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Carbon Efficient Investing in Emerging Markets as a Tool to Combat Global Warming

Carbon Efficient Investing in Emerging Markets as a Tool to Combat Global Warming

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Published by IFC Sustainability
Carbon Efficient Investing in Emerging Markets as a Tool to Combat Global Warming
Carbon Efficient Investing in Emerging Markets as a Tool to Combat Global Warming

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Published by: IFC Sustainability on Mar 05, 2012
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Research Insights
December 2009
Carbon Efficient Investing in Emerging Marketsas a Tool to Combat Global Warming
Alka Banerjee
VP, Global Equities(212) 438 3536alka_banerjee@sandp.com
With the 2012 expiration of the Kyoto Protocol on global warming looming large,emerging markets, which have begun to surpass the U.S. as some of the largest emittersof carbon, are taking a central role in the debate over how to reduce emissions. As globalattention turns to these countries, Standard & Poor’s has designed an index which allowsfor reduced carbon emission exposure in their portfolios while replicating the broademerging market returns.Developed countries continue to lead the world in terms of per capita emissions,according to data the U.S. Energy Department's Carbon Dioxide Information AnalysisCenter released in 2006, the most recent numbers available. However, the largestemerging market countries are fast becoming the biggest carbon polluters
, whichexplains why total global emissions have risen alarmingly in the last decade.Emerging markets are polluting more for several reasons. Manufacturing services havemoved increasingly to emerging markets, thirst for commodities has increased worldwidewith the rapid growth of emerging market economies, and populations have exploded indeveloping countries, along with an attendant demand for energy, materials andinfrastructure, following which environment and carbon emissions have been immediatecasualties. While per capita emissions in these countries are still several notches belowthat of advanced economies, they’re catching up fast (see table on page 2); totalemissions have already exceeded many of the developed markets.
Fossil fuel CO
is one of the six green house gases identified as critical to climate change. Fossil fuel CO
 is the result of the burning of fossil fuels like coal, oil, and gas. In addition to the CO
that already exists inthe air, fossil fuel CO
acts as a blanket trapping more of the sun’s energy and raising the temperature of the earth, hence the epithet ‘ global warming’. Global warming induces changes in rainfall levels, dailytemperatures, sea levels, and the rate of glacier melting.
Research Insights Carbon Efficient Investing in Emerging Markets as aTool to Combat Global Warming
Top 20 Carbon Emitting Countries in the World
Country National emissions(thousands of tons ofcarbon)Emissions per
person (tons ofcarbon)CHINA (MAINLAND)
1,664,589 1.27
1,568,806 5.18
426,728 2.99
411,914 0.37
352,748 2.80
219,570 2.67
155,051 2.56
148,549 4.55
129,613 2.68
129,313 2.19
127,357 1.81
118,950 1.13
113,086 2.39
104,495 1.71
104,063 4.38
101,458 4.90
96,143 0.51
96,064 2.18
90,950 0.41
87,043 1.86
 Ranking of the world's countries by 2006 total CO2 emissions from fossil-fuel burning, cement production,and gas flaring. Emissions (CO2_TOT) are expressed in thousand metric tons of carbon (not CO2).Source: Tom Boden, Gregg Marland, and Bob Andres, Carbon Dioxide Information Analysis Center, Oak  Ridge National Laboratoryhttp://cdiac.ornl.gov/trends/emis/overview_2006.html
In our view, governments alone can’t fight the battle against carbon emissions. The task is too large and the scope too wide. Thus we think that a public private partnership is amust to make carbon reduction a reality. A process where stock market mechanismsreward companies that are more carbon efficient can be an effective way to deliver theeco-conscious message to the private sector.One popular approach so far has been to create equity indices and investment tools thatfocus on companies whose primary interest has been on producing clean technology andclean energy. This approach has its uses; it highlights the specific companies that areleading the charge in the green space and allows for focused investments that are bettingon the market's ability to reward these companies.
Research Insights Carbon Efficient Investing in Emerging Markets as aTool to Combat Global Warming
However, it is an inescapable fact that fiduciary responsibility to achieve market returnsdictates the flow of a large amount of institutional money. Niche investment strategiesthat cater to an audience of socially responsible investors haven’t crossed over into themainstream market, as the relatively smaller size and liquidity of the ‘clean’ companieshampers huge investments. What is required, in our view, is a broad market strategy thatcan meet the dual objectives of replicating a broad market and, at the same time,rewarding carbon efficiency. Pension funds, sovereign funds, and other governmentbodies with large assets can make a difference if they support an agenda that promotescarbon efficiency, and yet allows them to satisfy their fiduciary responsibilities at thesame time.
S&P/IFCI Carbon Efficient Index Replicates the Risk Return Profile of the S&P/IFCI LargeMidCap
On the heels of the launch of the S&P U.S. Carbon Efficient Index in March 2009,Standard & Poor’s, under sponsorship of the International Finance Corp. (IFC), theprivate sector arm of the World Bank Group, began work in the area of emergingmarkets. The idea was to replicate the risk return profile of the S&P/IFCI LargeMidCapfor emerging markets, but with an emphasis on carbon emissions. The resultingS&P/IFCI Carbon Efficient Index, which will launch on December 10, 2009 inCopenhagen, Denmark, closely tracks the investment performance of the parent indexwhile the index constituents provide a 24% reduced exposure to carbon emissions.
There are Challenges in Working with Emerging Markets' CarbonFootprint Data
The S&P/IFCI Carbon Efficient Index, like its parent, includes 21 emerging markets andmore than 800 stocks. Market weights within the index range from approximately 20%for countries like China and Brazil to less than 1% for Hungary and the Philippines.Frequently, smaller markets lack sectoral diversity, and a limited number of companiescontribute nearly 100% of their emissions. Carbon footprints
, as calculated by Trucost, acompany that provides comprehensive data on corporate environmental impacts, arenaturally highest for companies in the utilities, energy, and materials sectors. A simpleexclusion of these companies from an index provides a vast sector bias toward investingin financials and technology companies, an approach unacceptable to most investors.Carbon footprints differ greatly between emerging markets, and between sectors withinthe same emerging market (see table on page 4). This exponentially increases thecomplexity of designing an emerging market carbon efficiency index.
Trucost has partnered with Standard & Poor’s to provide data on carbon efficiency. Trucost calculatestotal greenhouse gas emissions of each company in the index based on company’s resource usage,emissions, and supply chain. It then divides total emissions by total revenue dollars earned to get anormalized, comparable carbon footprint 

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