Dealing with climate risk as financial risk

Climate change has been a concern for PGGM Investments and our clients for years. It is an urgent matter and an increasingly important risk. As a large global investor, with a diversified portfolio, we expect climate change and the energy transition to impact our clients’ investments. Each new year, previous climate risk estimates are replaced by new and always more material estimates, underlining the necessity to fully integrate climate risk into our financial risk management processes and policies.

The relationship between climate change and investing is twofold. On the one hand, our client’s investment decisions have an impact on the climate. Our clients feel societal responsibility to reduce negative impact on the climate. On the other hand, climate change - and measures to combat climate change - have an impact on the value of our clients’ investments. It is our fiduciary responsibility to understand and respond to these effects. We therefore see this as one of our material topics. PGGM Investments manages its clients' investment portfolio by effectively contributing to the energy transition in the interests of participants.

Also, it is part of PFZW climate strategy to identify and mitigate climate risks for all asset classes. Full integration of climate risks, and more broadly sustainability risks, into existing risk management practices is furthermore being enforced by new regulation such as the Alternative Investment Fund Managers Directive (AIFMD) and the Markets in Financial Instruments Directive II (MIFID II) and climate risk stress testing is expected to be requested by the Dutch central bank as of 2022. In the upcoming years, PGGM Investments and our clients will have to provide more insight into climate and other sustainability risks in investment products complying with SFDR requirements. Furthermore, in 2022 the European Insurance and Occupational Pensions Authority (EIPOA) will carry out a stress test for pension funds in which climate risks will be a major focus. We expect to use our expertise to help our clients deliver on this request.
Below we reflect on the key themes for 2021 regarding climate risk and how we are preparing our risk management for the future. Also, we show how different investment teams integrate climate change risks in their day-to-day investment activities.

Achievements dashboard

In the entire PGGM Investments portfolio, fossil fuel exposures (both GICS and Barclays), have been reduced from 2.4% in 2017 to 1.6% in 2021.
Exclusion of 109 companies that derive more than 30% of their turnover from coal extraction or combustion or more than 10% from tar sands oil extraction. This concerns among others Coal India and Conoco-Phillips.
Seven companies with activities in fossil energy have been excluded based on the OECD screen (human rights), for a total of approximately €81.5 mln.
227 companies (of a total of 3,791) were removed from the equity benchmark due to our CO2 index by 2021, including RWE, Exxon Mobil and Gazprom. Through the CO2 index, the CO2 intensity of the equity portfolio has been reduced by more than 50% between 2015 and 2020. In 2021 a further reduction of 5.3% was realised.
We voted at 27 shareholder meetings on climate related resolutions to encourage Paris alignment
€15.8 bln is currently invested in climate solutions in equities, bonds (green bonds), infrastructure and Private Equity, contributing to Sustainable Development Goals #7 and #13.

Achievements dashboard Achievements dashboard

In the entire PGGM Investments portfolio, fossil fuel exposures (both GICS and Barclays), have been reduced from 2.4% in 2017 to 1.6% in 2021.
Exclusion of 109 companies that derive more than 30% of their turnover from coal extraction or combustion or more than 10% from tar sands oil extraction. This concerns among others Coal India and Conoco-Phillips.
Seven companies with activities in fossil energy have been excluded based on the OECD screen (human rights), for a total of approximately €81.5 mln.
227 companies (of a total of 3,791) were removed from the equity benchmark due to our CO2 index by 2021, including RWE, Exxon Mobil and Gazprom. Through the CO2 index, the CO2 intensity of the equity portfolio has been reduced by more than 50% between 2015 and 2020. In 2021 a further reduction of 5.3% was realised.
We voted at 27 shareholder meetings on climate related resolutions to encourage Paris alignment
€15.8 bln is currently invested in climate solutions in equities, bonds (green bonds), infrastructure and Private Equity, contributing to Sustainable Development Goals #7 and #13.

