Cop26 Perspectives

Five for the Future: Protecting the Planet and Your Portfolio

Following the IPCC report, how should investors adjust their portfolios to mitigate and adapt to climate change?

To limit the causes and effects of climate change, reliance on fossil fuels has to be drastically reduced and investment in the world’s defences increased. This much we knew. But the current pace of progress isn’t fast enough, investors and policymakers have concluded, following the Intergovernmental Panel on Climate Change’s (IPCC) latest report on climate change.

With the IPCC predicting that the world will hit 1.5°C of warming by the late 2030s, greenhouse gas (GHG) emissions need to be slashed by the end of this decade to offer hope of temperatures falling back below 1.5°C by 2100.

We are already seeing the damage done. Flooding in northern Europe, wildfires in Greece and other extreme weather events around the world are proving costly – financially, environmentally and socially. These are existential issues of concern to all.

This includes investors. Managing huge amounts of capital, asset owners and managers have a huge role to play, by increasing pressure on high emitting companies to transition to low-carbon products and operations and funding innovative solutions contributing to a net-zero future.

“We now have a much clearer picture of the past, present and future climate, which is essential for understanding where we are headed, what can be done, and how we can prepare,” said Valérie Masson-Delmotte, Co-Chair of IPCC Working Group I.

As the end of the year draws closer, investors will be examining portfolio performance and implementing changes. The IPCC report will influence their deliberations, as will the policy response of governments gathering in Glasgow for COP26.

Looking through the report, ESG Investor has outlined five key areas on which investors are likely to focus.

Reinforcing water infrastructure 

Asset owners with investments in water-intensive sectors, such as utilities, need to be aware of infrastructure risks, while monitoring usage reduction strategies of firms in sectors such as construction and textiles. They may also be looking for firms investing in new technologies that improve efficiency and reduce wastage and pollution.

Continued ocean warming, acidification and pollution could lead to the collapse of the Atlantic Meridional Overturning Circulation – a large system of ocean currents carrying warm water from the tropics into the North Atlantic. This would cause more “abrupt shifts in regional weather patterns and water cycles”, the IPCC said, increasing variability and unpredictability of water supply.

Water security investment needs to “increase significantly” to US$6.7 trillion by 2030 and US$22.6 trillion by 2050, warned the High Level Panel of Water, a group of 11 sitting Head of State and Government convened by the United Nations Secretary-General and President of the World Bank Group.

Water is largely “under-valued and under-priced resource, resulting in a poor record of cost recovery for water investments”, the panel noted. It has encouraged policymakers to better enable investment in sustainable water-related infrastructure by promoting the preparation of investment-ready high impact projects and investing at least one-third of international climate finance in water-related projects aimed at improving climate adaptation and mitigation.

But there are already water-related business opportunities available as companies look to transition, according to a CDP report, which estimates them at US$711 billion.

For example, Florida’s Emerald Coast Utilities Authority, which provides water, wastewater and sanitation services, now employs a treatment technology that enables the reuse of 100% of the 22.5 million gallons of water treated at the facility. Following damage caused by Hurricane Ivan in 2004, the plant is now built to withstand Category Five hurricanes and is stationed 50 feet above sea level.

Shoring up flood defences

Coastlines, particularly in low-lying areas, face the risk of continual flooding as sea levels rise.

“Extreme sea level events that previously occurred once in 100 years could happen every year by the end of this century,” the IPCC warned, due acceleration in the rate of permafrost thawing and the melting of glaciers, ice sheets and Arctic sea ice. The global mean sea level rose by 0.2 metres between 1901 and 2018, the IPCC report noted, increasing at its fastest rate in history at 3.7 millimetres per year between 2006-2018.

By 2050, the flooding and erosion of coastal urban areas will cost US$1 trillion in damages and loss of land, according to the Ocean Risk and Resilience Action Alliance (ORRAA).

Investment in flood defence technologies such as sea dikes for the open coast, river dikes for coastal reaches of rivers influenced by sea level and storm surge barriers will decrease the risk of flooding and therefore restrict the financial and social costs incurred by damage to tourism, agricultural spaces and buildings.

Tools such as the World Resources Institute’s (WRI) Aqueduct Floods help investors measure the costs and benefits of investing in riverine flood risk and flood protection infrastructures around the world. For example, every US$1 spent on dike infrastructure in Bangladesh could result in US$123 in avoided damages to urban property, WRI said.

The ORRAA aims to drive US$500 million of investment into nature-based solutions by 2030, backing at least 15 products that funnel finance into coastal natural capital. ORRAA recently secured the financial backing of the UK Government’s Blue Planet fund, which aims to scale up support to protect the world’s oceans.

Asset managers are also launching more fund solutions to bolster flood defences. In June, BNP Paribas Asset Management launched the BNP Paribas Ecosystem Restoration thematic fund, which invests in companies engaged in flood control solutions.

