trucostifc emerging markets report
TRANSCRIPT
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Cro R &Oore Emer Mre
www.trucost.com
Ocoer 2010 CaRbOn Risks &
OppORtunitiEs in
EMERging MaRkEts
Trucost study on the exposure o dierentregional equity strategies to carbon costs
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This report analyses how equity portolios ollowing dierent regional strategies could be exposed
to carbon costs, ocusing on emerging markets. Carbon-intensive companies will increasingly
pay to reduce or emit greenhouse gas (GHG) emissions under government policies and mechanisms
such as perormance standards, emissions trading and carbon taxes. The analysis covers listed equity
portolios, excluding the implications o carbon-related risks or allocations across other asset classes.
Trucost has measured the carbon ootprint1 o a typical emerging markets portolio benchmarked
against the S&P/IFCI LargeMidCap Index. The study examines opportunities or und managers to
manage nancial risk rom rising carbon costs by tilting their portolios toward more carbon-ecient
companies in emerging markets, whilst maintaining nancial perormance consistent with the market
benchmark. Trucost analysed the carbon ootprint o the S&P/IFCI Carbon Ecient Index, whichenables investors using the index as a benchmark to shit assets towards carbon-ecient companies.
This could help encourage listed companies in emerging markets to compete or capital on carbon
eciency and make the transition towards low-carbon uels, technologies and processes.
Key fs:
Companies in the S&P/IFCI LargeMidCap Index emit 563 metric tonnes o GHGs, measured
in carbon dioxide equivalent (CO2e), per US$ million o revenue on average. Emerging-market
equity unds could be more exposed to rising carbon costs than portolios benchmarked against
developed market indices such as the S&P 500 and MSCI Europe. However, the S&P/IFCI
Carbon Ecient Index, which contains the same constituents as the S&P/IFCI LargeMidCap, but
with index weight adjustments to reduce exposure to carbon emissions, has a smaller carbon
ootprint at 440 tCO2e/US$ mn.
Based on wide variations in the carbon intensity o companies in sectors in the S&P/IFCILargeMidCap Index, the S&P/IFCI Carbon Ecient Index overweights carbon-ecient
companies and underweights those with relatively high carbon intensities. Investors that use the
S&P/IFCI Carbon Ecient Index as a benchmark could reduce the carbon ootprints o typical
equity portolios invested in emerging markets by 22%. This would reduce portolio exposure to
carbon costs while maintaining sector and market weights.
Carbon costs associated with companies in the S&P/IFCI LargeMidCap Index could equate to
up to 3% o revenue i emerging market companies had to pay US$22 per tonne or 4% o their
projected direct emissions in 2013. Carbon exposure would vary signicantly at a company
level. The rm with the greatest prot risk rom carbon costs could see earnings all by more
than 97%. At US$108 per tonne o CO2e in 2030, carbon costs could equate to 20% o revenue
or one company, and more than 100% o EBITDA or 16 rms.
Carbon costs could equate to more than 5% o earnings or 24 companies in the Utilities, BasicResources, Oil & Gas, Construction & Materials and Travel & Leisure sectors in 2013, and or 84
companies in 2030. Carbon-intensive companies could nd it dicult to pass on carbon costs
without losing market share.
I companies in the ve carbon-intensive sectors had to pay or all o their current emissions,
portolios could be exposed to US$7,964 in carbon costs or every US$ million invested.
However, reweighting holdings based on carbon eciency in line with the S&P/IFCI Carbon
Ecient Index could reduce exposure to carbon costs by 20%, to US$6,402/US$ mn.
A back-test showed that the S&P/IFCI Carbon Ecient Index matches the nancial perormance
o the S&P/IFCI LargeMidCap Index, with an annualised tracking error o 1.41%. Large
institutional investors can thereore reduce exposure to carbon costs in emerging markets while
replicating the return prole o the underlying Index.
ExEcUTivE SUmmARY
Key fs
Carbon ootprint
o the S&P/IFCI
LargeMidCap
Index
563 tonnes o
CO2e/US$ mn
Number o
companies
analysed inthe S&P/IFCI
LargeMidCap
Index
788
Carbon ootprint
o the S&P/IFCI
Carbon Ecient
Index
440 tonnes o
CO2e/US$ mn
Carbon saving
rom S&P/IFCI
Carbon Ecient
Index
22%
Back-test o
the nancial
perormance
o the S&P/IFCI
Carbon Ecient
Index against
parent Index
1.41%
tracking error
1 Measured as greenhouse gas emissions in carbon dioxide equivalent (CO2e) per US$ mn of revenue associated with
companies. Carbon footprints of indices and portfolios provide an indicator for exposure to carbon costs.
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CARbON iNTENSiTyAS A pROxy fORCARbON RiSk
potenta nanca eosre to
caron costs at a coman or
sector eve can e assessed ased
on caron ntenst measred
as emssons reatve to revene.
Comanes that are ess deendent
on sng es and rocesses that
emt hgh eves o GHGs cod
ace ess ward rcng ressre
and gan comettve advantage.
Throghot ths reort, caron
rss reer to eosre to caron
costs nder regator measres
sch as erormance standards and
emssons tradng, rather than the
costs o damages rom the hsca
macts o cmate change.
ExpOSURE TO cARBOn RiSKSin EmERging mARKETS
Emerging markets are becoming a core part o institutional investment unds.2 Growing
asset fows to developing economies such as China, India and Brazil refect und manager
expectations that they are well positioned to deliver the required returns, compared to many
developed markets with subdued growth prospects. About 60% o European pension plans
now have exposure to emerging markets through debt or equity markets.3 Over 42% o large US
institutional investors surveyed by Bank o America Merrill Lynch planned to increase exposure to
emerging markets equities, seen as the most desirable asset class.4
A large share o global production now takes place in emerging markets, where many
companies currently have stronger cash fows and greater nancial resources than many o their
sector peers in developed markets.5 Rapid economic growth and high commodity prices haveboosted transnational corporations in developing economies particularly Brazil, the Russian
Federation, India and China.6
However, a large share o assets are allocated to resource- and carbon-intensive companies.
