Did COP26 move the needle for investors and provide greater clarity on the path to a net-zero global economy?
Views on COP26’s achievements remain mixed, and opinions vary on whether those with the clout and the responsibility took sufficient steps in Glasgow to limit climate change.
A group of experts, moderated by ESG Investor’s Founding Editor, Chris Hall, met virtually at the end of November to consider the summit’s likely impact on the climate, government policy and asset owners.
Discussions began on the question of the Paris Agreement’s central objective of keeping climate change within 1.5 degrees Celsius of pre-industrial temperatures. Was 1.5 degrees Celsius still alive and could COP26 have done more to support it?
“1.5 degrees Celsius is still alive, but it is on life support and its family is discussing when to switch it off,” said Jeremy Lawson, Chief Economist and Head of the abrdn Research Institute.
Lawson said the pledges made in Glasgow were not as ambitious as many had hoped, but he acknowledged there had been some meaningful announcements related to methane, deforestation and pathways for exiting coal, including further progress on ending its foreign financing. India’s net zero 2070 target, which was met with dismay by some when announced, was cited as evidence of individual countries showing initiative on the transition to renewables; no small achievement given the pandemic-related challenges facing emerging markets nations.
Even so, Lawson pointed out, we’re still some distance from achieving the 7% per annum reductions in greenhouse gas (GHG) emissions needed to reach net zero by 2050.
“I don’t see anything – in either the pledges themselves or in terms of binding legislation to support them – that would make me confident we’re on that pathway after COP26,” he added.
Placing further pressure on GHG emitters is essential to achieve these reductions, panellists agreed. With governments newly committed to revisiting their pledges next year, COP27 is assuming greater significance.
“Increasing the pressure to ratchet up the commitments made under the Paris Agreement is a good thing, but we had the same conversation heading into COP26 with countries being asked to deliver new nationally determined contributions (NDCs). Those were clearly lacking in giving us confidence that net zero by 2050 will remain in reach,” said, Hugh Gimber, Global Market Strategist at J.P. Morgan Asset Management.
As such, the new commitment made in Glasgow by countries to revisit NDCs next year needs to bear fruit ahead of negotiators meeting again in Egypt, said Gimber. “The increased scrutiny gives more hope for progress, but only if we see it before COP27.”
There was a consensus on the panel that keeping climate change to 1.5 degrees Celsius may be beyond political reality, but that limiting it to below 2 degrees was still salvageable.
The lack of ambition and accountability in governments’ climate commitments risked sending weak signals to the finance sector, panellists warned.
In short, the commitments made by governments to date have been “woefully inadequate” in terms of making good on the promises of the Paris Agreement, said Lawson.
“That’s not to say there has been no change. But there’s a big difference between recognising policy change is taking place and that policy change being sufficient to meet objectives set out at a higher level. It’s time to pay less attention to what people say and more attention to what they do,” he said, noting the domestic political challenges faced by governments, such as the recent failure of the US Senate to adopt a clean electricity standard.
Making up for lost time
The extent to which agreements and discussions on funding climate mitigation, adaption and ‘damage and loss’ could guarantee a smoother transition for less developed countries was an area where the panellists thought more needed to be done to bring institutional investors on board.
“Simply, the need for international finance is increasingly urgent,” said Gimber. “We now have a statement in the Glasgow Climate Pact that urges countries to deliver on the US$100 billion target, but still very little clarity as to when exactly that is going to happen, or how that is going to happen.”
The implication from this is that the onus is going to fall on the private sector, said Gimber, welcoming the announcement made at COP26 that finance sector firms worth US$130 trillion had signed up to the Glasgow Financial Alliance for Net Zero (GFANZ). But the public sector will still need to take the lead, he said.
“Governments still have a huge role to play in allowing private sector capital to be mobilised. Only through a combination of policy incentives and clear guidance on future regulation can the financial sector effectively and quickly put capital to work,” said Gimber.
Alison Midgley, Senior Sustainable Finance Specialist, WWF UK, noted increasing evidence of financial innovation, both in terms of blended finance solutions and in the fixed income market, where more sovereign and corporate bonds are being issued with sustainability and environmental criteria attached.
“These could really start to mobilise private capital, especially if they come with public incentives. But there still needs to be a broader shift in how ESG issues are factored into investment decision-making to recognise a wide range of nature-related risks as material, now that there is an increased understanding of climate risk,” she said.
As private sector investment flows increase, pressure on the governments of developed nations is unlikely to relent, suggested Jason Mitchell, Co-Head of Responsible Investment, Man Group, pointing to frustration shown by less developed countries on the lack of progress on climate finance commitments from rich nations.
