Climate Investing cheat sheet

Radiative forcing (W/m²) is the change in net energy flux at the top of atmosphere; positive forcing warms. CO2 doubling gives roughly 3.7 W/m² forcing, and equilibrium climate sensitivity (ECS) is the eventual warming from that doubling - IPCC AR6 best estimate 3°C, likely range 2.5–4°C.

Physical risk splits into acute (flood, wildfire, cyclone, heatwave) and chronic (sea-level rise, shifting precipitation, temperature trend). Investors map acute hazards to tail-event loss distributions and chronic hazards to long-horizon productivity and asset-life assumptions.

Transition risk drivers: carbon pricing, emissions performance standards, technology cost curves (solar PV and lithium-ion battery costs fell roughly 90% and 85%+ respectively between 2010 and 2023), litigation, and shifting consumer preference.

Scope 1 = direct combustion/process emissions; Scope 2 = purchased electricity, heat, steam; Scope 3 = value-chain emissions (15 GHG Protocol categories, upstream and downstream). For most sectors Scope 3 dominates total footprint, often 70–90%.

GHG accounting standards: GHG Protocol Corporate Standard and Scope 3 Standard; TCFD (now consolidated into the ISSB) for governance/strategy/risk management/metrics; ISSB IFRS S1 and S2 for general and climate-related disclosure; CSRD/ESRS in the EU.

Financed emissions are attributed using the PCAF framework: attribution factor = outstanding amount / (equity + debt) for corporate lending; for listed equity, attribution = shares held / shares outstanding.

Carbon price exposure: emissions × price gives direct cost. Internal carbon prices used in capital budgeting typically range USD 20–100/tCO2e; EU ETS prices have traded above EUR 80/t in the 2020s.

Scenario analysis uses representative concentration pathways (RCPs) for physical risk and shared socioeconomic pathways (SSPs); NGFS scenarios combine both with transition pathways (Net Zero 2050, Delayed Transition, Current Policies, Divergent Net Zero, Hot House World).

Regulatory architecture: EU Taxonomy (substantial contribution, do no significant harm, minimum safeguards), SFDR Article 6/8/9 fund classification, EU CSRD, ISSB adoption across jurisdictions, and national carbon markets.

Transition finance funds abatement in high-emitting or hard-to-abate sectors (steel, cement, shipping, aviation, chemicals) where the entity is not yet aligned but has a credible, time-bound decarbonization plan.

Credible transition plan elements: baseline emissions, quantified targets with interim milestones (near-term 2025–2030 and long-term 2050), capex alignment (share of capex that is transition-aligned), governance/accountability, and independent verification.

Key instruments: sustainability-linked loans and bonds (coupon tied to KPI/SPT, e.g., emissions intensity reduction), green bonds (use-of-proceeds), transition bonds, and blended finance with concessional capital.

Sustainability-linked bond structure: KPI selection, sustainability performance targets (SPTs), step-up/step-down margin or premium, verification, and reporting. Pricing ratchets are typically small (often 12.5–25 bp), so credibility comes from the KPI, not the penalty.

SLB credibility checks: KPI materiality to the issuer's core business, KPI baseline and benchmark (peer or science-based), SPT ambition relative to a 1.5°C or well-below-2°C pathway, and whether the step-up is economically meaningful.

Just transition considerations: workforce reskilling, community dependence on high-carbon activity, and affordability impacts. Lenders increasingly require just-transition assessment in transition finance frameworks.

Transition finance frameworks: ICMA Climate Transition Finance Handbook (four elements: issuer climate transition strategy and governance, business model environmental materiality, climate transition strategy implementation, and transparency), and the GFANZ transition finance guidance.

The 'transition premium' and greenium are empirically small (single-digit basis points for green bonds) and vary by currency and issuer; do not assume a material cost-of-capital benefit without issuer-specific evidence.

Avoid transition-washing: an entity with a target but flat or rising absolute emissions, capex flowing to carbon-intensive expansion, or no interim milestones does not qualify as transition finance.

Climate-adjusted DCF: adjust cash-flow forecasts for transition costs (carbon price, capex for abatement, compliance), revenue effects (demand shifts, price pass-through), and terminal value (stranded asset risk, terminal growth).

