Rigorous, fundamental bottom-up research is paramount to the Breckinridge investment process. Proprietary credit algorithms, a risk-based credit matrix, environmental, social and governance (ESG) factors, and quantitative and qualitative data each play a role in assessing an issuer’s credit quality. Among ESG factors, climate-related risks are an integral component.
Like many ESG factors, the relevancy of climate risk to any specific sector or industry may vary. Breckinridge analysts integrate third-party data and their own analysis of financial and nonfinancial factors to develop forward-looking views.
Third party ESG resources that Breckinridge analysts consider include work by the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-Related Financial Disclosures (TCFD).
The mission of SASB is to support public companies in disclosing decision-useful, financially material and comparable data about their performance on sustainability measures. The data is intended to help fixed income and equity investors, as well as financial analysts develop well-informed views about the investment quality of companies.
SASB’s approach informs our consideration of ESG factors with a materiality map of ESG issues across 10 economic sectors and 77 industries. General issues identified by SASB within its environmental dimension include greenhouse gas (GHG) emissions, air quality, energy management, water and wastewater management, waste and hazardous materials management and ecological impacts. Within its business model and innovation dimension, SASB-identified general issues are materials sourcing and efficiency and physical risks of climate change. SASB ranks the materiality of each issue for companies within a sector or industry based on three criteria: 1) the issue is likely to be material for more than 50 percent, 2) fewer than 50 percent or 3) none of the industries in a sector. SASB’s materiality ranking clearly illustrates the fact that every issue will have varying degrees of influence within sectors and industries.
The TCFD also seeks to measure the level of materiality of climate-related financial disclosures within different sectors and industries. In its 2017 guide on implementing recommendations, TCFD noted, “While climate change affects nearly all economic sectors, the level of exposure and the impact of climate-related risks differ by sector, industry, geography, and organization.”
TCFD’s approach to financial disclosure encourages organizations to consider how climate-related risks affect their current financial positions and may potentially affect its future financial positions in terms of four major categories of financial impact: 1) revenues, 2) expenditures, 3) assets and liabilities and 4) capital and financing.
Breckinridge extends the work of SASB and TCFD and other third-party providers through our own security research and engagement efforts.
For example, during 2018 and 2019, Breckinridge engaged with large, globally integrated oil and gas companies as well as exploration and production businesses as part of our thematic engagement efforts. Our goal was to better determine how these companies are managing carbon transition—the risks and opportunities present and emerging as the global economy evolves to a low-carbon future.
Our key takeaway was that European-domiciled companies are largely ahead of U.S.-based companies across many areas including:
- setting emission reduction targets
- investing in renewables/low carbon technologies
- broader use of carbon pricing
- more extensive use of scenario analysis
- more closely tying executive remunerations to climate change goals.
We consider insights like these, gained through our direct engagement with issuers, as we further develop our research into climate risk across sectors.
In 2019, we also engaged with companies within the chemicals sector to better understand their efforts around initiatives aimed at achieving a circular economy—an economic system aimed at eliminating waste and the continual use of resources—and associated constraints on progress.
We learned that while chemical companies have started the effort, they are in the early rounds of reducing emissions and waste. We also gained insight into technologies and innovations that potentially could have great impact on overall emissions and waste.
For example, carbon renewal technology could enable chemical companies to process waste plastics, which historically have been destined for landfills, in ways that significantly lower waste and potentially reduce scope 2 emissions— emissions from purchased or acquired electricity, steam, heat and cooling. Related benefits associated with recycled feedstock also are potential outcomes of increased use of carbon renewal technology.
Additional sustainable product innovations that stood out to us include incorporating plastic into the construction of asphalt roads and development of concentrated solid chemical products. During our engagements, we noticed a meaningful uptick in collaboration between companies and foundations or other third parties as chemical companies seek to address waste/emission issues around plastics production.
We believe engagement supports a timely and more comprehensive picture of an issuer’s climate-related risks because third-party resources, while extensive, sometimes await cyclical revisions and updates. So far in 2020, Breckinridge is engaging with issuers in the banking industry to assess their activities related to climate risk.
Security research is often referred to as a mosaic, one that combines information from a range of sources to provide a view to investment risks. Breckinridge’s efforts to assess a company’s climate risk provides another important piece to the credit quality mosaic.
DISCLAIMER: The opinions and views expressed are those of Breckinridge Capital Advisors, Inc. They are current as of the date(s) indicated but are subject to change without notice. Any estimates, targets, and projections are based on Breckinridge research, analysis and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.
Nothing contained herein should be construed or relied upon as financial, legal or tax advice. All investments involve risks, including the loss of principal. Investors should consult with their financial professional before making any investment decisions.
While Breckinridge believes the assessment of ESG criteria can improve overall credit risk analysis, there is no guarantee that integrating ESG analysis will provide improved risk-adjusted returns over any specific time period.
Some information has been taken directly from unaffiliated third-party sources. Breckinridge believes such information is reliable but does not guarantee its accuracy or completeness.
Any specific securities mentioned are for illustrative and example only. They do not necessarily represent actual investments in any client portfolio.
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