“The expectations of developing countries are certainly reaching a pitch around how you address loss and damage,” he observed. “This has legal implications for developed nations and so has to be treated gingerly. This has potential to become a wedge issue going forward.”
One small step toward carbon pricing
Agreement on Article 6 of the Paris Rulebook – paving the way to meeting institutional investors’ demand for more transparent carbon emissions pricing – has been hailed as an important development by Patricia Espinosa, Executive Secretary of the UN Framework Convention on Climate Change (UNFCCC), allowing countries to “scale up their cooperation, mobilise additional finance and private sector engagement”.
While welcoming progress in Glasgow, panellists acknowledged it was only one step toward the more extensive use of carbon pricing across major economies to penalise heavy-emitting businesses.
“I’m glad that Article 6, at least from a national perspective, was quelled,” said Mitchell. “Given it was a blocking issue at several previous COPs, it was fantastic to see the efforts made to resolve that.”
“We now have better transparency and we’ve addressed the double-counting issues, as well as how to account historically for previous schemes. The use of internationally transferred mitigation outcomes (ITMOs) enables the creation of tradable emissions at a country level, which means countries can sell them if they’re running ahead of their net-zero plan,” he added.
The agreement will also lead to proceeds of around 5% peeled off from transactions conducted under a new UN-controlled trading scheme, which would go to help developing countries in adaption and mitigation.
With China now joining the EU in operating a large-scale carbon market, the extent of the US’s place in the carbon pricing debate remains in doubt, noted panellists, despite a raft of climate-positive initiatives under the Biden administration.
“There is not the Congressional support to create a carbon dividend or a national carbon market. The US is forced to regulate not legislate, following the demise of bipartisan initiatives such as the Baker-Schultz proposal,” said Mitchell, admitting to pessimism on the role of the US in a harmonised global carbon pricing system or even a looser ‘climate club’.
The carbon offset market could also cause some worry about over-reliance by heavy emitting firms rather than cutting emissions from their operating processes and business models. There were risks that corporates could cause the nascent market to overheat, panellists said, highlighting the urgent need for strict standards in the voluntary carbon markets to ensure both credibility and scale.
Fossil fuels consigned to history?
More commitments and tougher wording than has been used at previous COPs were seen in Glasgow on the reduction, if not outright elimination, of fossil fuels. How developments during COP26 might shape institutional investors’ future engagement with fossil fuel firms remains unclear.
“There is a question about engagement versus disinvestment,” said Tim Mohin, Chief Sustainability Officer at Persefoni. “We have to engage with the oil and gas sector to reach this low carbon economy.” Recent energy price volatility has already indicated that managing investors’ exposure to fossil fuels will be one of the biggest challenges on the path to net zero.
“What are we going to do if we just ostracise these companies and put them to one side? You’re seeing it right now – there is going to be an ‘accordion effect’ with the price of oil and gas,” he said. “That swing will continue, but hopefully the trend will ease off as we see renewables come into the market in increasingly attractive forms and we see use of energy start to change in areas such as aviation and transportation.”
Transition to renewables may be a long-term trend, but the investments will need to be made now, Mohin added, asserting that oil and gas companies must plan strategically.
If companies don’t begin to move quicker, the world will move without them, he suggested, as highlighted by May’s Exxon Mobil shareholder vote. “Some companies refuse to take these issues into account, and are being punished by the markets,” said Mohin. “As we start to see a decarbonising world, the smart companies will make more bets in this space to avoid the stranded assets that will come with a transition to a decarbonised economy.”
To combat stranded assets the market will need offsets and to get those properly working there will need to be fully realised rules and regulations.
This could see a stronger role for central banks in prudential policy to drive transition in terms of reducing finance sector support for the fossil fuel sector.
Reducing emissions through engagement
The role of the finance sector in driving the global transition to a low-carbon economy depends to no small extent on the ability of investors and lenders to identify climate risks in their portfolios. Institutional investors made progress in 2021, both in terms of the improved flow of information from investee companies and engaging with them and scrutinising their decarbonisation strategies.
These efforts were boosted by a number of initiatives announced at COP26, but the scrutiny of climate risks in investment and loan portfolios remains a work in progress.
“We’ve seen a number of positive resolutions this AGM season,” said UK Sustainable Investment and Finance Association (UKSIF) Senior Policy and Communications Officer Oscar Warwick Thompson. “There is a case to make because engagement works, it has been a game changer through initiatives like Climate Action 100+,” he said. “Active stewardship and engaging with company management year round can deliver results as opposed to opting for divestment.”
