From Ambition to Delivery

While pushing for public policy action in support of COP26 commitments, private sector actors must accelerate their low carbon transition, say experts.

In the wake of COP26, it falls on many shoulders to implement and operationalise the rhetoric of Glasgow. The core question is: what must policymakers, corporates and investors do to make good on last year’s pledges and commitments to keep the world on track for net zero by 2050?

The transition to a low carbon economy has begun, but constant pressure will need to be applied to all stakeholders to drive financial capital towards projects and solutions supporting climate change mitigation and adaption.

Evidence to date suggests that governments, companies, asset managers and asset owners are not doing enough.

Just one of the top 20 country emitters, the UK, will reach net-zero by 2050 and, of the other 19, eight are still registering a rise in per capita emissions, according to Invesco’s Economic Transition Monitor.

The New Climate Institute’s Corporate Climate Responsibility Monitor recently found that while most large corporates have climate strategies and targets, just three of 25 global firms analysed had committed to deep decarbonisation across their full value chains.

Recent academic and industry research also casts doubt on the efforts of asset managers and owners to act swiftly and decisively to decarbonise their portfolios and encourage portfolio companies to accelerate their net zero transitions plans.

Time for action

ESG Investor, supported by Persefoni, assembled last week an experienced panel of industry experts to share their views on the core priorities for the critical year, and indeed decade, ahead. Titled ‘Actioning COP26’, the discussion began with carbon pricing and why, given its importance, there has been so little progress in its implementation.

COP26 reached consensus on how to implement Article 6 of the Paris Agreement, but there are still many steps before national emissions trading schemes can work together to establish a global price level for carbon pollution.

Paul Dickinson, Founder and Chair of CDP, the global climate disclosure platform, believes carbon prices are essential to tackling climate change since, without that price, accounting for carbon emissions becomes an excessively complex exercise.

“A carbon price is key,” he said. “The Paris Agreement set the scene, but we need policy to back it up and we have to focus on how to get that policy because once a price of carbon exists, then the accounting takes care of itself.”

More tangible definitions and frameworks around carbon pricing are a pre-requisite step, albeit an insufficient one, toward achieving net zero, panellists agreed.

Tim Mohin, Chief Sustainability Officer at Persefoni, drew on his prior experience as a regulator to highlight effective policy action, citing the use of a market-based mechanism for sulphur dioxide trading to successfully drive down emissions.

“We created a scheme that worked flawlessly because we knew how much sulphur dioxide we had to get out of the air and we knew exactly where it was coming from,” said Mohin. “We created scarcity, which created a price, and opened up trading.

“Carbon is different. Carbon comes from everywhere and it’s very difficult to create the scarcity to know exactly what the price should be. That’s why a market-based mechanism for carbon hasn’t worked well.”

“Transparency works”

Carbon pricing is just one weapon in a government’s policy armoury, panellists noted.

“Governments have a few levers,” said Torsten Lichtenau, a London-based Partner at Bain and Company. “Carbon taxation is one, but they can also subsidise technology that needs investment – such as hydrogen and carbon capture, utilisation and storage (CCUS).”

The most commonly used lever by governments is increased reporting requirements, often by mandating the recommendations for the Task Force on Climate-related Financial Disclosures.

“We know transparency works,” said Mohin. Strong transparency based on rigorous accounting practice ensures companies report progress against net zero goals to stakeholders; analysing and addressing firms’ carbon footprints can have commercial benefits too. “By looking at emissions through transparent reporting, firms tend to do better,” he said.

The onus is on investors and corporations. Many are incorporating carbon-related metrics into their strategies and calculations.

“Corporates and investors are already capable of using an internal price of carbon for valuation scenarios and allocating capital,” said Bridget Fawcett, Co-head of Sustainability and Corporate Transactions at Citi. “We’re seeing them looking at asset optimisation and acquisitions through a carbon pricing lens, using it in their sensitivity models to think about value.”

Although COP26 disappointed investors with a lack of tangible movement on carbon pricing, the formation of the International Sustainability Standards Board (ISSB), tasked with developing a global baseline for sustainability reporting, starting with a framework to deliver more standardised information on carbon emissions, was seen as a positive development.

“With tangible disclosures, the quantum can be debated, and the market will arrive at an answer as to what prices are good for one country versus another,” said Chandra Gopinathan, Senior Investment Manager in the Sustainable Ownership team at £35 billion AUM pension scheme Railpen. “There needs to be a carbon price and it has to be non-zero, so let’s start there.”

Engagement expectations

While the need for decisive policy action becomes more urgent, it is becoming increasingly clear that engagement between investors and investee companies needs to move on to real world impact.

“There’s been a lot of discussion on ambition but the focus in 2022 is very much on delivery,” said Lichtenau.

To date, said panellists, most investors have been more focused on sustainability themes than their investee companies. But many corporates are now rising to the challenge, integrating sustainability into core strategies, and working with investors to understand the metrics by which they’ll be held accountable.

