Our approach to climate risks in our credit assessment largely relates to the commercial viability of businesses or sovereign economic models as low carbon transition evolves at a different pace by industry and region according to stakeholder demand trends and development stage. Our security selection process is aligned with the concept of identifying issuers with lower carbon footprint (or future prospect for such), but with similar yields as others as a form of insurance if / when the market starts to demand more compensation for relatively large carbon footprints. For issuers with larger footprints, we require sufficient spread premium for the risk bearing carbon tax costs or future stranded costs (e.g. due to potential regulatory action). We evaluate the magnitude of a spread premium based on an issuers current business model, the effectiveness and feasibility of its future operational goals, and management’s commitment to those goals.
At PGIM Fixed Income our analysts perform in-depth bottom up fundamental research with a view towards long term sustainability. The Principles of the UN Global Compact and the UN Sustainable Development Goals are a part of the lens through which we analyse all issuers and industries. We measure all our companies (especially those who operate with higher carbon footprints) in terms of their long run business plans and we try to determine if those plans are credible and achievable. We measure their progress against their plans to determine if management is reliable. When we think about long run sustainability, we take into consideration the carbon footprint and whether or not a company’s plans will ensure that they are a viable enterprise for the long run.
Climate risks and opportunities are one of the topics we address during engagements. For example, engagement on climate related issues is often discussed within our electric utilities and energy sectors. Our utilities analysts monitor carbon emissions, fuel mix, power generation, carbon targets, renewable targets among other metrics disclosed by the companies as well as third party research from MSCI or Sustainalytics. To the extent they have questions or need updates they engage with the issuers directly.
Most of the European power generating companies we cover invest in renewable power and therefore have growth targets for their renewable units and CO2 reduction targets. These are topics of discussion every time we meet. We also discuss their green bond frameworks and issuance plans since many issue green bonds to fund these renewable development plans.
For the energy sector, we discuss their migration to cleaner fuel like gas instead of oil, processes they have in place to reduce gas flaring, as well as their recycling water policy in the fracking process since it is water intensive. We also engage with pipeline issuers regarding their integrity spending on pipelines to reduce Methane leakage.
We look at a range of environmental metrics when analysing auto suppliers and manufacturers. We engage regularly on electric vehicle strategies and carbon reduction programmes. We have modelled in detail European OEMs progress towards their fleet CO2 targets and use these models to challenge management assumptions on electric vehicle uptake, diesel vs petrol fuel mix and improvements in conventional engines. We have also engaged in the past on responsible procurement of minerals used in EV batteries, specifically cobalt which is often mined in the Congo with little to no regard for workers’ rights or environmental standards. We closely track the scope 1 and 2 emissions of all firms under our coverage and engage with firms on this, especially when their numbers are substantially different to peers.
Companies and countries adjust to climate risk based on the typically extended development pace within their specific environment by way of employing new energy sources, changing their product mix, adjusting their supply chains etc. As such a long-term quantitative assessment of these risks based on information we know today is not as valuable to us as our bottom up industry and issuer risk assessment and associated engagement.