Cost of capital channel: physical and transition risk premia raise the discount rate for exposed issuers; empirical estimates of a climate risk premium in equity returns are contested and sensitive to specification and sample period.

Carbon beta measures sensitivity of a company's cash flow or valuation to carbon price changes; carbon intensity (tCO2e per revenue or per enterprise value) is a screening proxy, not a risk measure.

Stranded asset analysis: compare reserves or asset book values to a carbon budget-consistent demand path; for oil and gas, reserves life versus the net-zero demand trajectory determines impairment risk.

Green bond pricing: 'greenium' is typically small (often 0–5 bp, occasionally more in EUR), reflecting demand from dedicated mandates and liquidity, and is not a reliable measure of environmental impact.

Credit analysis: transition risk affects issuer creditworthiness through margin compression, capex needs, and asset impairment; physical risk affects collateral values, business interruption, and sovereign/municipal revenue bases.

For sovereigns, climate vulnerability enters credit ratings via growth, fiscal exposure to disaster relief, and external balances; for municipalities, via property tax base and infrastructure liabilities.

Materiality mapping: use SASB/ISSB industry metrics to identify financially material climate factors by sector rather than applying uniform carbon screens.

Scenario-based valuation: run DCFs under NGFS Net Zero 2050, Delayed Transition, and Current Policies; report the valuation spread and identify which assumptions drive the divergence.

Private equity: climate risk enters at due diligence (physical asset exposure, regulatory permits, emissions liabilities), at underwriting (capex for abatement, insurance cost), and at exit (buyer pool shrinks for high-carbon assets).

Infrastructure: assets have long lives (20–50 years) so chronic physical risk (sea-level rise, heat, water stress) and policy risk (carbon pricing, renewable support schemes) compound; concession terms and regulated asset bases matter.

Real estate: physical risk affects insurance premiums, occupancy, and cap rates; flood-zone designation can lower property values and raise financing costs. CRREM-style pathways assess stranding risk against energy-performance standards.

Agriculture and timber: yield sensitivity to temperature and precipitation, water rights, wildfire risk, and carbon-credit revenue potential; long biological cycles make assumptions highly path-dependent.

Private credit and direct lending: covenants can embed climate KPIs, insurance requirements, and capex conditions; lenders have limited ability to price transition risk in illiquid, relationship-driven markets.

Venture and growth equity: climate tech valuation depends on policy support (subsidies, tax credits), technology cost curves, and offtake certainty; policy reversal is a primary downside risk.

Climate metrics for alternatives are data-poor: rely on asset-level due diligence, third-party physical risk models, and proxy data; disclose estimation methodology and uncertainty.

Exit-multiple risk: high-carbon assets may face compressed buyer pools as climate-aware capital withdraws; model this as a terminal valuation haircut rather than a going-concern assumption.

Portfolio carbon metrics: WACI = Σ (portfolio weight × issuer carbon intensity); carbon footprint = Σ (weight × emissions / enterprise value); both are backward-looking and sensitive to Scope 3 inclusion.

Implied temperature rise (ITR) maps portfolio alignment to a warming outcome; it relies on company targets and sector pathways and is highly sensitive to methodology and data coverage.

Transition alignment metrics: share of portfolio aligned to a net-zero pathway, share with credible targets, and capex alignment; these are forward-looking but depend on target credibility.

Scenario stress testing: apply NGFS or bespoke scenarios to portfolio holdings, aggregate P&L or valuation impacts, and report by sector and scenario; disclose methodology limitations.

Stewardship levers: voting (climate-related resolutions), engagement escalation (letter, meeting, public statement, voting against), and collaborative engagement (Climate Action 100+, CA100+).

Net-zero commitments: set a target year, interim targets, base year, coverage (AUM share), and use of carbon credits; define the role of offsets carefully - most frameworks prioritize abatement over offsets.

Divestment versus engagement: divestment reduces portfolio exposure but may not change real-world emissions; engagement can influence issuers but has uncertain efficacy. Document the theory of change.

Attribution: separate climate-driven return effects from other factors using factor models or scenario-conditional attribution; avoid attributing all 'green' performance to climate skill.

Regulatory and fiduciary considerations: climate risk is increasingly treated as financially material; disclosure under TCFD/ISSB, SFDR reporting, and local stewardship codes shape implementation.