Senior Investment Specialist – Public Markets
This new guidance outlines how investors seeking to maximise real economy emissions reductions can consider the emissions profile of derivatives, short-selling strategies and hedge fund holdings. It offers reporting guidance, alternatives where needed, and a clear position on long and short ‘netting’.
It aims to clarify what information investors need from the managers who use these instruments, to help support clear and consistent net zero reporting. This should enable investors to include derivatives and hedge fund holdings within their individual net zero commitments, targets, and strategies.
The guidance was created with support from our investor working group and is supplementary to the Net Zero Investment Framework, the most widely used guidance by investors who have committed to net zero today.
Derivatives are financial contracts which enable investors to benefit from the performance of an underlying asset without direct ownership. Though these financial instruments do not themselves constitute an asset class, maximising transparency in their reporting can play a positive role in accelerating the transition to the low-carbon economy. This resource addresses derivatives with equity and credit as the underlying assets, though in future, other asset classes could be considered.
In the guidance, we highlight the importance of ensuring transparency when attributing greenhouse gas (GHG) emissions to securities owned by investors. We also recommend that investors report on the real-world impact of derivatives and short-selling strategies, offering details on how to do so.
Though indirect exposure to assets through derivatives may not directly contribute to greenhouse gas emissions, the guidance points out that it is tied to underlying assets, such as stocks or bonds, which do have associated emissions.
Disagreement persists among investors and hedge fund managers as to how to best account for the role that derivatives and shorts play in net zero investment strategies. Some suggest attributing emissions associated with derivatives and shorts based on economic exposure (i.e., using a net carbon metric), but our guidance explains that to achieve maximum real-economy emissions reductions, economic exposure should not be conflated with net zero alignment. While a net-carbon metric shows the exposure to carbon risk, it is less useful for tracking real economy emissions and decarbonisation.
When investing in derivatives and hedge funds, the guidance encourages investors to consider, within their mandate, all channels of influence to maximise positive real-world impact and to report on their use. To ensure transparency, the guidance suggests reporting separately:
- Financed emissions: Attributed emissions from companies directly owned by the investor, whether acquired through secondary or primary markets
- Long associated emissions: Emissions associated with companies where long exposure is gained via prime brokers or derivatives
- Short associated emissions: Emissions associated with companies where short exposure is gained via prime brokers or derivatives
To maximise real economy emissions reductions, both long direct exposures and long indirect exposures should target net zero by 2050 to be considered ‘aligned with net zero’ under NZIF criteria. Long and short emissions should not be aggregated or netted, either under financed emissions or associated emissions.
The guidance includes a detailed example to help investors understand its recommendations in the context of their own financial portfolios.
It also sets out the challenges that implementing and reporting under these recommendations may create, together with suggested alternatives in specific circumstances. This includes leveraged exposure; data limitations when separating indirect and direct exposures; strategies with high turnover and low influence; and multi-manager allocators with decarbonisation targets.
As a call to action, we encourage hedge fund and asset managers to provide their best efforts in offering complete and transparent information to investors. The ultimate goal is to shift away from an exclusive focus on financed emissions and long associated emissions, to characterising these emissions in the context of portfolio alignment and the different channels of investor influence.
If you’d like to take part in our working groups and help shape the outputs of our resources, why not speak to our investor relations manager today to find out more about becoming a part of IIGCC?