LGIM blasts ‘dangerous’ netting of short positions on carbon emitters
Netting shorts on big polluters distracts investors from task of persuading firms to slow climate change
Investors that use their short positions on oil producers and airlines to reduce the carbon emissions of their portfolios – a practice adopted by AQR – are distracting themselves from taking the actions that will help avert the climate crisis, according to Legal & General Investment Management.
Reporting low or even negative carbon emissions on funds does little to increase companies’ cost of capital and could stymie efforts to meet the Paris Agreement’s goal of reducing global warming to “well below 2C”, LGIM’s head of climate solutions, Nick Stansbury, told the ESG & Climate Risk Summit Europe.
“I worry that using shorts as a sort of quasi-indulgence from a societal-alignment perspective is somewhere between a bit of a red herring and being a little bit dangerous,” said Stansbury, during a panel discussion on May 11.
AQR’s billionaire co-founder Cliff Asness has argued in favour of hedge funds short-selling the most polluting companies because this will increase the cost of capital for the biggest contributors to global warming. “This higher cost of capital will mean they do, well, less of the stuff we want them to do less of,” Asness wrote at the end of February.
Asness also argues that investors should net off short positions against long positions to accurately measure the carbon footprint of a portfolio.
Stansbury played down the notion that short-selling a stock makes it harder for the issuer to finance carbon-intensive projects such as steel plants or coal mines. “Yes, there is some evidence, weak evidence in my view, that going short on high-emitting companies may start to raise their cost of capital, but it is at the margins.”
Worse, by arguing that shorting increases financing costs, investors such as AQR are allowing themselves to get distracted from the task of persuading the companies they invest in to change their behaviour, Stansbury said. “Being long stocks and then really going for it in terms of engaging companies to help drive down emissions, improve the quality and strategy of their transition plans, that really does make a difference and therefore that is where from an alignment perspective the focus needs to be.”
LGIM plans to decarbonise £97 billion ($118 billion) of assets that it manages on behalf of its parent company, the life insurer Legal & General. The asset manager is relying on engagement with the issuers of those securities to meet its targets of reducing emissions intensity by 12% by the end of this year and by 50% by the end of the decade. The UK’s biggest investor has committed itself to a target of net-zero portfolio emissions by 2050.
AQR, however, expects shorting to do most of the hard work on climate change. “If the virtuous investor is willing to actually sell the bad guys short, the non-virtuous will have to own even more, and the cost of capital goes still higher (even less bad stuff!),” Asness wrote. “By raising the cost of capital, or discount rate, on the bad guys we get them to do less of the bad stuff as fewer of their (bad for the world) projects clear the higher hurdle. This is the mechanism where we actually affect the real world.”
An investor that shorts ExxonMobil, for example, while going long on technology companies could report negative carbon emissions on their fund even as the oil producer kept on pumping the black stuff. “The only way you go short on emissions is by going long on carbon removal whether that is the ultra high-quality nature-based carbon removal or physical carbon removal services in the form of geological carbon storage solutions,” Stansbury added. “That is a very small asset class today. I believe it is going to grow rapidly and it’s one of the most exciting areas in capital markets. That generates genuinely negative emissions. Shorting high emissions companies does not generate genuinely negative emissions.”
Netting short positions has a part to play in managing climate risk. The most climate-aware asset managers, including LGIM, model different climate scenarios to understand how their portfolios will be affected. In scenarios where warming is limited to 1.5C, “well below 2C”, or 2C, the models assume that a carbon price is introduced globally.
A portfolio with zero or negative carbon emissions thanks to short positions would perform well in a world where the price of carbon rose rapidly, Stansbury said.
Asness has not written about shorting as a tool to mitigate the risk of a rising carbon price. The European Union, Canada and California all have carbon-allowance systems that put an effective price on carbon, but the rest of the US does not.
Bodies such as the IFRS Foundation, which has published a draft set of climate disclosures for companies, have yet to say whether they favour or disapprove of using short positions to lower the overall emissions of a fund.
“It is not for a standard-setter to tell an investor how to manage its portfolio,” Lois Guthrie, a senior technical adviser to the IFRS, told the same panel. “It’s not for a standard-setter to tell a company how to run its business. It’s for the standard-setter to elicit information from party A to deliver decision-useful stuff to party B.”
Editing by Alex Krohn
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