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What is the role of derivatives and hedge funds in the transition to net zero?

8th February 2024

Keith Guthrie, Head of Sustainability UK, shares his thoughts on the latest guidance from the Institutional Investors Group on Climate Change (IIGCC). Cardano has worked with the IIGCC for the last few years to explore this important topic more deeply.

The IIGCC guidance published this week makes clear both to the potential for derivatives and hedge funds to be a force for good, as well as the potential for greenwashing if metrics are misused.

In their guidance they focus on measurement and management of factors that will drive real-world decarbonisation. This includes transparent reporting of “associated emissions” with both long and short derivative positions separately from financed emissions which only apply to directly owned securities. The guidance considers the various channels through which investors can influence real-world outcomes which differ substantially in primary and secondary markets and physical and derivative markets.

Importantly real-world decarbonisation needs to focus on a reduction of gross emissions and the many potential metrics that track real-world decarbonisation and influence such as managers alignment on engagement and voting, and exposure to companies with credible science based targets initiatives (SBTi) decarbonisation targets and transition plans. Netting of carbon exposure from longs and shorts should only be used in a financial risk measurement context and not to claim alignment with net zero real world targets.

Applying such principles allows investors to consider how derivatives and short positions can be used to help manage risks and increase real-world influence, and should help guide asset owners when assessing investment managers’ alignments with their beliefs.