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Corporate bonds are the most carbon-intensive

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The latest analysis from index and analysis group MSCI reports that the carbon emissions from corporate bonds, or debt, have the highest carbon intensity of any financial instrument. This identifies a new risk concern for corporations and bond investors.

MSCI has used the Partnership for Carbon Accounting Financials (PCAF) methodology to report on the financed emissions of investment portfolios. The analysis shows that the corporate bond market is responsible for the highest level of financed emissions – the emissions intensity of investments made in a year.

What carbon footprints of different assets tell us

Carbon footprinting across multi-asset-class portfolios allows investors to measure and manage financed emissions on their road to net zero emissions. It is this need to understand the profile of their portfolio emissions that is driving much investor focus on corporate disclosure, so that they can better understanding their exposure, both to climate risk and to increasingly stringent regulatory frameworks.

To help financial institutions align with the Paris Agreement, the Partnership for Carbon Accounting Financials (PCAF) has been developing a transparent and consistent methodology to report the financed emissions of investment portfolios. MSCI investigated PCAF-aligned financed emissions for various asset classes, including global equities and sovereign, corporate and municipal bonds.

Why carbon intensity matters to investors

Thomas Verbraken, executive director, MSCI Research said: “We saw significant variation in financed emissions across asset classes and across sectors within asset classes, which can help inform climate-aware investors as they construct portfolios … We analysed the financed emissions of indices and representative portfolios worth $1 million in global equities and sovereign, corporate and municipal bonds using the MSCI Total Portfolio Footprinting solution.”

The results showed, he continued, “Corporate bonds had the highest total financed emissions — including Scopes 1, 2 and 3 — although there was significant variation between segments of the corporate bond market. For example, US-dollar high-yield bonds were more emission-intensive than US-dollar investment-grade bonds. Sovereign bonds also registered a large carbon footprint, but we should note that all sovereign emissions are currently lumped together in Scope 1.”

Financed emissions not only provide the foundation to set and track net-zero commitments, but to help identify climate-risk drivers in the portfolio across asset classes, sectors and geographies. Allocation and selection effects play a significant role in how this differs across portfolios.

For example, allocation effects mean that high-yield debt indices contain bonds that are sold by the carbon-intensive energy sector, while selection effects means that the debt of utilities, energy, and financial companies within these indices are more carbon-intensive relative to their investment-grade counterparts.

Different emissions intensity across asset class and scope

One of the interesting findings was what was termed the ‘wild variability’ in emissions intensity across municipal bonds. Scope 1 and 3 were the major contributors to a hypothetical municipal bond portfolio’s financed emissions; Scope 2 emissions were an order of magnitude lower.

While power utilities were the highest-emitting project type for Scope 1, economic and industrial development and government-related buildings registered the highest Scope 3 financed emissions. The top Scope 2 contributors were energy-consuming facilities such as schools, universities and government facilities.

Access to reliable data still a key stumbling block

The point about the reliability, comparability and transparency of data was raised once again.  The PCAF standard defines a data-quality scorecard, ranging from 1 for highest to 5 for lowest data quality. Within the analysis, score 2 was dominant in terms of the outstanding amount for equities and sovereign and corporate bonds, which means that emissions are based on either reported emissions or data on the primary physical activity of the company’s energy consumption.

For lower data-quality scores, missing emissions data is estimated based on the company’s production or revenue data or, if that is also unavailable, based on sector averages for emission intensity. For instance, municipal bonds’ financed emissions are entirely model-driven. Coverage for the analysed indices is more than 99% of the market capitalisation weight

Overall, MSCI said that although the quality of climate-related data reported by issuers is constantly improving, fewer than 40% of companies in the MSCI ACWI Investable Market Index (IMI) disclosed Scope 1 and 2 emissions and fewer than 25% disclosed Scope 3, as of January 20, 2022.

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