UK financial markets exposed to embedded fossil fuel reserves

Financial market indices provider S&P Dow Jones (S&P DJI) has captured data from the S&P Global 1200, which covers around 70% of the global equity market capitalisation. The research found that the UK index ranks second-highest for emissions from owned reserves, which could be burned depending on political and market factors.

S&P DJI’s Carbon Scorecard analyses the carbon efficiency and energy mix alignment with the 2C target of the Paris Agreement for major S&P DJI equity benchmarks globally. While the UK index is performing well on energy transition and power generation share metrics, the markets are still exposed to both reserved emissions – which could translate to stranded assets for investors – and coal revenue – which marks the percentage of companies in the index that derive more than 10% of their revenues from fossil fuels.

According to the report, investors should work with companies on the index to outline how they plan to transition to a low-carbon economy. The report, made in partnership with environmental consultants Trucost, urged investors to anticipate and enforce government-created climate policies to help with this transition.

“The S&P United Kingdom BMI ranked second in our Coal Exposure metric,” Trucost’s chief executive Richard Mattison said. “Understanding the preparedness of fossil fuel companies to adapt to a lower-carbon economy and anticipating climate policy is important as governments begin to commit to the 2C energy scenario by creating policies to enforce this promise.”

However, a large number of foreign companies are dual-listed on the London Stock Exchange, including Australian mining firm Rio Tinto and Royal Dutch Shell. Dual-listed companies, especially those located in Australia which had the worst ranked index, may be less enticed to push towards national polices, another key consideration for investors to take into account.

“Many indices represent the companies listed on the country’s main exchange—companies that may not be physically based there. A large number of foreign companies are dual-listed on the London Stock Exchange,” Mattison adds. “These make a significant contribution to the embedded emissions and, by extension, have implications for those market participants that use such indices for the basis of their investments.”

Building portfolios

S&P DJI’s analysis comes at a time where the Task Force on Climate-related Financial Disclosures (TCFD) proposed how businesses should voluntarily disclose climate-related information under traditional financial filings.

The Carbon Scorecard is meant to act as a barometer for the carbon efficiency of the markets, and an indication of the direction of the economy. Markets listed in the report have been urged to “build climate resilient portfolios” using the analysis of the scorecard to address issues.

The report notes the “growing commitment” from pension funds to divest from coal as an example of the financial risks associated with fossil fuels. Earlier this week 50 MPs called for their £612m pension fund to sever investment ties with fossil fuels.

Last month, it was revealed that 60% of the world’s biggest investors recognise the risks associated with climate change and the economic opportunities of the low-carbon transition and are actively taking steps to remove climate risks from portfolios.

Matt Mace