China Southern Asset Management: Application of a carbon emissions database

Provide a short overview of the practice, process or product that is being proposed for the award, including a description of how it is an innovative approach to ESG incorporation and its coverage within your firm.

With climate change becoming a global issue, interest in net-zero-aligned investing is growing. Given carbon emissions are one of the most important factors behind climate change, and can easily be modelled and quantified, we can use them in the investment process to identify climate risks and opportunities, as well as track progress on the green transition. Southern Asset Management (SAM) is one of the first Chinese asset managers to establish a carbon emissions database covering all equity portfolios.

As carbon data disclosure is limited in the A-share market, we obtained data from several third-party data providers to build a carbon emissions database based on Gradient Boosting Decision Tree (GBDT) models and economic activity-based models using factors from environmentally-extended input-output (EEIO) tables. Our carbon emissions database is aligned with the Partnership for Carbon Accounting Financials (PCAF) methodology. We compiled data from companies that disclose carbon emissions and classified these into sub-sectors. We identified their energy structures, geographic factors, and levels of corporate activity to simulate corporate-level carbon emissions in each sub-sector, including direct emissions, indirect emissions, and carbon intensity.

SAM’s carbon emissions database enables our research teams to combine quantitative analysis and active research to adjust the investment ratio of high pollution companies and achieve portfolio decarbonisation in situations with poor data quantity and quality.

Describe why you decided to undertake this approach.

As a responsible institutional investor, SAM is highly concerned with climate change issues and China’s dual carbon target (that China will peak carbon emissions before 2030 and achieve carbon neutrality by 2060). We play a leading role in the climate transition by directing financial resources to sustainable investment. As China is an emerging market for sustainable investment, there is a lack of ESG data disclosure in the Chinese A-share market compared with other mature markets, especially carbon emissions data. According to the 2021 Carbon Rating Report of China’s 100 Overseas Listed Companies, only about 20% of A-share listed companies disclose information relating to climate change and carbon emissions. Since China has not yet established a unified and standardised ESG disclosure system, the poor ESG data performance in China’s A-share market seriously restricts asset managers from developing a net-zero alignment of portfolios. As climate transition encompasses a high degree of uncertainty, companies with higher carbon emissions may face higher transition risks due to more stringent environmental regulation. As a long-term investor, SAM fully understands the importance of incorporating climate data into equity portfolios to identify climate-change-related risks and opportunities. To achieve carbon neutrality in our investments as quickly as possible, we track and forecast carbon emissions so we can make the necessary adjustments to our portfolios. Our self-established carbon emissions database serves as a dynamic tool to track the progress of companies’ carbon reduction efforts. It provides comprehensive and practical information for qualitative analysis and proactive research.

Provide a practical example of how you have applied your approach to an investment (security/issuer/sector/asset class/portfolio).

Integrated into our ESG rating system

SAM has integrated our carbon emissions database into our ESG rating system, which increases the importance of climate factors. We use AI algorithms to train all data and unlock the complicated non-linear relationship between carbon emissions and emission features. This helps us monitor corporate carbon emissions and our equity portfolios’ carbon footprints. Currently, a significant challenge is that data acquisition and estimation methods are not consistent, so we compare data sources from several international and domestic third-party institutions, combined with the characteristics of the Chinese market, to establish our data evaluation system. Based on the self-established database, we complete the measurement of carbon emissions of equity portfolios and compare it with an industry benchmark, so that we can proactively adjust the asset allocation of our portfolios to reduce our exposure to carbon. Our approach has led to significant progress. Target weighted average carbon emissions in our portfolios are lower than industry benchmarks, particular in the coal, oil & gas, and transportation sectors, in which the ratios are 26.32%, 55.27%, and 6.51% respectively. At this stage, our carbon emissions database covers all equity portfolios and some fixed income portfolios. However, due to a lack of data on fixed income assets, we are unable to measure carbon emissions data for all fixed income portfolios. In the future, we will continue to promote the carbon emissions database to achieve net-zero targets for all portfolios.

Combined with the stewardship strategy

SAM’s carbon emissions database helps us formulate engagement targets. As a signatory of Climate Action 100+, we use collaborative engagement to encourage the world’s largest corporate greenhouse gas (GHG) emitters to take action on climate change. SAM also leverages individual engagement with companies that have the highest carbon emissions, according to our database. We hand out questionnaires to enrich our understanding of companies’ carbon emissions. We also offer companies suggestions about climate transition activities and reducing GHG emissions to achieve the dual carbon target.

Provide an example of the outcomes, outline the benefits and challenges associated with the introduction of this initiative, and state what you have learned from this approach that can be applied more broadly. How might you intend to develop the process or practice?

Achievements

Through external data collection and independent R&D, SAM’s carbon emissions database calculates the portfolio’s carbon emissions based on the PCAF standard. The rating level of our carbon emissions data has reached the international standard level 2 to 3 (scores are on a scale of 1-5; the smaller the number, the higher the quality of the data). By analysing absolute emissions and relative carbon intensity in the carbon emissions database, users can understand the emissions situation of various industries, analyse the carbon emission efficiency of companies, and revaluate investment portfolios. Using our self-established carbon emissions database, SAM has successfully helped reduce carbon emissions in several high-emission sectors compared with the industry benchmark, including coal, oil & gas, and transportation.

Strengths

SAM’s improvement on its ESG integration strategy by building a carbon emissions database is cutting-edge for the entire Chinese market, as it fully integrates quantitative analysis with active research for investment. Even with insufficient carbon disclosure in the A-share market, we can still comprehensively analyse the transition risks relating to climate change, and optimise our investment strategies. To improve the reliability and accuracy of the database, we classify data into different categories, including verified data (e.g., CDP), disclosed data, feedback from engagement, and estimated value. We assign them various weights to increase the credibility of the ESG assessment. We also incorporate EEIO analysis into our carbon emissions database, which allows us to assess climate change from both environmental and socioeconomic perspectives. A more accurate and comprehensive database can provide multi-dimensional information to research teams.

Challenges

The small-scale and low-quality data in the A-share market have become a bottleneck for investors. Therefore, our estimates model is based on global research of carbon emissions databases. By combing global benchmarks, as well as the characteristics of the Chinese market, we estimate the carbon emissions of all investment targets in the A-share market. However, there may be a bias in the estimated data compared with the actual carbon emissions of companies.

Next steps

Achieving portfolio net-zero seems like a significant task, as historical carbon data is limited in the A-share market and ESG disclosure standards are still being developed. We are fully aware that many climate-related risks and opportunities will be idiosyncratic, materialising from company-level revenues and expenses associated with the low-carbon transition and physical climate events. In the future, as a responsible investor, we will further refine carbon disclosure requirements in line with the TCFD and CDP’s recommendations. We will also improve our climate-related data pool to enhance our portfolios’ resilience against climate change, so that we can set up a net-zero pathway for our portfolios.