“There frequently needs to be a transformation in business models and that is complicated,” said Fawcett. “But I think it’s encouraging that there’s greater investor engagement around expectations, disclosure and how to create accountability internally.”

There’s an increasingly marked distinction between companies executing transition versus those still trying to understand what emissions mean for their business, she added.

Leading corporates are now actively engaging with investors, providing clarity on the transition risk they face, changing their capital allocation priorities, and beginning to market low carbon products to become new value creation drivers. Middle tier companies are in the early stages of setting ambition, but trying to move in the right direction. “The lower tier is still trying to figure out how fast this transition thing will happen,” said Lichtenau. “But the dialogue is shifting. And that’s critical.”

Given the high stakes, it is inevitable that investors’ appetite is growing for information to better understand net zero pathways within portfolios. But managing, interpreting and contextualising the data is an issue.

“One of the risks around metrics is getting too deep into the quantification,” said Gopinathan. “Climate modelling and climate metrics are extremely complex, but it’s important not to lose sight of the end-goal, in terms of contextualizing what the quantification means for your portfolio, the investee companies and for decarbonisation.

“You have to ask what it means for my allocations, how much control do I have over one asset or another, and how do I exercise that control?” said Gopinathan.

“Let’s not get too bogged down with the quantification but let’s use it for what it’s most useful for: identifying the misalignment,” he said. “Then we can focus on fixing it.”

Tilting toward transition

As well as engaging to address the climate-related risks in existing portfolios, the net-zero transition offers new investment opportunities for asset owners to pursue, particularly in companies and technologies with the capacity to make a scalable impact on climate change.

Lichtenau divided the opportunities into four broad sectors: technology enablers, such as wind turbines or electrolysers; enablers for the transition, such as software and service providers; new asset classes, such as nature-based solutions for offsets; and legacy companies transforming at pace.

“There’s clearly a sustainability revolution underway, encompassing new emerging sustainable businesses but also entrenched global, multinational transitioning companies,” said Fawcett.

And while there is no one-size-fits-all for investors, some fundamental truths must be considered in making investment decisions. “Investors must know whether target companies have the low carbon business models that give them access to capital,” she said.

That’s an increasingly important consideration given the weight of finance tilted towards transition, Fawcett observed.

“Climate risk has become financial risk,” said Mohin. “This is not ‘woke’. This is capitalism. And access to capital is not a right, it’s a privilege. You have to account for all your risk to have that privilege.”

The creation of the Glasgow Financial Alliance for Net Zero (GFANZ), a coalition of financial institutions committed to mobilising US$130 trillion of capital towards low carbon business models, can be seen as evidence of the growing appreciation of such realities, panellists suggested.

While the market may have many of the answers and the responsibilities, the role of the public sector in facilitating net zero pathways remains essential.

“Another truth is that governments are reorienting their investment agendas around growth,” said Fawcett. “Selecting investments where governments are supporting low carbon strategies is important.”

“The wisest investors look at an alignment of fundamentals: technology and its position on the experience curve, regulation, and customer demand,” said Lichtenau who proffered ‘green’ steel as a good example of this alignment. “If you’re in Europe, there is significant customer demand from the automotive sector, strong regulatory backup and technology is coming down the experience curve,” he said.

Avoid herd behaviour, he warned: “Valuations in hyped markets are going through the roof, and investing in these areas might not meaningfully contribute to the transition.”

Change is gonna come

It’s too early to say whether 2022 really will be the much-desired year of delivery, panellists said. There is uncertainty but also momentum.

“A transition DNA has been established and movement is happening,” exhorted Fawcett. “Maybe not as fast as we want, but we are at a tipping point.”

In anticipation of systemic change, it’s likely that the upcoming proxy voting season will test the level of investor commitment and the efficacy of engagement.

“In the past year, shareholder resolutions around climate were the highest ever, so empirically the level of engagement is increasing,” said Fawcett. “We will continue to see increased shareholder engagement and resolutions to focus corporations on transition plans.”

Yet most proxy votes are cast with the company management and most passive investors do not and cannot disinvest. They may also own too many assets to actively engage with across all their holdings.

Investing passively does not make asset owners powerless, said Gopinathan, nor does it absolve them of their responsibility to call for change, either from companies or governments.

“Do we just sit there, or do we go and find out how our asset managers can give us a proxy vote? It should not have got to the position where we have to ask, but investors should be aware that they have that right in place,” he said.

Governments, companies, asset managers and asset owners are not yet doing enough to keep us on track for net zero by 2050. Ranged against the forces of inertia, the motivation and dedication exist to ensure they up their game.

For Dickinson, the spirit of collective action goes beyond those key public and private sector actors.

“We’re evolving a kind of collective consciousness,” he said. “Investors are involved, through their investments, citizens are involved as consumers. The whole economy is developing a wisdom. It’s affecting businesses’ capital investment decisions, strategy, marketing, and innovation. Will we pull it off in time? I don’t know, but the infrastructure to do so is looking much more solid.”

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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