In 2018, the 2° Investing Initiative (“2DII”) — an international, non-profit think tank working to align financial markets and regulations with the Paris Agreement’s goal of keeping global temperature rise this century well below 2 degrees Celsius above pre-industrial levels — launched the Paris Agreement Capital Transition Assessment (“PACTA”) tool. Recognizing that participants had historically assessed climate risk and impact using “backward-looking carbon footprinting,”1 2DII created the PACTA tool to help investors assess “the extent to which corporate capital expenditures and industrial assets behind a given equity, bond, or lending portfolio are aligned with various climate scenarios”2 and to enable investors to stress test their portfolios by analyzing the effects of different physical, legal, and transition risks related to climate change. The tool is intended to enable financial institutions, major regulators, central banks, and international banks to understand how their portfolios, or those held by a regulated entities, align with the goals of the Paris Agreement.

PACTA Methodology

The PACTA tool aggregates available climate-related financial information, including prospective asset-level data (for example, a manufacturing plant’s 5 year production projection) and parent company level data.3 The model is intended to assess climate-relevant sectors (such as the power, automotive, oil and gas, coal mining, aviation, shipping, cement, and steel sectors) using data from independent industry data providers from each sector to evaluate listed equity, corporate bonds, and corporate loans.4 For example, GlobalData provides power plant data (e.g. installed capacity), oil and gas field data (e.g. annual production volume), and coal mine data (e.g. annual production mass), along with other key data points for the power, oil and gas, and coal mining sectors. The tool incorporates the user-specific data provided when users upload their portfolios and produces a customized output report, which allows users to assess the overall alignment of their portfolios with different climate scenarios and to compare their results to similar portfolios held by other investors in the same markets.

The first analytical component of the tool is the climate scenario analysis, which analyzes three components for users:

  1. the user’s portfolio’s “current exposure to climate-relevant sectors;”
  2. the “alignment of the investment and production plans of the companies” within the portfolio with four different climate scenarios developed by the International Energy Agency (“IEA”); and
  3. the user’s portfolio’s current and future exposure to selected climate-relevant technologies and comparison to the average exposure of similar portfolios.5

The figures shown below6 are examples of the type of output users might see after using the PACTA tool’s climate scenario analysis. These figures come from an assessment of the investment portfolios of 672 insurers operating in California.7 The graph shows the alignment of oil production from companies in the insurers’ equity (first graph) and fixed income (second graph) portfolios relative to IEA scenarios for 2°C, 4°C, and 6°C temperature change and relative to the global listed equity and fixed income markets.

The second analytical component of the tool is a stress-testing module that allows the user to study the effects of different parameters on alignment, for example, by modifying the scenarios and geographies of the analysis. This analytical component “incorporates a calculation of potential losses under climate stress-test scenarios, considering physical, legal, and transition risks.”8 Physical risks relate to the physical effects of climate change and could include incremental changes, like sea-level rise or coastal erosion, as well as acute weather events, such as wildfires or flooding. Legal risks would include the passage of policies aimed at decreasing GHG emissions or risks that may arise as a function of climate litigation. Finally, transition risks would include uncertainty in technological development and deployment across climate-relevant sectors, such as increased production of electric vehicles.

The third analytical component of the tool is a qualitative impact analysis of “climate actions taken by financial institutions to date to support GHG emissions reduction[s].”9 Users will be asked a series of questions about the climate actions they have taken as of such date and the climate-related outcomes and commitments that resulted from those actions. Currently, the qualitative analysis cannot be matched with a quantitative analysis. Over time, however, 2DII hopes that its analysis may be useful to determine the effectiveness of climate actions taken by the tool’s users.10

Users have the flexibility to determine which of these analyses to run based on the goal of their assessment. The PACTA tool itself does not provide any guidance or recommendations to its users on whether or how to modify their portfolio holdings.

Key Users

As of June 2020, the PACTA tool has been used by over 1,500 financial institutions that hold more than $106 trillion in assets under management, as well as by regulators and central banks to perform stress-testing and assess climate-related risks to their regulated entities (e.g. European Insurance and Occupational Pensions Authority, California Department of Insurance, Bank of England, and more).11 The user base spans more than 90 countries, and will likely continue to grow as additional tools are developed.12 While the majority of users have chosen to utilize the tool anonymously, a number of entities, including the California Department of Insurance, the Colombian Federation of Insurers, and Dutch bank ABN-AMRO have published the results of their assessments.

Expanded Tool for Corporate Lending to Become Available in Q3 2020

In 2019, 2DII began to develop a PACTA tool for corporate lending portfolios with the hope of empowering the banking sector to verifiably commit to the Paris Agreement goals. The new tool is currently being tested by seventeen major international banks, including Barclays, Citi, Credit Suisse, and UBS. To date, an estimated $550 billion in assets have been analyzed out of the approximately $18 trillion in total assets held by these pilot banks.13 The tool is currently in the testing phase, with the release of the new, free, open-source tool slated for some time this quarter. While its impacts remain to be seen, it appears that the new tool may address some of the barriers that may have prevented banks from aligning more fully with the Paris Agreement, including the lack of data on non-publicly listed companies and the establishment of a standard benchmark that banks can look to when considering the path forward.

Even amidst all of the uncertainties of 2020, investors, banks, and governments alike will likely continue to face growing pressures to incorporate climate risks and impacts into their risk management frameworks and strategic planning. The stated goal of PACTA is to provide a robust analytical tool that will allow financial institutions and regulators to assess their investment portfolios and regulatory programs’ alignment with the Paris Agreement.14 While PACTA’s materials emphasize the growing frequency of the tool’s use,15 the extent of uptake of this tool, and the weight placed on it by users, remains an open question. Perhaps more importantly, the usefulness of such a tool is constrained, at least to some extent, by the quality of the underlying data. Those entities that intend to rely on this tool for planning purposes — as well as those entities whose operations are being evaluated under it — may be well served by making some effort to evaluate both the quality and consistency of the relevant data.