities where, most notably, disclosure on energy use from renewable energy sources is one of the long-term strategic issues Etica Sgr aims to discuss and to vote in favour of in related shareholder resolutions, and it is one of the topics for shorter-term dialogue with companies.

ESG considerations are in fact integrated into Etica Sgr’s risk management through the proprietary methodology “Rischio ESG” (i.e. ESG Risk). “Rischio ESG” is built on an ESG score that inter alia includes the climate-related indicators.

Rischio ESG is a statistic and predictive tool that calculates the risk arising from ESG-related issues that impact the performance of stocks in a mutual fund. Every security in Etica Sgr’s Portfolio holdings is assigned an ESG score. This score is higher for the securities of corporate and sovereign issuers that have a better ESG profile, and securities are then categorised in terms of classes of Rischio ESG. Considering this distribution, the ESG Risk is lower when the best performing securities (in ESG terms) are concentrated in the classes with a higher score.

Etica Sgr has measured a strong statistical correlation between Rischio ESG and the traditional financial risk represented by non-diversified Value-at-Risk (VaR), which consists in the potential loss on an investee in a given timeframe. This statistical correlation applies to both sectors and countries. A fund with a higher VaR also has a higher Rischio ESG and vice versa. Therefore, Etica Sgr approach to the risk/return analysis of a Portfolio can be regarded as holistic since it includes traditional as well as non-financial (ESG) variables.

Regarding the metric of VaR_ESG, for the portfolios belonging to the Linea Valori Responsabili, in order to have a coherent and complete integration between financial risk and ESG risk, Etica Sgr calculates an expected loss, affected by both the risk dimensions, i.e. a VaR_ESG, which represents a more prudential risk measure. Etica Sgr is looking for extending this metrics also to the Fund Etica Impatto Clima, so that is possible to predict portfolio drawdowns than simple traditional VaR (even if calculated with skewness, kurtosis and volatility jumps).

METRICS AND TARGETS

Climate change is regarded as a systemic issue with a focus on climate mitigation (GHG emission reduction targets and SBTs, disclosure and TCFD recommendations), climate adaptation, just transition and green bonds due diligence.

“The results of the TCFD Analysis of the Fund confirm Etica Sgr’s effort over the past 20 years to invest in businesses and countries adopting virtuous practices from a climate prospective. Many of the recently observed climate changes are unprecedented and this is why we are reinforcing our commitment by applying TCFD recommendation and taking more ambitious steps.”

Mr. Luca Mattiazzi – Etica Sgr’s General Manager

“The results seem to confirm Etica Sgr’s effort in order to elaborate new risk metrics, which consider both financial and ESG spheres. Indeed, our risk management aim to control the risk in a holistic perspective, i.e. following a more complete approach than traditional one, as the final goal is to reduce the Portfolio’s drawdowns”.

Mr. Paolo Capelli– Etica Sgr’s Head of Risk Management

^{[1] Launched after the 2015 Paris Agreement by the Financial Stability Board (FSB), the Task Force on Climate-related Financial Disclosure (TCFD – https://www.fsb-tcfd.org/) considers climate transparency as a crucial factor for the stability of financial markets. The objective of the TCFD is therefore to improve climate transparency in financial markets through recommendations on disclosure. These recommendations provide a “consistent framework that improves the ease of both producing and using climate-related financial disclosures”. The TCFD aims to create a unique standard for both corporate and investment disclosure, understanding that local regulatory frameworks may require different compliance levels.}

^{[2] The metrics mentioned in the list refer to equity and corporate bonds portfolios. For sovereign bonds portfolios the risk-related metrics are limited to physical risk exposure of countries.}

^{[3] https://www.icmagroup.org/green-social-and-sustainability-bonds/green-bond-principles-gbp/}

^{[4] The benchmark used in the Data Analysis is ISHARES MSCI ACWI ETF as a proxy of the MSCI World Net Total Return (in Euro). This benchmark is applied to the Equity Portfolio and to the Corporate Bonds Portfolio of both asset classes for the fund Etica Impatto Clima.}

^{[5] CRR is based on a scale of 0 (very poor performance) to 100 (excellent performance) and allows to categorise companies according to their carbon-related performance into four groups: Climate Laggards, Climate Underperformers, Climate Performers, and Climate Leaders. For more details, please refer to Appendix.}

^{[6] The GHG emission pathway and carbon budget of the Portfolio are the result of the aggregation of company-level data. The GHG emission trajectories at the company-level include both historical (i) and forward-looking indicators (ii) to project the emission intensity profile of a company from now until year 2050:}

• ^{The scenario analysis utilises 5 years of the ISS ESG historical, high-quality emission intensity data to create a trend for each company included in the analysis.}
• ^{The historical trend is then combined with forward looking emission reduction commitments and targets to estimate future emissions.}

^{For a specific company to be in line with either the 2°C, 4°C and 6°C climate scenario, the allocated carbon budget per year need to be higher than the estimated direct emissions for the same company. The emissions and carbon budget at the company-level are then aggregated to get a Portfolio 2°C, 4°C and 6°C scenario alignment.}

^{For more details, please refer to the Appendix.}

^{[7] Further details on the methodology are reported in the Appendix.}

^{[8] Further details on the methodology are reported in the Appendix.}

^{[9] For the Sovereign bonds portfolios two benchmarks are used: AMUNDI INDEX JPM EMU GOVIES ETF as a proxy of the benchmark JP Morgan EMU and the index Invesco Euro Government Bonds 1 – 3 Year UCITS ETF EUR Inav as a proxy of the benchmark ICE BofAML Euro Treasury Bill Index.}

^{[10] In the Sovereign Bonds section of this report, Figure 7 displays the “Sovereign Emissions Exposure” of the Portfolio taking Scope 1 & 2 emissions into account. The “Relative Carbon Footprint” is a normalised measure, defined as the total carbon emissions of the Portfolio per million EUR invested. “The Weighted Average Carbon Intensity” differs from the one calculated for non-sovereign portfolios because the GDP of the country is used instead of the revenue of the company.}

^{[11] Adjusted Enterprise Value is calculated as Total Market Cap + Total Debt. For non-listed entities where MCap is not available, total debt only is used.}

^{[12] For sovereign bonds the revenue is replaced by the GDP of the country.}

^{[13] The PCAF is a coalition of twelve Dutch financial institutions launched via the Dutch Carbon Pledge at the COP-21 Summit in Paris and is led by ASN Bank. The objective of this coalition is to develop a standard that enables financial institutions to set targets for carbon emissions and measure the extent to which these targets are achieved, which was presented in a December 2017 report (http://carbonaccountingfinancials.com/).}

^{[14] Data availability limits the implementation of the exact methodology in practice. Data scarcity consists of (i) lack of data based on the same sector classifications for emissions and for expenditure, resulting in inaccuracies when matching the two data sets; and (ii) lack of sector-based expenditure data for many countries, particularly developing countries.}