Hedge Funds Are Split Over Short Sellers’ Impact on Emissions Debate

(Bloomberg) -- Hedge funds can’t agree on how short selling should affect the way they report their financed emissions.

Some managers argue that short selling -- whereby an investor makes money if an asset such as an oil producer falls in -- should be booked as negative CO2 emissions. Others say an oil company doesn’t suddenly emit less CO2 just because it’s being targeted by short sellers. As for the regulators, they aren’t providing much help to resolve the debate.

Financial watchdogs in the U.S. and Asia haven’t really weighed in. In Europe, some guidance is expected later this year, though it’s not clear whether that will explicitly address the hedge fund industry’s confusion. In the meantime, firms are taking matters into their own hands. 

At Capital Fund Management, Pierre Lenders said the firm’s sustainability-focused fund has a negative carbon footprint because of its short positions. He said many in the industry are leaning toward a similar treatment of shorting as a tool for cutting their portfolios’ reported emissions.

Lenders, who oversees ESG at CFM, said fund managers already tend to provide details of both their long and short positions, letting clients choose what to make of the data. 

“A consensus now seems to be growing in favor of extending that same approach to carbon footprint disclosures, and in fact to disclosures of any other material ESG dimension,” he said in an interview. “This doesn’t come from regulators, but from the industry.”

Europe’s rulebook for environmental, social and governance investing, the Sustainable Finance Disclosure Regulation, “doesn’t say anything” about shorting, Lenders said. “So we use our own reporting technique,” which shows that the “carbon footprint of the short positions is much bigger than the carbon footprint of our long positions,” he said.

The extent to which regulators will accept such assessments is unclear. The United Nations-backed Principles for Responsible Investing has found that “while the process for calculating the carbon footprint of a long-only portfolio is relatively established, there is no equivalent approach for reporting a similar metric for a portfolio that holds short positions.” 

In an op-ed published Feb. 18 in the Financial Times, Man Group Plc’s co-head of responsible investment, Jason Mitchell, said the notion that shorting an emitter reduces the shorter’s carbon footprint “should be treated with skepticism.” He said the idea conflates a financial impact with a real-world environmental impact. 

“If investors really care about combating climate change, they will need to understand and ultimately account for both the financial and non-financial portfolio effects of their investments,” Mitchell wrote.

A few days later, the co-founder of AQR Capital Management, Cliff Asness, wrote on the firm’s website that he doesn’t think shorting counts as a carbon offset. “But it still does what it’s supposed to do,” which is an indirect reduction in activities that lead to emissions, he said.

No matter which side hedge fund managers lean toward, most agree that the absence of regulations is a problem.

The question remains: “How do you deal with short positions?” said My-Linh Ngo, BlueBay Asset Management’s head of ESG investment. “Carbon is still there whether you’re short or long,” she said. “That’s why you have to account for it.”

Those advising hedge funds say the industry is starting to worry about the risk of choosing models that may end on the wrong side of future regulations.

“Carbon footprinting for a long-short portfolio hasn’t been defined anywhere from a regulatory perspective,” William Bryant, head of advisory at NorthPeak Advisory, said in an interview. “And it’s something that would be useful to have more clarity over because investors are looking to have investments in vehicles that they’re able to go long and short, but they also want to meet the regulatory requirements.”

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