This could present nancial risks to investors as many large emerging market countries take action to
reverse a trend o rising greenhouse gas (GHG) emissions. The United Nations Copenhagen Accord
o December 2009, backed by 114 countries, marks a step towards an international agreement to
replace UN Kyoto Protocol carbon reduction targets which cover the commitment period 2008 to
2012.7,8 Industrialised countries need to reduce emissions by 25-40% below 1990 levels by 2020 and
80-95% by 2050 to contribute to global emission reduction goals (see Cuts in emissions to stabilise
greenhouse gases on page 5). However, 70% o projected global emissions will be generated in
developing countries by 2050. Many emerging markets are now among the biggest carbon emitters
and their emissions are rising rapidly. Pressure is thereore mounting or policy makers in severalrapidly growing emerging market countries to limit emissions growth. Developing countries need to
reduce emissions by 15-30% below business-as-usual levels by 2020.9
The BASIC countries Brazil, South Arica, India and China helped shape the Copenhagen
Accord and have since set targets to reduce emissions by 2020 (see National emission reduction
targets and policy measures on page 6). Many climate change policies support wider goals
such as energy security, pollution abatement, green growth, resource-ecient production and
sustainable development.10 Shiting economies to low-carbon growth will require signicant action
by high-emitting sectors.
Several planned policy measures will set perormance standards and create a monetary cost
or carbon in order to create an incentive or energy- and carbon-intensive companies to invest
in low-carbon inrastructure, technologies, uels, materials and processes to reduce emissions.
Companies in carbon-intensive industries could also incur carbon costs through proposed
border taris on imports to developed countries with stricter GHG controls. Carbon-intensive
manuacturers that supply companies in developed countries could also lose market share as their
customers target carbon hotspots to reduce emissions rom their supply chains.
Changing cost structures or industries to place the economy on a low-carbon trajectory will
see carbon-intensive companies most exposed to rising carbon costs, while carbon-ecient
companies gain a competitive edge. This would have nancial implications or equity por tolios.
2 http://www.institutionalinvestor.com/Article.aspx?ArticleID=2585783, accessed 11 August 2010
3 http://www.mercer.com/assetallocat ion, accessed 9 August 2010
4 http://www.institutionalinvestor.com/Article.aspx?ArticleID=2585783, accessed 11 August 2010
5 http://www.enancialnews.com/story/2010-02-22/banks-get-emerging-markets-lift,accessed11August2010
6 http://www.unctad.org/en/docs/wir2010_en.pdf, accessed 11 August 2010
7 As of 19 August 2010, a total of 138 countries have expressed their interest to be listed as agreeing to the Accord.
8 http://unfccc.int/resource/docs/2009/cop15/eng/11a01.pdf,accessed20July2010
9 http://www.unep.org/climatepledges/, accessed 20 August 2020
10http://www.greengrowth.org/policies.asp,accessed21July2010
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CuTS iN EMiSSiONSTO STAbiliSEGREENHOuSE GASES
Goa emssons w have to ea
2020 and a 50% eow 1990
eves 2050.11 Ths 2-3% anna
ct n emssons cod stase GHG
concentraons in the atmosphere
at 450 arts er mon (m), and
provide a 50% chance of liming
a goa average temeratre
rse to 2C aove re-ndstra
eves. Deang goa emsson
reducons unl 2030 would require
4-5% annual emission reducons
to stabilise GHG concentraons at
550 arts er mon. Ths wod
rovde a 50% chance o a 3C
average goa temeratre rse,
wth the rs o more severe and
cost cmate change macts.12
GHGconcentraons are currently 387 ppm
and rsng at aot 2 m a ear.
The onger acton s deaed,
the more rad emssons w
need to e redced and the
hgher the cost o mtgaton.
Greater energ ecenc, demand
management and deoment o
estng ow-caron eectrct
sorces cod dever aot ha o
the required emission reductions
as we as nanca savngs.
indstr and the ower sector
cod redce energ consmton
20-30%, sng estng
technooges and est ractce.13
The eanson or reacement
o cata stoc rovdes an
oortnt to nvest n ow-caron
equipment and infrastructure.
Ths can mnmse mtgaton costs
and avod oc-n to a hgh-caron
trajector that wod e more
eensve to adjst n the tre.
Environmental data provider Trucost assessed potential carbon risks and opportunities
or listed equity portolios ollowing dierent regional strategies, but excluded an assessment
o carbon-related risks associated with allocations across various asset classes. The analysis
ocuses on exposure to carbon costs among typical emerging market portolios, based on the
carbon perormance o companies in the S&P/IFCI LargeMidCap Index as a benchmark. Trucost
also analysed the S&P/IFCI Carbon Ecient Index, which aims to replicate the return prole o
the S&P/IFCI LargeMidCap, but with lower exposure to carbon emissions than the parent index.
Market weights within the S&P/IFCI Carbon Ecient Index are greatest or China, India, Brazil,
the Republic o Korea and Taiwan. Shiting investment to carbon-ecient companies could help
reduce their cost o capital. Providing a nancial incentive or listed companies in emergingmarkets to improve their carbon eciency could promote uptake o low-carbon uels, technologies
and processes as emerging-market companies compete or capital on carbon eciency.
mAnAging Und ExpOSURE TO cARBOn cOSTS
Mitigation policies present new opportunities and risks or investors. Investors can benet
rom emission reductions in emerging markets through nancial products including
investment in climate change-themed unds and green bonds. Many institutional
investors are increasing exposure to equity indices and investment tools ocused on
companies delivering low-carbon, energy-ecient inrastructure and technologies such
as renewable energy.
However, the relatively small size and liquidity o many o these companies limits
the size o investments in them. In addition, niche investment strategies can only make
up a proportion o assets owned by institutional investors who have a duciary duty to
diversiy investments in order to reduce nancial risk and achieve broad market returns.
A greater share o mainstream assets thereore continues to be allocated to carbon-
intensive, long-lived inrastructure such as ossil uel-based power stations, energy-
intensive buildings and high-carbon industrial plants. This leaves asset owners invested
in broad, carbon-intensive unds exposed to rising carbon costs under government
policies that price carbon. The S&P/IFCI Carbon Ecient Index provides long-term
investors with access to carbon-ecient companies to help manage nancial risk rom
corporate greenhouse gas emissions.
