Why Impact Investing Needs A Standardised Climate Metric

Why impact investing needs a standardised climate metric

1. Assets can devalue over time due to climate change.

Emerging regulation can affect a company by imposing more stringent environmental requirements. So, you need to be on top of policy and regulatory settings to make sure your investments don't devalue. If not, you may be buying something that has a lot less value in a couple of years - the so -called "standard assets

2. Relying on historical data is not enough

You know how the story goes: historic performance is no guarantee of future performance

Any major purchase or investment has the potential to go wrong if not analysed through a proper forward-looking lens

3. Transparency on climate metrics is needed.

These forward-looking metrics, however, need a high level of transparency in order to be able to truly inform the investment decision-making process and to allow more allocation of capital towards climate resilient companies.

4. There is no general best practice on how to calculate such metrics.

There have been several attempts at creating such metrics. Yet so far, they are based on propriety methodologies and require additional data collection.

Different data providers use their own methodologies which in turn proved different results.

So what to do?

Idea:

Adjust the P/E ratio for climate risks the price to earnings ratio (P/E) is used to give an idea of whether a company is over- or undervalued by the market.

So why not provide a more climate- adjusted picture with the P/E ratio? For instance, you could simply calculate a carbon adjusted earnings per share, where estimated financial cost of carbon would be deducted from the earnings per share.

What this could look like:

The price of carbon offsets is currently around €50 per tonne and is expected to increase in the future.

So let's say we take a company's current Scope 1, 2, and 3 emissions and multiply these by the cost of carbon. How much would it cost today and in 10 years for a company to emit X amount of CO2e?

Food for thought

Seeing the negative monetary impact on a company's earnings would hugely affect investment decision-making process.

Companies would either need to act get rid of high carbon emissions or take the hit!

So, could establishing common forward-looking climate metrics become the next priority on the impact investment to-do-list?