Funds faced with decarbonisation dilemma to meet YFYS

Super funds are facing a dilemma in trying to decarbonise their portfolios while meeting the demands of Your Future, Your Super (YFYS) regulation and an ESG climate index platform has launched a new service to assist them.

Scientific Beta, which launched in Australia and New Zealand in September 2022, is a global provider of advanced index solutions designed to help asset managers and institutions understand and invest in smart factor and ESG equity strategies.

Established by the EDHEC Risk Institute, part of EDHEC Business School, it brings its established track record in Europe to provide guidance to Australian super funds. 

According to the firm, Australian super funds have made “ambitious commitments” to align their investments with net-zero objectives. However, they continue to allocate significant portions of their members’ funds to high-carbon Australian and international companies without making clear to these companies they may divest if they do not decarbonise fast enough.

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This is in contrast to Europe, where the regulator has clear rules that must be fulfilled if an investor is going to claim such lofty net-zero goals, best embodied in the EU Carbon Transition Benchmark regulatory framework with a core commitment of an annual reduction in the carbon intensity of pension funds’ equity portfolios of 7 per cent.

“Super funds are essentially walking a tightrope. YFYS performance testing imposes tracking error targets that tether them to high-emitting Australian companies, hindering their ability to achieve both satisfactory returns and an acceptable rate of decarbonisation,” ​said Michael Aked, senior investment strategist at Scientific Beta.

An unintended consequence of these regulations is restricting fund investment behaviour to continue to fund high-carbon emitters regardless of their ESG performance.

According to Aked, unlike the low-carbon benchmarks readily available in Europe, the absence of a YFYS-compliant low-carbon benchmark in Australia leaves super funds with few viable options. 

He believes their two possible paths are fulfilling their YFYS obligations but risk allegations of greenwashing for making net-zero commitments they may not fulfill or invest in line with their net-zero commitments but prepare for potential repercussions if they fail the YFYS performance test, which could lead to significant regulatory action. 

“This presents an exceedingly challenging scenario for super funds, as both options expose them to regulatory scrutiny, jeopardising members’ funds and eroding trust,” Aked emphasised.

He suggests the optimal solution is for super funds to publicly commit to a 7 per cent annual decarbonisation targets that requires forced divestment of carbon laggards. 

“Only if Australian companies risk losing capital from our super funds will they see the importance of acting annually and with the required magnitude to meet net-zero 2050 goals,” Aked said.

“In essence, super funds can opt to stay the course and employ the coercive power of forced divestment to compel companies to meet their decarbonisation targets, thereby driving meaningful change.”

Recently, $76 billion fund HESTA was ca​lled out by its fund members for failing to divest from Australia’s largest oil and gas company Woodside.

More than 500 healthcare professionals and HESTA members signed an open letter to the fund’s chief executive, Debby Blakey, regarding its engagement with Woodside as the company continues to sanction new oil and gas fields.

They called on the fund to implement its escalation framework to the fullest extent, publicly denounce Woodside’s decision to sanction Trion, and publish a time frame for divestment.

Meanwhile, AustralianSuper was also pulled up for purchasing millions of Woodside shares and failing to use this increased influence over the company to demand an end to its oil and gas expansion plans.

Analysis by Market Forces revealed the $240 billion fund is one of the top five shareholders in Woodside, increasing to 85 million shares in 2022 across all investment options.