11http://ec.europa.eu/environment/climat/future_action.htm,accessed20July2010
12WorldBank,WorldDevelopmentReport2010,DevelopmentandClimateChange,2010
13WorldBank,WorldDevelopmentReport2010,DevelopmentandClimateChange,2010
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natoa esso reuto tarets a oy easures
Copenhagen Accord pledges Climate change policies include:
China Reduce CO2 emissions per unit o
GDP by 40-45% by 2020 compared
to 2005 levels.
Pilot carbon trading programmes
in several cities and provinces.14
Possible carbon tax on ossil uels.15
Penalties or closure o energy-
wasting and polluting plants.16
India Reduce the emissions intensity o GDP by 20-25% rom 2005 levels
by 2020.
Carbon tax on coal. Mandatory ueleciency standards.17
Brazil Reduce GHG emissions by 36.1-
38.9% rom projected 2020 levels.
This equates to about a 20% cut in
emissions rom 2005 levels.
Reduce deorestation in the Amazon.
Improve energy eciency. Increase
use o biouels. Develop alternative
energy sources.18
Republic o Korea Reduce GHG emissions by 30%
below business-as-usual levels by
2020. This equates to a 4% cut in
emissions rom 2005 levels.
Planned emissions trading
programme and possible carbon
tax.20
South Arica Reduce GHG emissions by 34%below business-as-usual levels by
2020 and 42% below by 2025. This
equates to a 1% emission reduction
rom 1990 levels.
Feed-in tari where prices paid togenerators o renewable electricity
are higher than those paid to ossil
uel-based suppliers.21 Carbon
taxes.22 Fuel eciency standards.23
Taiwan Reduce GHG emissions to 2005
levels by 2020, and to 2000 levels
by 2025.
Levies on energy and carbon dioxide
emissions.24 Feed-in-tari. Planned
emissions trading system.25
14CarbonexchangeskeyinChinalowcarbonplan,PointCarbon;Govtselectspilotcarbonreductionlocations,ChinaDaily,19
August 2010
15Carbontaxlikely,expertforecasts,ChinaDaily,10May2010
16Chinaordersheavyindustrytoshutoldplants,PointCarbon,9August2010
17http://moef.nic.in/downloads/public-information/India%20Taking%20on%20Climate%20Change.pdf,accessed20August
2010
18http://unfccc.int/les/meetings/application/pdf/brazilcphaccord_app2.pdf,accessed20August2010
19FactboxS.Koreamovestowardcap-and-trade,ThomsonReuters,4May2010
20SouthKoreamullscarbontax,PointCarbon,17February2010
21http://www.renewableenergyworld.com/rea/news/article/2009/04/south-africa-introduces-aggressive-feed-in-tariffs,accessed
20 August 2010
22SouthAfricamaybenetfromcarbontax:OECD,PointCarbon,20July2010
23Motlanthebackscarbontax,Mail&Guardianonline,10August2010,http://www.mg.co.za/article/2010-08-10-motlanthe-
backs-carbon-tax,accessed20August2010
24TaiwanplanstaxesforenergyandCO 2emissionsby2011,BusinessGreen,20October2009
25TaiwanstartsregulatoryETSprocess,PointCarbon,3September2010
Brazil, the Republic
o Korea and South
Arica plan to cut
emissions by at
least 30% rom
business-as-usuallevels.
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TRuCOSTMETHODOlOGy TOMEASuRE CARbONfOOTpRiNTS
The caron ootrnts o the
ndces are cacated aocatng
tonnes o CO2e emssons rom
each consttent coman toeach nde. The anass ncdes
emssons rom oeratons as
we as those rom drect (rst-
ter) sers sch as eectrct
and ogstcs rovders. Caron
ootrnts are measred as
tonnes o CO2e er mon uS
Doars o revene. The weghted
GHG emssons and revenes
rom comanes n each nde
are smmed to cacate the
tota caron ootrnts o ndces.
Ths aroach to assess caronootrnts aows or comarson
o a ndces and ortoos,
regardess o sze. To nd ot more
aot Trcosts methodoog, see
Aend 1 on age 19. Trcost
and Standard & poors (S&p)
se derent methodooges to
measre caron ootrnts o
ndces.27 Other organsatons
ma se derent methodooges
to measre ortoo and nde
caron ootrnts.
ScOpE O STUdY
Trucost analysed the GHG emissions o 788 o almost 800 companies listed in the S&P/IFCI
LargeMidCap Index, based on constituent data as o 30 June 2010. 26 Their market capitalisation
o more than US$8 trillion represents over 99% o the value o the Index. Trucost analysed the
latest available data in its database o corporate GHG emissions, measured in carbon dioxide
equivalent (CO2e). Data analysed in this report is not ree-foat adjusted. The carbon perormance
o indices is measured as quantities o GHG emissions relative to revenue. This is the standard
metric used to assess the carbon ootprints o portolios (see Trucost methodology to measure
carbon ootprints).
The analysis includes:
Comparison o the carbon eciency o portolios benchmarked against the S&P/IFCI
LargeMidCap Index, S&P/IFCI Carbon Ecient Index, MSCI All Country World Index, MSCI
Europe, S&P 500 and MSCI Asia ex-Japan Index. Equity portolios with regional strategies that
track these indices or use them as benchmarks could ace similar levels o exposure to carbon
costs, indicated by the size o carbon ootprints.
Assessment o variations in the carbon eciency o sectors across dierent geographies.
Breakdown o absolute emissions rom companies in the S&P/IFCI LargeMidCap Index by source.
Analysis o potential exposure to carbon costs.
Overview o opportunities to reduce carbon exposure in emerging market unds based on the
variation in the carbon intensity o companies within sectors.
Historical analysis o the nancial perormance o the S&P/IFCI Carbon Ecient Index
compared with the underlying S&P/IFCI LargeMidCap Index.
Analysis o company disclosures o GHG emissions in dierent regions.