Planting seeds for change

With more than one quarter of the world’s emissions caused by agriculture, forestry and land-use, weather extremes will have huge consequences for the agricultural industry.

If global warming reaches 2°C or above by 2050, then this will exceed “critical thresholds” for agriculture, the IPCC report warned, as this would result in more extreme rainfall and increased surface run-off or droughts – both of which will disrupt the growing and harvesting of seasonal crops.

Sustainable agriculture, which limits attempts to conserve natural resources and avoid man-made ones, is becoming an increasingly popular investment trend for asset owners. A recent Kempen Asset Management and ESG Investor roundtable discussed how institutional investors can invest in farmland assets contributing to the UN’s Sustainable Goals (SDGs) relating to land use.

Further investment is needed in farm sustainability metrics to better allow farmers to measure and report on their environmental impact. For example, the Cool Farm Alliance has developed the Cool Farm Tool which provides metrics on emissions, water usage and biodiversity impacts, thus allowing farmers to implement more effective strategies for change.

Investor coalitions are urging policymakers to better support agriculture’s transition to net-zero. One coalition managing US$4 trillion in assets, led by the collaborative investor framework, the FAIRR Initiative, called for the Group of 20 to be more transparent about the extent to which agricultural decarbonisation must contribute to their updated Nationally Determined Contributions (NDCs).

Policymakers are responding. For example, New Zealand’s Ministry for Primary Industries manages the Sustainable Farming Fund (SSF), which supports applied sustainable research and projects led by farmers, growers and foresters.

Green foundations 

Many cities around the world aren’t built to handle extreme weather events, the IPCC report highlighted. Responsible investors are looking to invest in sustainable real estate initiatives that both reduce impact on the environment and withstand climate change.

Jana Hock, Senior Research Officer for Climate Change at ShareAction, previously highlighted that the innovations to reduce the operational carbon emissions of buildings are already available if not yet fully scalable. She told ESG Investor that it is just as important to invest in the reduction of embedded carbon by transitioning away from the use of unsustainable materials.

The World Green Building Council (WGBC) has outlined that new buildings must have net-zero operational emissions by 2030 and net-zero embedded carbon by 2050. As regulatory pressures ratchet up this transition, asset owners will need to ensure real estate firms are setting quantifiable interim targets for both the reduction of operational emissions and unsustainable materials.

The European Public Real Estate Association (EPRA) noted that large institutional investors invested over 8% of their assets in real estate last year, a percentage the association expects will increase.

Increasing resilience will be a priority alongside minimising emissions. Schroders’ real estate arm (£16.9 billion in AUM as of December 2020) has committed to developing a net zero pathway for all its real estate investments, annually disclosing progress. Direct real estate products will have energy and carbon targets by 2022, the firm has pledged, and it will further engage to ensure its investments are working to improve energy efficiency and climate resilience through the introduction of building management systems, solar PV and technical building audits.

There are also emerging technologies, such as GeoPhy, that aim to analyse the current degree of climate-related impact on real estate, thus allowing investors to assess which building designs are already more resistant to climate change and what kind of changes need to be made to those that are not.

Investors could save US£4.2 trillion by investing in more resilient infrastructure, according to a World Bank report.

Last month, the United Nations Environment Programme (UNEP) published guidance for the types of buildings that need to be constructed to cope with climate extremes: heatwaves, drought, coastal flooding, strong winds, and cold.

Leaving fossil fuels in the ground

While the IPCC recognised natural changes do play a part in the Earth’s shifting climate, ultimately 1.07°C of the current 1.09°C of warming is caused by human activities, such as usage of fossil fuels. In fact, around 85% of global emissions are from burning fossil fuels, IPCC said.

Viable net zero action plans are needed to ensure that the world – especially carbon-intensive and hard-to-abate sectors – transitions away from fossil fuels as soon as possible.

The Climate Action 100+ initiative – which is investor-led – launched the Net Zero Company Benchmark to assess 160 of the largest global corporates on their commitments to reducing emissions, improving climate-related governance and strengthening climate-related financial disclosures. Companies with persistently low scores risk being left behind as investors support corporates prioritising the transition.

As well as ensuring companies are reducing their usage of fossil fuels, investors are also supporting the continued growth of renewable energy markets and innovations.

The IEA’s 2050 roadmap predicts that almost 90% of global electricity generation will need to come from renewable sources in order for the world to align with Paris temperature goals, with solar and wind accounting for nearly 70%.

The good news is that renewables are becoming cheaper and more reliable at scale, drawing the attention of public and private investors.

Investors ultimately need to take the dual approach when fighting climate change: reducing existing climate-related risks in their portfolios and investing in future alternatives to undo some of the damage mankind has already done.

“It has been clear for decades that the Earth’s climate is changing, and the role of human influence on the climate system is undisputed,” said Masson-Delmotte.

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.

Copyright © 2023 ESG Investor Ltd. Company No. 12893343. ESG Investor Ltd, Fox Court, 14 Grays Inn Road, London, WC1X 8HN

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