Carbon emission monitoring and climate stress testing

This year we have further integrated climate risk into our financial risk management processes. We added ‘Sustainability’, including climate risk, to our Portfolio Risk framework that we use to monitor, review and challenge the public market portfolios. This framework ensures a complete and consistent portfolio investment risk management process and is used by our risk managers. To evaluate ESG and climate risk in existing public market portfolios, both stand alone and against benchmarks, we are developing new dashboards containing ESG, Reputation and Carbon metrics for the equity and credit portfolios.
In order to quantify climate risk, we monitor carbon emissions of the companies in our investment portfolios. Our previous research showed that a global increase in carbon tax levels to $100, or even $200 per ton CO2, presents a substantial risk for equity portfolios. While much smaller, it also presents a non-negligible risk for credit portfolios. Monitoring carbon emissions for the public market portfolios therefore gives a good idea of the level of climate risk, more specifically climate transition risk, in the investment portfolios.

A day as an investor: Tony de Graaf

Tony de Graaf (42) is an Expert Investment Risk Manager as has been with PGGM Investments for 12 years. His educational background is in quantitative areas such as mathematics, actuarial science and financial risk management (FRM).

Read: A day as an investor by Tony de Graaf

A day as an investor: Tony de Graaf A day as an investor: Tony de Graaf

Read: A day as an investor by Tony de Graaf

Sustainability risk: knowledge building and sharing Investing in Insurance Linked Investments and climate change Real Estate and the CRREM Global pathways

PGGM Investments organized multiple workshops on sustainability risks for various departments. With the front office teams, a workshop was organised that dealt specifically with the impact of climate risks on the portfolio. A multidisciplinary workshop was organized on sustainability risks, during which meeting sustainability risks were discussed in a broader sense, both from a financial and an enterprise perspective (reputation, etc.). Also, an online session on the latest IPCC report was organized for all PGGM Investments employees, and in December we welcomed Ben Caldecott for a new edition of our so-called Power Lunch. Ben is respected internationally as the expert in the field of sustainable finance. He is affiliated to the University of Oxford. In his presentation, he discussed his core message: ‘Entire sectors could lose their value and become “stranded assets” as a result of climate change.’ With the Power Lunch, we bring the outside world in. We ask well-known speakers to reflect on us and our field of work; to learn from, to be inspired by, and to enrich our view of the whole and thus build together the PGGM of the future.

Since 2006 PGGM Investments invests in Insurance Linked Investments for PFZW, through leading investment partners. These investments are focused on sharing very low probability, but high impact financial risks of global natural catastrophes, such as hurricanes and earthquakes. For PFZW, these investments have achieved an average annual return of about 6% while offering diversification, as there is no direct link with stock market valuations or interest rate movements. In addition, these investments help keeping insurance affordable by expanding the financial capacity the (re)insurance industry and provide homeowners and businesses around the world affordable insurance, to rebuild after a natural catastrophe.

Climate change is an important topic for the (re)insurance industry. There is scientific consensus that high temperatures, heavy rainfall, and drought will occur more frequently. These can cause increasing damage from floods or large wildfires. Such manifestations give clear guidance to our investment partners of which risks to steer away from. We aim to limit the portfolio’s chance of incurring such losses. Our main exposure is to hurricanes and earthquakes. The latest United Nations’ Intergovernmental Panel on Climate Change (UN’s IPCC) report’s findings indicate only a small increase in risk of loss from hurricanes, due to a decrease in frequency and an increase in intensity. No relation has been found between climate change and earthquakes. The (re)insurance contracts that underlie our investments run typically for one year. This yearly renewal allows for quick adaption of prices and contract terms. This way, with updated knowledge on climate change and accountability we further limit any impact on the portfolio.

Climate change is high on the agenda within PGGM Investments and our stakeholders. With approximately 40% of the annual global greenhouse gas emissions related to real estate, this asset class is part of the problem but as such also part of the solution. As mentioned earlier, carbon reduction is one of the focus points for the PGGM Real Estate teams. While climate change could lead to changes in physical risks across the globe, e.g. more frequent storms and flooding, there will be transition risks on our path of preventing climate change.

Transition risk is the risk associated with the changes required to combat climate change. One could think of changing laws and regulations from governments or changes in tenant preferences in the transition to a CO2 neutral world. To illustrate, as of January 1, 2023, every non-monumental office building larger than 100 m2 in the Netherlands must have at least energy label C. If a building does not meet this requirement, it may not be rented out or used as an office. However, we see limited comparable initiatives from legislators globally thus far to push carbon reduction.