Overview o major environmental impacts o companies in the S&P/IFCI LargeMidCap Index.
26DataonmarketcapitalisationwasnotavailablefortheremainingIndexconstituents,whichwerethereforeexcludedfrom
theanalysis.Theyrepresentlessthan1%ofthevalueoftheIndex.
27http://www.standardandpoors.com/indices/sp-ifci-carbon-efcient/en/us/?indexId=sp-ifci-carbon-efcient,accessed
5 October 2010
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cARBOn EiciEncY O EmERgingmARKET STRATEgiES
The S&P/IFCI LargeMidCap Index had a carbon ootprint o 563 tonnes o CO2e per US$
million. The range in the carbon ootprints o indices shown in Table 1 indicates that typical
emerging market equity portolios would have larger carbon ootprints than those invested in
developed markets.
Tabe 1: Rak o es by arbo ootrt
Typical regional equity
strategy
Benchmark Index Carbon ootprint (tonnes
o CO2e/US$ mn)
US large cap S&P 500 354
Europe large cap MSCI Europe 356
Developed and emerging
market large cap
MSCI All Country World 360
Emerging market carbon-
efcient large and mid cap
S&P/IFCI Carbon Efcient 440
Developed and emerging
markets in Asia
MSCI Asia ex-Japan 533
Emerging market large and
mid cap
S&P/IFCI LargeMidCap 563
Funds with emerging markets strategies could be more exposed to carbon costs under policy
measures and mechanisms such as energy eciency standards, emissions trading and carbon
taxes. However, the carbon ootprint o the S&P/IFCI Carbon Ecient Index is 22% smaller than
that o the S&P/IFCI LargeMidCap Index, used as its benchmark. The S&P/IFCI Carbon Ecient
Index is constructed around substantial variations in the carbon intensity o companies within
sectors in the underlying S&P/IFCI LargeMidCap Index (see page 15). To create the S&P/IFCI
Carbon Ecient Index, stocks in sectors that include both high and low polluters were reweighted
based on their carbon intensities. Holdings were rebalanced within each sector by overweighting
companies that are carbon ecient relative to industry peers, and underweighting those that are
more carbon intensive. The proportional market weights o the underlying Index were maintained.
Equity portolios that are associated with less carbon emitted by holdings could be less
exposed to carbon costs. However, screening out carbon-intensive sectors is not an option or
institutional investors that have a duciary responsibility to achieve market returns. By reducing
exposure to carbon through stock e ects while maintaining sector weightings, the S&P/IFCI
Carbon Ecient Index allows or a broad market strategy with diversication.28
Stok a setor aoato eets o arbo erorae
Stock eects drive the greater carbon eciency o the S&P/IFCI Carbon Ecient Index
relative to its benchmark Index. The inclusion o relatively low-carbon stocks in the S&P 500,
MSCI Europe and MSCI All Country World Index (ACWI) would also contribute to portolios in
developed markets being more carbon ecient than typical passive emerging market strategies.
Indices and unds with larger carbon ootprints include companies that are relatively carbon
intensive. Companies in emerging markets have a higher average carbon intensity than theirdeveloped market peers in several sectors. For instance, Basic Resources stocks in the S&P/IFCI
28 http://www.ifc.org/climatechange, accessed 4 October 2010
Equity portolios
with smaller carbon
ootprints could be
less exposed to
carbon costs.
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Cro R &Oore Emer Mre
LargeMidCap Index emitted 2,021 tCO2e/ US$ mn on average, whereas sector peers in the S&P
500 Index emitted 1,554 tCO2e/US$ mn. Chart 1 below compares the average carbon intensity o
the ve most carbon-intensive sectors in the S&P/IFCI LargeMidCap Index against sector peers in
the other indices analysed.
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
Utilities Basic Resources Construction & Materials Travel & Leisure Oil & Gas
CARBON
INTENSITY(TCO2E/US$MN)
MSCI World
MSCI Europe
S&P 500MSCI Asia ex-Japan
S&P/IFCI LargeMidCap Index
S&P/IFCI Carbon Efficient Index
Chart 1:Comparison of carbon intensity of indices in top 5 sectors
Source: Trucost Plc
Reweighted securities in the Utilities, Basic Resources and Construction & Materials sectors in
the S&P/IFCI Carbon Ecient Index are signicantly more carbon ecient than sector peers in the
underlying Index. For instance, Utilities have an average carbon intensity o 3,001 tCO2e/ US$ mn
in the Carbon Ecient Index, compared with 4,832 tCO2e/ US$ mn in the benchmark sector.
Utilities have the greatest range in average carbon intensity across the indices (1,510 tCO 2e/
US$ mn in the MSCI Europe vs. 6,433 tCO2e/ US$ mn in the MSCI Asia ex-Japan Index). Although
variations between Oil & Gas companies in dierent indices appear relatively small given the
scale o the carbon intensity axis, there is a 40% dierence between the highest and lowest
average carbon intensities (390 tCO2e/ US$ mn in the MSCI Europe vs. 546 tCO2e/ US$ mn in the
S&P 500 Index).
Some variations in carbon intensity may be due to diversied sources o revenue or companies
in certain sectors. For instance, the India-based conglomerate ITC Ltd has a large carbon ootprint
relative to the average or Personal & Household Goods companies in the MSCI ACWI due to
multiple business activities ranging rom paper manuacturing to cigarette production.
The high average carbon intensity o Utilities and Basic Resources companies in the MSCI Asia
ex-Japan Index refects a high dependence on coal in the energy mixes o countries such as China
and India. Companies in the MSCI Asia ex-Japan Index are more carbon-intensive than those in the
S&P/IFCI LargeMidCap Index overall. This has a negative eect on its carbon perormance against
the emerging markets index. Portolios invested in Asian markets (excluding Japan) could thereore
include more carbon-intensive stocks than those invested in the wider emerging markets, withholdings in regions including South America, Arica, Eastern Europe and the Middle East.
Reweighted utilities
in the S&P/IFCI
Carbon Ecient
Index are more
carbon ecient than
sector peers.
