The ‘Paris Agreement Capital Transition Assessment’ (PACTA) was launched in 2018 by the 2° Investing Initiative (“2DII”) to measure the alignment of stocks, bonds and bank loans with a range of climate scenarios under the Paris Agreement. By aligning portfolios with the Paris Agreement, financial institutions can help limit global temperatures to 2 °C (2.7 °F) above pre-industrial levels.
PACTA was released as free open-source software (under MIT licence) and has been co-developed by dozens of researchers since 2012, most notably the Principles for Responsible Investment (PRI), University of Zurich, and Frankfurt School of Finance. As of today, PACTA has helped more than 4,500 individuals from over 3,000 institutions better understand their alignment with various climate scenarios.
In this article, we will discuss the key technical components of PACTA, how they are applied, and how they can be used by financial institutions in practice. Specifically, we will cover the three core analytical components within the PACTA framework, notably climate scenario analysis (also known as climate compatibility tests), climate stress-tests, and qualitative analysis of climate actions
PACTA Climate Scenario Analysis
The first building block of PACTA is the “climate compatibility test” or climate scenario analysis. This covers a) an analysis of the portfolio’s current exposure to climate-relevant sectors, b) an analysis of the alignment of the investment and production plans of the companies in the portfolio with global climate goals, and c) an analysis of the portfolio’s future technology exposure relative to scenarios and the market.
The Climate Scenario Analysis gives answers to three questions, each corresponding to a metric included in the results of the analysis:
- What share of the portfolio is currently exposed to activities in sectors affected by the transition to a low carbon economy?
- How aligned are the investment and production plans of companies in the portfolio with different climate scenarios and the Paris Agreement?
- What is the portfolio’s technology mix in climate-relevant sectors expected to look like in five years based on current investment plans of the company’s underlying the portfolio, and how does it compare to peers, the market, and a technology mix aligned with the Paris Agreement?
The model assesses the scenario alignment of financial portfolios with a 5-year time horizon/forecast period, relying on physical, asset-based company data as the core analytical concept. The time horizon is limited to the time horizon of capital expenditure planning for which data can be tracked at a meaningful level, and while it may differ across sectors, a homogenous time horizon is taken to allow for the comparability of results.
The analysis covers listed equity, corporate bonds, and corporate loans, and leverages a financial database covering 40,000+ companies and 230,000+ energy-related physical assets to assess climate-relevant sectors, including: power, coal mining, oil & gas upstream sectors, auto manufacturing, cement, steel, and aviation. Collectively, these sectors account for about 75% of global greenhouse gas emissions.
PACTA Stress Testing
The second part of the analysis is a stress test, which quantifies the potential financial losses to an
investment portfolio under different economic transition scenarios. A main component of the stress test is the Transition Disruption Metric (TDM), which helps investors indicate the degree of potential portfolio disruption under the Inevitable Policy Response’s (IPR) new Forecast Policy Scenario (FPS), going out to 2030.
TDM complements PACTA’s alignment model, in that it makes it easy for investors who want to mitigate policy risk to adjust their portfolios ahead of the IPR’s Forecast Policy Scenario (FPS). The higher the TDM score, the higher the chance of portfolio disruption in the medium-term (see visual representation below).
PACTA Impact Analysis
The third part of the analysis is an impact analysis, which highlights climate actions taken by financial institutions to support emissions reductions in the real economy. It provides guidance to a single question, “what are the climate actions I can take, similar to other financial institutions, to support GHG emissions reduction in the real economy?”
While this section will involve an overview of potential actions taken by peers and individual case studies, its important to note that 2° Investing Initiative and its partners are not regulated investment advisors, managers, or consultants and are thus not regulated to give financial advice. Moreover, the current evidence as to the effectiveness of one strategy over another is limited. More evidence-building is required, to which PACTA will hopefully contribute.
Other Benefits of PACTA
In addition to the tools outlined above, PACTA can be used for a variety of other applications, including:
- Measuring exposure to risks associated with the transition to a low-carbon economy
- Obtaining relevant data to support shareholder engagement
- Implementing the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD)
- Supporting compliance with related reporting and disclosure regulations
- Allowing governments and supervisors to assess their regulated entities’ alignment with climate benchmarks