At PGGM Investment we pursue to be a leader in the field of carbon reduction for the real estate sector. We are one of the founding partners on a leading global initiative to quantify carbon reduction goals and transition risks for the real estate sector. This project, the Carbon Risk Real Estate Monitor (CRREM), is science based and divides the global 'budget' for greenhouse gas emissions, as stipulated in the Paris Agreement of 2015, by country, sector and building level. In addition, the results contribute to making decarbonisation measurable and thus reducing the transition risk in the real estate sector. Over the next couple of years, we expect to use the decarbonisation pathways to measure to what extent results align with the Paris agreement aimed at keeping global warming below 1.5 degrees. This makes something important measurable and thereby actionable.

Sustainability risk: knowledge building and sharing Sustainability risk: knowledge building and sharing

Investing in Insurance Linked Investments and climate change Investing in Insurance Linked Investments and climate change

Real Estate and the CRREM Global pathways Real Estate and the CRREM Global pathways

CO2 reduction

Following the 50% reduction in the carbon footprint of the Equity portfolio between 2015 and 2020, PFZW has set the new goal to further reduce CO2 emissions in the listed equity portfolio by 30% in 2025. Previous CO2 strategy focused on reducing exposure to the CO2-inefficient companies in the three most polluting sectors (Energy, Materials and Uilities). For the actively managed Equity portfolios a gradually declining CO2 budget was used to achieve a lower carbon footprint.2 A different scope and method will be used to achieve the -30% reduction. Previously the carbon footprint was measured using the classification of emissions into direct and first tier indirect emissions. Going forward the classification of emission in Scope 1, 2, and 3 will be used. Moreover, instead of using a rule-based approach (as was the case in previous years), optimization will be used to achieve the necessary reduction.

Objective: 30% reduction of the carbon footprint (measured by the weighted average carbon intensity) of the Equity portfolio in 2025. Baseline measurement at 31-12-2020 of the Equity portfolio : relative carbon footprint = 189 tonnes of CO2 per milllion dollars revenue.
At 31-12-2021 the relative carbon footprint = 179 tonnes of CO2 per million dollars revenue. 5.3% less than 2020.

PGGM also monitors the impact of the CO2-reduction strategy on portfolio return. This has remained slightly positive and constant over the past years, at 0.3%. This is as intended: any ESG adjustments in the equity portfolio have to fit within a 1% tracking-error budget.

In addition to the Equity portfolio, the Credit portfolio will also start reducing its carbon footprint in the coming years. The first step is reducing emissions by 20% ultimo 2023, then 5% by 2024 which is followed by a reduction between 3-7% in the three years thereafter. For Real Estate and Infrastructure strategies are being develop which do not focus on CO2 targets, but on the number of companies that have set actionable, credible, and measurable targets to become Paris aligned.

By further reducing the carbon footprint and increasing the Paris-Alignment of the various portfolios, a clear signal is send to the market that businesses must reduce their CO2 footprint and actively take steps towards becoming Paris-Aligned. All these efforts include targets that we expect should not interfere with the risk-return profile of individual asset classes. Finding balance between realistic and ambitious targets is a key challenge. In this process, connection is sought with standards and regulatory frameworks that have been developed over the past years.

Dutch Climate Agreement

In 2019, clients of PGGM Investments committed to the Dutch Climate Agreement for the financial sector. With this, they pledged to report as of 2020 financial year onward on the carbon footprint of all relevant investments in the portfolio.

PGGM Investments also reports itself, in line with the Dutch climate accord, on the absolute footprint (in CO2 equivalents) of the total investments under our management (see table 3.1). We aim to inspire market participants to do the same, especially companies we invest in on behalf of our clients. Such measurements are important in monitoring and constructing our portfolio. By identifying greener companies and sectors, we can (re)direct funding and limit the exposure to transition risks with regards to climate change. In addition, this data is of importance in our engagement activities with companies we have invested in. The climate objectives of organizations usually relate to the emissions of greenhouse gases. By using CO2 footprints, we can use our influence as a major investor in the monitoring our portfolio to put energy efficiency and climate action on top of their agendas.