12 Pension Protection Fund Climate Change Report 2021/22 STRATEGY AND RISK MANAGEMENT CONTINUED CASE STUDY Assessing our portfolio alignment with the Paris Agreement There has been a lot of focus recently on how investment portfolios can align to Net Zero commitments, with varying opinions on what it should entail. Wanting to be better informed about our own fund’s position, we began an innovative project in early 2021 to carry out a practical, bottom-up assessment of our portfolio and the implied temperature rise our investments indicate relative to Paris targets. The challenge To address this, we adopted an alternative approach that Implied Temperature Rise (ITR) baseline In 2019, we became involved with the IIGCC’s Paris considered how companies are operating today and then score of our Fund Next steps Aligned Investment Initiative (PAII) to support investors estimated the amount of global warming if the entire world to align their portfolios to the goals of the 2015 Paris operated at the same emissions intensity as the entity in Firstly, we acknowledge the data limitations with Agreement. The PAII developed the Net Zero Investment question. This was then compared with a target emissions these calculations and we’ve had to make some Framework (NZIF), which provided a useful starting reduction pathway for each company’s sector. We also assumptions during the project. However, we do point for us to assess the alignment of our own portfolio estimated sector-speci昀椀c baseline scores for companies now have a much better understanding of the with the Paris target to limit global warming to no more lacking emissions data, which was crucial in allowing us to Market benchmark >3.4ºC most material contributors to climate change in than 1.5°C. proxy our private markets holdings on a more granular basis our portfolio and can therefore make much more in the second phase of the project. PPF 2020 Baseline 2.5ºC informed decisions about what we need to do But the NZIF covered less than 25 per cent of our going forward. portfolio. This was primarily because our signi昀椀cant Interpreting the results Paris Agreement Target 1.5–2ºC allocations in liability hedging instruments and private The overall weighted ITR score for the Fund’s December There are few assets in the broad investment universe market assets were out of the NZIF’s current scope. 6 that can already be categorised as “aligned” to Net 2020 baseline was assessed as 2.5°C, covering all desks . We therefore appointed an external consultant, Ortec For context, this is below the global market estimate of Zero. Just under 20 per cent and 4 per cent in the Finance, to help us design an independent, objective 3–3.5°C warming and at the bottom of the global current PPF Equities and Credit portfolios were identi昀椀ed measure that could baseline our entire portfolio in a country policies ITR projection of 2.5–2.9°C by 2100, both respectively through Ortec Finance’s analysis of these way that aligns with the PAII’s goals. 7 portfolios8 assessed by Climate Action Tracker. . Credible targets set by companies are, Our solution therefore, a way to identify both the opportunities The results indicate that LDI is the biggest overall certain companies face to improve their alignment For the 昀椀rst phase of the project in summer 2021, we contributor to the Fund’s ITR (see chart right). However ITR baseline contribution by desk to Net Zero, and the risks others face if they don’t analysed our public equities and bonds (including LDI, the relative strength of UK climate policies means that UK adopt a feasible strategy to become aligned. See page sovereigns and corporates across both developed and LDI assets contribute to a lower overall ITR (although we 26 for our current exposure to companies that have emerging markets), and real estate portfolios. As a starting note that even the UK is not yet deemed to be aligned committed to or set science-based targets. point, we applied one of the open-source methodologies with 1.5°C). But we can also see that a lot more needs to referenced in the NZIF. However, its default implied be done by both corporates and governments, especially We are now highlighting the parts of our Fund where temperature rise (ITR) of 3.2°C for all companies without in emerging markets. We cannot address this in isolation, the greatest need to transition lies, and identifying a disclosed targets, regardless of their sector or current but we can undertake targeted engagement with speci昀椀c subset of portfolios, sectors and companies as our emissions, meant we were unable to identify the better issuers to encourage a shift towards a more aligned Liquids highest priority engagement targets. We will work or worse performers in speci昀椀c sectors for over 80 per trajectory, starting in many instances with better disclosure. Alternatives with our stewardship services provider EOS, with our cent of our corporate holdings by value. We therefore fund managers, and also consider direct engagement couldn’t prioritise companies for engagement, or identify Hybrid assets ourselves, to ensure this subset is held to clear and companies that were unlikely ever to align. LDI measurable progress. We will provide more detail on 6 But excluding derivatives, short positions, pure cash instruments, FX, Forestry & Farmland and holdings without lookthrough (e.g. ETFs, secondaries). how this will feed into our engagement plan in our 7 Glasgow’s 2030 credibility gap: net zero’s lip service to climate action | Climate Action Tracker next Responsible Investment Report. 8 By market value, holdings as at 31 December 2021.