Investors can use temperature scores to assess whether sovereign bond portfolios are aligned to the Paris Agreement, according to a paper from De Nederlandsche Bank (DNB).
The Dutch central bank has tabled its own proposed calculation for the metric. It said this addresses concerns over complexity, variation in scores between providers, and non-transparent methodologies which make users “dependent on commercial providers for calculations and proprietary data”.
The scores are used to identify the future temperature outcome associated with a company or groups of companies, sectors and whole portfolios based on their projected climate performance.
DNB is advocating for the use of temperature scores because of “its communication simplicity” and its potential “for portfolio aggregation and comparability across asset classes”, the central bank said.
While sovereign debt instruments make up around half of global bond markets, methods for assessing their climate performance are “still in their infancy”, it added.
Temperature scores should be used as a proxy for transition risk, with high scores “signalling a higher probability that temperature and emission targets will be exceeded”, DNB said. It added that the scores are not suitable for physical climate risk due to sovereign-specific characteristics such as geographical location and policy preparedness.
The approach tabled by DNB incorporates only the current climate policies implemented by countries, rather than national climate targets submitted to the UN or other longer-term targets, as the latter “often do not align with real-time government actions”.
The central bank also said it tried to incorporate a “fair share” approach, which would apply stricter decarbonisation timelines for wealthier countries, but found it “challenging to implement”.
DNB used population numbers and consumption data to “capture an equitable forward-looking measure”. Using consumption numbers, which accounts for imports, ensures that developing countries reliant on agricultural or manufacturing exports “are not unfairly penalised for serving global markets”.
However, the central bank was unable to account for “the relative historical outperformance of a sovereign compared to its peers” by increasing emissions allowances for countries which have “contributed minimally to climate change”, it said.
Finally, DNB recommended rounding up to temperature scores to the nearest 0.1C “to avoid the perception of precision”.
A DNB spokesperson told Responsible Investor that the analysis “is not intended to be used as an instructional paper for regulated entities, but rather something to help asset owners measure climate risks and opportunities in sovereign portfolios”.