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However, a lower weighting o constituents in carbon-intensive sectors in the MSCI Asia
ex-Japan Index results in a positive sector allocation e ect on its carbon perormance against
the S&P/IFCI LargeMidCap Index. An underweight position in carbon-intensive sectors also
contributes to the carbon eciency o the S&P 500 and MSCI ACWI relative to the S&P/IFCI
LargeMidCap Index. This refects the tendency or investors in emerging markets to increase
diversication and exposure to natural resource and production sectors.29
The over-representation o carbon-intensive sectors in the S&P/IFCI LargeMidCap Index
is shown in Chart 2. The Index is overweight in relatively high-carbon sectors such as Basic
Resources and Oil & Gas compared with the other indices analysed. For instance, the value o
Basic Resources securities is greater in the S&P/IFCI LargeMidCap Index than in the MSCI AllCountry World Index (12% vs. 4%).
Index equity unds invested in emerging markets would be more exposed to carbon-intensive
sectors than developed market equities. For institutional investors that need to maintain sector
weights, this increases the importance o the carbon intensity o holdings within sectors and
related exposure to carbon costs.
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
S&P/IFCI
LargeMidCap
S&P/IFCI Carbon
Efficient
S&P 500 MSCI Asia
ex-Japan
MSCI Europe MSCI ACWI
High carbon
Medium carbon
Low carbon
SECTORWEIGHTINGS
Chart 2 :Index sector weighting by carbon intensity
Source: Trucost Plc
29Source;StateStreetGlobalAdvisors(2010)theAppealofEmergingMarketsEquitiesinanAssetAllocationFramework30FinancialServiceshasahighercarbonfootprintthanbanksbecausesomermsinthesectorhavemorediversied
operationsandaremuchmorecarbonintensivethananyofthebanks.Forinstance,BradesparS.A.isaholdingcompany
with investments in mining and has a carbon footprint of over 870 tCO2e/US$mn.Themostcarbon-intensivebankhasa
footprint of 83 tCO2e/US$ mn.
Key: Classifcation o sectors bycarbon intensity
High carbon
(>475 tCO2e/
US$ mn)
BasicResources
Chemicals
Construction&
MaterialsOil&Gas
Travel&Leisure
Utilities
Medium
carbon(88-
475 tCO2e
Automobiles&Parts
Financial Services30
Food&Beverage
IndustrialGoods&Services
Personal&HouseholdGoods
Technology
Lowcarbon
(
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Companies analysed in the S&P/IFCI LargeMidCap Index together emitted a total o 3.8 billion
tonnes o CO2e annually. This equates to 43% o the total GHG emissions rom companies in
the MSCI ACWI. The analysis includes gases emitted rom the worldwide operations o multinational
companies, not just those released in emerging markets.
As shown in Chart 3, 78% o emissions (2.98 billion tCO2e) were directly rom operations. These
GHGs known as Scope 1 under the Greenhouse Gas Protocol corporate accounting standard31
are largely emitted through uel combustion and industrial processes owned or controlled by the
companies. This refects the rise in heavy industry and other manuacturing in countries such as
China and India.
The remaining 22% o emissions were rom purchased electricity (Scope 2) and other direct (rst-
tier) suppliers, such as transport and logistics providers. Service-based rms were mainly responsible
or emissions through purchases o electricity and other outsourced goods and services.
Many o the GHGs analysed were likely to be generated rom the production o goods or
export, and thereore represent the supply chain emissions o many companies in industrialised
countries. This is refected in the breakdown o GHG emissions rom companies in the S&P 500
Index, where a larger share o emissions (23%) were rom rst-tier direct suppliers.
16%
6%
78%
S&P/IFCI LARGEMIDCAP S&P 500
23%
11%
66%
Chart 3 :Breakdown of emissions by source Scope 1 direct from operations
Scope 2 purchased electricity
Scope 3 other first tier suppliers
Source: Trucost Plc
cOmpAniES diREcTlY EmiTSigniicAnT gHgS
31DevelopedbytheWorldResourcesInstituteandWorldBusinessCouncilforSustainableDevelopment
78% o greenhouse
gases were directly
emitted by the
operations o
companies in
the S&P/IFCILargeMidCap Index.
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Five sectors emitted 86% o emissions rom the Index: Utilities, Basic Resources, Oil & Gas,
Construction & Materials and Travel & Leisure. The majority o GHGs rom companies in these
sectors were emitted directly rom operations (see Chart 4).
0
Utilities
Basic Resources
Oil & Gas
Construction & Materials
Travel & Leisure
Scope 1
Scope 2
Other first-tier suppliers
TONNES OF CO2E
Chart 4 :
Breakdown of emissions from top 5 sectors
200,000 ,000 400 ,000 ,000 600 ,000 ,000 800 ,000 ,000 1 ,000 ,000 ,000 1 ,200 ,000 ,000
Source: Trucost Plc
Companies in ve
sectors emitted 86%
o greenhouse gases
rom the Index.
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The ndings suggest that emissions-intensive companies in emerging markets are mainly
exposed to carbon costs internalised through their operations, rather than those passed on by
suppliers in higher prices. To model potential exposure to carbon costs among the 788 companies
analysed in the S&P/IFCI LargeMidCap Index, Trucost thereore applied carbon prices to their
direct Scope 1 GHG emissions.
Future carbon costs incurred by the companies are likely to refect emission reduction targets
in emerging markets. Several emerging market countries aim to reduce emissions by at least 30%
below BAU levels by 2020 (see page 6). To achieve the 30% cut, BAU emissions would need to all
by 4% annually rom 2013 onwards.In line with this, Trucost assumed companies would only pay a carbon price or abatement
costs or 4% o their projected annual emissions under climate change policies in emerging
markets. The analysis assumes that companies direct emissions could rise by 59% rom 2007
levels by 2030. This is in line with the increase in carbon dioxide emissions rom energy use in
non-OECD countries projected by the US Energy Inormation Administration (May 2010).32 Trucost
modelled carbon exposure using two scenarios:
Searo A 2013:
Assumes a 10% increase in projected emissions rom companies in the Index to
3,276,784,869 tonnes o CO2e by 2013.