GFANZ members, particularly asset managers, have a role in ensuring investee firms’ transition plans not only cover Scope 3 emissions but also impacts on nature, said Midgley. “The Agriculture, Forestry and Other Land Use (AFOLU) sectors are huge GHG emitters as well as drivers of biodiversity loss, both at source and throughout the supply chain. That will continue without targeted interventions to shift away from business-as-usual practices that degrade environmentally-sensitive areas and direct investment to nature-based solutions,” she observed.
In addition to driving down emissions, engagement can bolster the finance sector’s reputation with its customers, Warwick Thompson asserted. “Stewardship can help rebuild the public’s trust in financial services. We can show investors are playing a positive role in contributing to a better society and a better economy.”
If companies change policies and practices as a result of their investor engagement and if the discussion leads to positive outcomes for workers and those operating in the supply chain, the finance sector can be seen as forging a positive path to equity and sustainability, he said.
The reporting initiatives unveiled at COP26 such as the new International Sustainability Standards Board’s climate-first prototype standard should also have positive effects, panellists noted, in terms of improving transparency of firms’ GHG emissions and other climate risks, alongside regulatory initiatives aimed at greater disclosure, such as the UK’s proposals for mandatory transition plans.
But Warwick Thompson suggested a more proactive approach is also needed by individual institutions. “Investors do need to take more forceful actions to show the positive outcomes of stewardship. We want our members to explain to their clients in simple language this is what happens as a result of engagement and help bring more transparency to this area.”
Divestment, he insisted, should be viewed as a last resort. “We are worried about pressure on governments to force net zero targets divestment, which we think will be counterintuitive due to the needs around decarbonisation of the real economy in the long run.”
Midgley cited the COP26 Declaration as an example of asset owners’ evolving engagement expectations from managers on climate risks, in terms of how they communicate to asset owners and how they put them into action.
“This means managers casting a critical eye over what companies are and are not reporting, but also not relying on exclusion of difficult sectors from their portfolios, engaging instead with firms that are signalling that they want to decarbonise their business models,” she said.
Metrics critical to biodiversity challenge
COP26 registered new commitments on reversing deforestation, limiting methane emissions, and increasing protection. But the extent that it provided sufficient support for action against biodiversity loss and the ability of investors to manage associated risks remains open to question. Panellists praised new steps being taken but expressed disappointment at the overall lack of pace.
This year saw the announcement of the Taskforce for Nature-related Financial Disclosure (TNFD). It follows the Task Force on Climate-Related Financial Disclosures (TCFD) though with several differences as the task on monitoring the impact of human activity on biodiversity is much more complex. Mitchell said he believes TNFD faces steep challenges, particularly in establishing convergence around reporting of metrics.
“There is scope for criticism of any metric, but from a climate perspective the fact that we can use weighted average carbon intensity as a starting point is at least useful. It will be interesting to see how we put together those metrics from a TNFD perspective.”
Mitchell also welcomed TNFD’s embrace of double materiality. “That means it looks not just at the impacts of nature on a firm, but also at what the firm is doing to biodiversity loss. This is a deviation from TCFD, which has been focused on financial materiality.”
The voluntary reporting mechanisms have the potential to help investors to understand the nature risks and impacts, said Midgley, highlighting also the problems of illegally traded commodities finding their way into supply chains.
“Despite the growing adoption of the UN Guiding Principles on Business and Human Rights, they’re not necessarily being factored into day-to-day decision-making at company level. Investors can play a role in flagging data gaps and reporting inconsistencies in supply chains, as well as engaging with governments on the need for stronger traceability requirements,” she said.
“It is action we need”
The panel concluded with most saying there had been progress at Glasgow though they had wanted more. “The pacts and agreements are the standard stuff of these meetings,” said Mohin. “It is action we need. What we saw in COP26 was a major support for accountability. By putting into place the foundational building blocks of accountability, in the form of the ISSB and the new accountability measures for NDCs, the hard work of accounting will start to move the needle.”
Observations on the insufficient steps taken in Glasgow resonated with Gimber, who suggested the lack of action sent a clear, if perhaps discomfiting, message to the private sector. “As the practicalities of what net zero means become clear, the costs involved for governments look increasingly unpalatable. Throughout COP26, it became apparent that both developed and emerging markets nations are reluctant to inflict the economic pain. On that basis, it is left to the private sector to drive change,” he said.
It may be too soon to tell whether Glasgow is a success or failure, panellists said, implying its place in history will be determined by the next steps, particularly of policymakers.
Lawson reiterated the need for governments to provide the impetus and funds to deliver transition. “This 12-month window is going to be a really important one. We already know that the US$100 billion per annum promised to finance transition and adaption in developing economies is inadequate, and was not even delivered. But seeing that number scale up – in reality, not just in pledges – would be one of the indicators that can give us more confidence that the Paris Agreement objectives can in fact be met.”