Over the past decade, many countries and companies have made ambitious pledges to reach net zero greenhouse gas emissions to tackle climate change. For investors, however, the implementation of similar commitments in investment portfolios has led to some unintended outcomes.
Some investors are unwilling to provide capital to high-carbon-emitting companies, even if they are in the process of decarbonizing their businesses. Divestment is the easy route for those looking to quickly get emissions off their books. But while divestment can lead to a greener portfolio, it will not necessarily result in a greener planet since it doesn’t take carbon-intensive assets offline. Investors’ net zero commitments also often have serious caveats such as excluding commingled funds – which comprise a substantial portion of global investments – rendering them effectively hollow or simply disingenuous.
Net zero commitments’ drawbacks are leading some investors to scale back or withhold commitments altogether. A mechanism to charge investors for the carbon in their portfolios – and encourage real world decarbonization – is sorely needed. The solution could lie in carbon charges for investment portfolios.
At a high level, carbon pricing offers an economic approach to paying for the externalities of carbon emissions, designed to incentivize a reduced carbon footprint and transition towards more sustainable practices. Short of a true carbon tax, which requires policy action, there are two other ways a carbon charge could be assessed and administered.
Shadow carbon charge:
The basic idea behind a shadow carbon charge is to assign a hypothetical monetary value to each ton of CO2 emitted, reflecting the environmental and societal costs of carbon pollution. By highlighting the costs of carbon emissions, a shadow carbon charge can help correct market failures and encourage the adoption of low-carbon technologies and practices. A shadow charge incorporated into capital allocation decisions leads to future capital flowing towards less carbon-intensive projects, all else equal. The term “shadow” is used when these charges are not officially implemented as government policies. Instead, they serve as indicated pricing mechanisms outside of the formal regulatory framework.
Internal carbon charge:
Unlike a shadow