Applies a traded carbon price o US$22 per tonne o CO 2e. This is based on the average price
o EU Allowances or 2013 under the EU Emission Trading System over the three months to
7 September 2010.33
Searo B 2030:
Assumes a 57% increase in projected emissions rom companies in the Index to
4,676,865,677 tCO2e by 2030.
Applies a carbon price o US$108 per tonne based on valuations used in UK Government policy
appraisals rom June 2010.34 This is the central estimated traded price o carbon, assuming the
development o a global carbon market. Carbon price estimates range rom US$53-US$162
per tonne.
Tabe 2: poteta eosure to arbo osts S&p/ici laremca ie
Carboncosts
(US$ mn)
Carbon costs as % orevenue
Carbon costs as % oEBITDA
Lowest Average Highest Lowest Average Highest
Scenario A 2013
(US$22/tCO2e)
2,884
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ACCESS TO CARbONMARkETSThe CDM aows emsson-
redcton rojects n deveong
contres to earn certed
emsson redcton (CER) credts,
each equivalent to one tonne of
CO2e. Chna has sod the argest
vome o CERs nt now. The
man ers have een comanes
n Eroe that se CERs to he
meet emssons cas nder the
Eu Emsson Tradng Sstem (Eu
ETS).35 However, greater restricons
on CER morts nto the Eu ETS,
and on the egt o certan
contres and sectors nder the
CDM, could limit access for rms
n more ndstrased economes
sch as the bASiC contres, Meco
and Soth korea. least deveoed
contres cod thereore e est
aced to access the CER maret
drng the thrd hase o the Eu ETS
rom 2013 to 2020.
equate to less than 0.01% o revenue or some companies. However, the company with the highest
nancial risk rom emissions could see carbon costs equate to up to 3% o sales. At US$108 per
tCO2e, uture carbon costs could equate to up to 20% o revenue at a company level.
For the 709 companies analysed that were protable, carbon costs could equate to 0.3% o
combined earnings beore interest, tax, depreciation and amortisation (EBITDA) on average in
2013. Carbon costs could equate to less than 0.01% o EBITDA or the least exposed companies,
and more than 97% o earnings or the company with the highest exposure. The projected rise in
emissions and carbon costs could increase prot risk signicantly by 2030, when carbon costs
could wipe out 100% o EBITDA or 16 companies.
Actual exposure to carbon costs may vary due to actors including reductions in greenhouse
gas emissions, sector-specic abatement costs, uture earnings, national policy mixes and access
to carbon markets. While emissions trading schemes aim to achieve mitigation cost-eectively
across the economy, delays in implementing cap-and-trade could increase abatement costs.
Companies in some developing countries could partly oset exposure to carbon costs by selling
carbon credits or mitigation projects under the UN Kyoto Protocol Clean Development Mechanism
(CDM).36 With carbon credits trading at almost US$18/tonne o CO2e,37 carbon markets could
present opportunities or some companies to reduce their emissions at little or no cost.
For 196 companies that were protable in the Utilities, Basic Resources, Oil & Gas, Travel &
Leisure and Construction & Materials sectors, carbon costs or 4% o projected emissions could
total over US$2.3 billion in 2013. I these costs were internalised, combined EBITDA would all by
less than 1% on average. However, carbon costs could reduce EBITDA by more than 5% or 24
companies in 2013, and or 84 companies in 2030. Carbon-intensive companies in sectors suchas Basic Resources could nd it particularly dicult to pass on carbon costs without losing market
share, given volatile commodity prices in world markets.
I all o the emerging market companies analysed in these sectors had to pay US$22 or all
o their current direct and rst-tier indirect supply chain emissions, portolios could be exposed
to US$7,964 in carbon costs or every US$ million invested. However, investments in the same
sectors with companies reweighted based on carbon eciency could reduce exposure to
carbon costs by 20%, to US$6,402/US$ mn. Investors seeking to protect risk-adjusted returns in
resource and carbon-intensive industries could reduce exposure to carbon costs by avouring
carbon-ecient companies in emerging markets. Funds that use the S&P/IFCI Carbon Ecient
Index as a benchmark can underweight carbon-intensive companies to manage nancial risk
rom carbon costs.
35 http://www.unfccc.int/resource/docs/publications/cdm_annual_report_2009.pdf, accessed 4 October 2010
36WorldBank(May2010)StateandTrendsoftheCarbonMarket2010
37SecondaryCERstradingat14.09asof7September2010,PointCarbon
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Signicant variation in the carbon intensity o companies in certain sectors in the S&P/IFCI
LargeMidCap Index presents an opportunity to overweight carbon-ecient companies.
Variations in carbon eciency are greatest in the Utilities, Basic Resources, Construction &
Materials, Travel & Leisure and Oil & Gas sectors as shown in Chart 5. Drivers or dierences in
carbon perormance within sectors include varied business activities, production processes, uel
sources and energy eciency.
0
5,000
10,000
15,000
20,000
25,000
30,000
Minimum
Average
Maximum
CARBON
INTENSITY
(TCO2E/US$MN)
Chart 5 :Range in carbon intensity in top 5 sectors
Utilities Basic Resources Construction & Materials Travel & Leisure Oil & Gas
Source: Trucost Plc
The most carbon-intensive companies in the above sectors are shown in Table 3. The weightings
o most o these companies were reduced by almost 50% in the S&P/IFCI Carbon Ecient Index.
Tabe 3: coaes rake botto o arbo testy fe setors
Company Carbon intensity
(tCO2e/US$ mn)
Percentage higher
carbon intensity thansector average
Utilities China Resources
Power Holdings Co. Ltd
29,318 >100%
Basic Resources National Aluminium
Co. Ltd
18,348 >100%
Construction & Materials Ambuja Cements Ltd 9,124 +100%
Travel & Leisure Genting BHD 1,724 +37%
Oil & Gas Essar Oil Ltd 8,176 >100%
The sector and market weights o the underlying Index were largely maintained, but portolio
carbon is reduced signicantly. The carbon ootprint o the resulting S&P/IFCI Carbon Ecient
Index is 22% smaller than that o the underlying index (440 vs. 563 tonnes o CO2e/US$ mn).
