Insurers are under increasing regulatory and market pressure to disclose the environmental profile of their businesses including their assets, while they face the challenges of lack of standardisation of metrics which they can use.
In this article, Isabelle Buckland, business development executive, RLAM and Andrew Epsom, insurance client solutions director, RLAM, co-authors of the report Climate Risk Management for Insurers – Benchmarking of Emerging Best Practice, discuss the limitations of one of the most commonly used metrics, the WACI.
Weighted Average Carbon Intensity (WACI) measures the exposure to carbon-intensive companies, expressed in tons of carbon dioxide equivalent per unit of revenue.
WACI is one of the most prevalent metrics used for disclosing the level of carbon emissions from investment portfolios, and is recommended, amongst others, by the Task Force on Climate-related Financial Disclosures (TCFD).
Gaining the right perspective
WACI has many advantages in that it is easily understood, relatively straightforward to calculate, can be measured across fixed income as well as equity and encapsulates information within a single metric.
However, WACI has a number of limitations, most notably its reliance on historical carbon footprint analysis which means the measure is inherently backward looking. As a result, WACI does not recognise any future plans from insurers or issuers to reduce emissions over time through a robust action plan, or in facilitating other important environmental objectives.
Considering WACI alone may, therefore, lead to a greater focus on shorter-term carbon reduction rather than a longer-term allocation to companies where the environmental position is expected to improve over time.
Examples of the latter include high emitters where either the insurer (or underlying asset manager) is consciously looking to work with an issuer through engagement to efficiently reduce carbon emissions rather than transferring the problem elsewhere, and / or the issuer is involved in a project supportive of net zero or sustainable goals, but has an increased initial level of carbon intensity.
Case study: adopting tunnel vision?
The Thames Tideway Tunnel is a bond opportunity which is financing a new super sewer currently being built underneath London and the River Thames (The Tideway Super Sewer).
The weighted average carbon intensity of the project is currently relatively high in its development phase. We illustrate this in the table below by reference to a gas network bond comparator.
|Thames Tideway Tunnel||Representative Gas Network bond|
|Spread over gilts||+80||+80|
|WACI (tCO2e / £m)||1,839||701|
Source: RLAM as at 7th December 2021
Considering only the WACI metrics above in isolation, this would suggest that the Thames Tideway bond is not attractive from a sustainability perspective (with a WACI more than double that of the alternative).
However, the Thames Tideway Tunnel is expected to provide material environmental and social benefits. Even during light rainfall, the current sewerage network cannot cope, resulting in untreated sewage spilling into the Thames. The project is circumventing this with the tunnel intercepting, storing and ultimately transferring sewage waste away from the river.
In addition, from a financial perspective the Thames Tideway bond has a protective regulatory framework providing visibility over cashflows and a strong security package and covenants. For the gas network comparator shown above, there is also material transition risk involved, with domestic gas use recognised as a major contributor to climate change.
Despite high carbon intensity initially from the construction process and the cement and steel needed to make the Thames Tideway tunnel, we believe this type of project should be viewed favourably through most ESG lenses. By focusing on WACI only, such an investment could be ruled out.
WACI – sharpening the message
WACI represents an obvious and convenient metric for insurers to disclose around the carbon intensity of their investments and facilitates comparability between different investors – we are supportive of this remaining in the “disclosure toolkit”. However, its backward-looking approach and narrow focus means it is a relatively “blunt” tool that may not adequately capture the longer-term environmental footprint or benefit of a particular issuer.
For insurers focusing on longer-term greenhouse gas reductions rather than purely immediate divestments from high polluters, the WACI needs to be complemented with additional data and disclosures to provide a truer picture of their current and future environmental profile.
The metrics could include quantitative measures such as future warming potential (although we accept that the methodology underlying this needs further development) together with more qualitative disclosures to justify certain investments, particularly where there is a high WACI.
While complementing the use of the WACI with additional metrics will increase complexity and potentially hinder comparability, we believe that a broader focus on disclosures is needed so insurers can continue to play their critical role in the transition to a more sustainable and net zero economy and society.
The authors are member of the Royal London Asset Management specialist insurance team.
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The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested.
The views expressed are those of the authors at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.
Issued in December 2021 by Royal London Asset Management Limited, 55 Gracechurch Street, London, EC3V 0RL. Authorised and regulated by the Financial Conduct Authority, firm reference number 141665. A subsidiary of The Royal London Mutual Insurance Society Limited.
 This is an actual Gas Network Bond, we have not disclosed the issuer name