TrucostIFC Emerging Markets Report

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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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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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12 www.trucost.com

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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13 www.trucost.com


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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14 www.trucost.com

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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15 www.trucost.com


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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16 www.trucost.com

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


17/20

17 www.trucost.com


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).


18/20

18 www.trucost.com

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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19 www.trucost.com


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.


20/20

Trucost Plc

22 Chancery Lane

London WC2A 1LS

United Kingdom

UK & iteratoa: +44 (0) 20 7160 9800

north Aera: + 1 203 671 1342

[email protected]

Documents

TrucostIFC Emerging Markets Report