REdUcing pORTOliO ExpOSURETO cARBOn EmiSSiOnS
Reweighting
securities based
on carbon
eciency reduced
the Index carbon
ootprint by 22%.
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Rebalancing holdings based on carbon eciency enables investors to reduce carbon risk while
maintaining sector allocations, diversication and benchmark nancial perormance. The S&P/
IFCI Carbon Ecient Index closely tracks the investment perormance o the parent Index.
Prior to the index launch on 11 December 2009, S&P conducted a back-test over more
than three years beginning on 1 November 2006 (see Chart 6). Using daily returns, the S&P/
IFCI Carbon Ecient Index has an annualised tracking error o 1.41% versus the S&P/IFCI
LargeMidCap Index rom the beginning o the back-test period through to 30 June 2010.
On a price return basis, the S&P/IFCI Carbon Ecient Index has declined 3.74% rom the index
launch on 11 December 2009 to 30 June 2010, but has outperormed the S&P/IFCI LargeMidCap
Index by 135 bps. Likewise, during the back-test period, the S&P/IFCI Carbon Ecient Index
returned a cumulative 19.17%, beating the 17.18% return o the S&P/IFCI LargeMidCap Index.
BEncHmARKing pORTOliOS AgAinST cARBOn-EiciEnT indicES
Large institutional investors such as pension and sovereign wealth unds can invest in emerging
markets while managing exposure to carbon costs. As governments in emerging markets come
under pressure to price or regulate GHGs emissions, carbon costs are likely to aect the prot
margins o carbon-intensive companies, causing their valuations to all. However, investors can
access carbon-ecient companies with lower risk rom uture rising carbon costs relative to
their sector peers. The S&P/IFCI Carbon Ecient Index provides an opportunity to replicate the
historical risk return prole o the S&P/IFCI LargeMidCap or emerging markets, with less carbon
linked to holdings. The Index provides a market benchmark to stimulate greater investment fows
to carbon-ecient companies. Long-term investors could allocate assets according to Index
weightings to position their investments or the transition to a low-carbon economy. Funds that shit
investment fows towards carbon-ecient companies will be well placed under carbon constraints.
mAnAging cARBOn RiSK
wHilE mAinTAininginAnciAl pERORmAncE
40
80
120
160
Nov-06 May-07 Nov-07 May-08 Nov-08 May-09 Nov-09 May-10
REBASED
RETURNS(1NOVE
MBER
2006=100)
S&P/IFCI Carbon Efficient
S&P/IFCI LargeMidCap
Chart 6 :Daily price return levels of S&P/IFCI Carbon Efficient Index vs. underlying Index
Historical performance (01 Nov 2006 30 June 2010)
Back-test period
Source: S&P
S&P/IFCI Carbon Efficient
Index launch
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Company disclosures on GHG emissions rom operations can help identiy and manage direct
exposure to carbon costs. Companies that measure their emissions are better placed to
reduce them. Almost two-thirds o GHGs analysed in this study are based on disclosed or par tially
disclosed data. Trucost compiled corporate GHG emissions data rom sources including annual
reports & accounts, environmental and sustainability reports and company websites. Data is
also collected and standardised rom other publicly available environmental reporting sources
such as the Carbon Disclosure Project (CDP). The S&P/IFCI Carbon Ecient Index is supported
by engagement with companies through the CDP and co-sponsored by the IFC to encourage
measurement and disclosure o GHG emissions. Where companies do not disclose adequate
data, Trucost uses environmental proles calculated by its model (see Analysis includes disclosedemissions data). Chart 7 shows the proportion o companies that disclosed Scope 1 emissions
data in each Index.
0%
10%
20%
30%
40%
50%
60%
70%
80%
MSCI Europe
PERCENTAGEOFCOMPANIES
Disclosed
Parally disclosed
Not disclosed
Chart 7 :
Carbon disclosure by Index percentage of companies
S&P/IFCI LargeMidCap MSCI World MSCI Asia ex-JapanS&P 500
Source: Trucost Plc
Four per cent o companies in both the S&P/IFCI LargeMidCap and MSCI Asia ex-Japan
Indices disclosed Scope 1 GHG emissions in line with the Greenhouse Gas Protocol. Their
disclosures accounted or a larger share o GHG emissions analysed (>7%), as shown in
Chart 8 below. This refects the act that companies in carbon-intensive sectors are more likely
to disclose emissions. Companies in the S&P/IFCI LargeMidCap Index that disclosed at least
some inormation emitted the majority (56%) o emissions analysed. Partial disclosures include
inormation that Trucost could use to derive GHG emissions. For instance, quantities o uel use or
electricity consumption were converted using emissions actors.
0%
10%
20%
30%
40%
50%
60%
70%
i i
PE
RCENTAGEOFGHG
EMISSIONS
Chart 8 :
Carbon disclosure by Index percentage of GHG emissionsDisclosed
S&P/IFCI LargeMidCap MSCI World S&P 500 MSCI Europe MSCI Asia ex-Japan
Source: Trucost Plc
diSclOSURE AnAlYSiS
ANAlySiS iNCluDESDiSClOSEDEMiSSiONS DATA
Trcost mantans the words
argest and most comrehensve
dataase o standardsed
cororate GHG emssons data.
The dataase ncdes coman-
secc envronmenta data. Ths
ncdes greenhose gas emssons
data rovded throgh drect
commncatons wth the coman
tse, or dscosed c. Where
a coman on dscoses data or
art o ts overa actvtes, Trcost
ma standardse or normase
quantities in order to calculate
the envronmenta macts o the
snesss entre oeratons n
ne wth envronmenta reortng
standards sch as the GreenhoseGas protoco. Where comanes
do not disclose adequate data,
cororate macts are cacated
sng Trcosts advanced
envronmenta rong mode (see
Aend 1 on age 19).
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Greenhouse gas emissions are the most signicant environmental impact o the companies
analysed in the S&P/IFCI LargeMidCap Index. Trucost applied external prices to each
environmental resource used and pollutant released by the listed companies. The cost
o environmental damages rom business activities are not ully paid by companies using
environmental resources, such as timber and water, or emitting pollutants such as carbon dioxide.
The external cost o using an environmental resource, such as timber, or emitting a pollutant,
such as carbon dioxide, is the cost o environmental degradation and harm to human health.
These costs are largely external to nancial decision-making and represent a ailure o markets
to accurately account or business environmental impacts. However, companies are increasingly
expected to pay the costs o reducing pollution and waste or compensate society or the damagethey cause as governments apply the polluter pays principle through measures such as
environmental liability regulations, emissions trading and taxes.
Pricing resource use and pollution in nancial terms provides a weighting actor to measure
the relative importance o dierent environmental impacts and their potential materiality. Total
environmental external costs associated with companies in the S&P/IFCI LargeMidCap Index
equate to 5% o their combined revenue. Greenhouse gas emissions account or 48% o
environmental costs relative to revenue, as shown in Chart 9.
4%
4%
4%
19%
22%
48%
Chart 9 :
Breakdown of environmental footprint by impact
GHG emissions
Water abstraction
Air pollutants
Waste
Land and water pollutants
Natural resource use
Source: Trucost Plc
The next most signicant environmental impacts o companies in the Index are water
abstraction and air pollutants, such as sulphur dioxide, nitrogen oxide and particulate
emissions. Waste and pollutants such as heavy metals released to land and water account
or 8% o external costs. Inormation on the sources o the top two impacts greenhouse gas
emissions and water abstraction at a sector and company level can be used to target actionto address related risks.
OTHER EnviROnmEnTAl impAcTS
Greenhouse gas
emissions account
or almost hal
o environmental
costs associated
with the Index.
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AppEndix 1: TRUcOST mETHOdOlOgY
Trucost has developed a comprehensive approach to calculating quantitative environmental
impacts across organisations, supply chains and investment portolios. Trucost has analysed
the environmental perormance o more than 4,500 companies worldwide.
Where reported, Scope 1 emissions data are included in Trucosts database. Some companies
analysed also disclose Scope 2 emissions data which were included in the analysis. Where
companies only disclose resource use such as uel consumption, this inormation is used to derive
environmental data where possible.
Analyses o the carbon perormance o companies and portolios includes direct GHGemissions rom operations and those emitted by direct (rst-tier) suppliers. First-tier indirect
emissions arise rom the companys direct suppliers, such as electricity and logistics providers.
Analyses o other environmental impacts include all upstream supply chain impacts, not just those
rom direct (rst-tier) suppliers. Adopting this method prevents companies eectively outsourcing
environmental external costs. For rst-tier supplier impacts and where companies do not disclose
adequate data, GHG emissions are calculated using Trucosts environmental proling model. The
model describes resources used through economic interactions between each sector based on
the latest census data rom the US Bureau o Economic Analysis to analyse interactions between
economic productivity and the environment, adapted to generate global input-output modelling.
Quantitative data on industrial acilities natural resource productivity is combined with
inormation on indicators such as pollutant releases rom national emissions registries including
the US Toxic Release Inventory and Japanese PRTR. The indicators cover the use o resources
such as natural gas liquids, as well as waste production and pollutants such as mercury and GHGemissions. The economic model calculates the quantities o over 740 environmental indicators,
per unit o output. The system is consistent with the United Nations Millennium Ecosystem
Assessment. Overseen by an international academic advisory panel, the model applies prices to
each o the environmental resources and pollutants to analyse, in nancial terms, the economic
and environmental perormance o each sector.
Environmental proling o companies is based on production data to calculate the likely GHG
emissions rom business activities in 464 sectors. Using inormation on a companys revenues in
dierent industries, the model can calculate an organisations likely direct and rst-tier supply chain
emissions, based on industry averages. Inormation on interactions between industries is used
to map each sectors supply chain environmental impacts. Calculations incorporate disclosed
quantitative data on industrial acilities actual resource use and pollutant releases where available.
Analysed companies are invited to provide additional inormation and to veriy environmental prolescreated by Trucost. Analysts quality check any urther disclosures made. Trucosts comprehensive
coverage ensures that all companies in an index or portolio are assessed, regardless o
environmental disclosure levels.
AppEndicES
MEASuRiNG GHGEMiSSiONSNne GHGs are ncded n
the anass, ncdng the
s covered the uN koto
protoco: Caron dode (CO2),
methane (CH4), ntros ode
(N2O), peruorocarbons (PFCs),
hydrouorocarbons (HFCs) andsulphur hexauoride (SF6). Each
GHG has a dierent capacity to
case goa warmng. Trcosts
converson o GHGs to CO2e s ased
on the Global Warming Potenal
(GWp) nde shed the
intergovernmenta pane on Cmate
Change, which assesses the eect
of the emissions of dierent gases
over a 100-year me period relave
to the emission of an equal mass
o CO2. To comare the caron
erormance o comanes o a
szes and sectors, GHG emssons
from operaons, electricity use and
other direct (rst-er) suppliers are
normalised by revenue to idenfy
caron ntenst.
The inormation used to compile this report has been collected rom a
number o sources in the public domain and rom Trucosts licensors.
Some o its content may be proprietary and belong to Trucost or
its licensors. The report may not be used or purposes other than
those or which it has been compiled and made available to you by
Trucost. Whilst every care has been taken by Trucost in compiling this
report, Trucost accepts no liability whatsoever or any loss (including
without limitation direct or indirect loss and any loss o prot, data,
or economic loss) occasioned to any person nor or any damage,
cost, claim or expense arising rom any reliance on this report or
any o its content (save only to the extent that the same may not be
in law excluded). The inormation in this report does not constitute
or orm part o any oer, invitation to sell, oer to subscribe or or to
purchase any shares or other securities and must not be relied upon
in connection with any contract relating to any such matter. Trucost is
the trading name o Trucost plc a public limited company registered
in England company number 3929223 whose registered oce is at
One London Wall, London EC2Y 5AB, UK.
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Trucost Plc
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London WC2A 1LS
United Kingdom
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north Aera: + 1 203 671 1342