Now or Never

Sylvain Vanston, Executive Director of Climate Investment Research at MSCI, says scientists have done their job in the climate debate, with more action needed from policymakers at COP28 to support decarbonisation.

Global temperatures are set to hit record-breaking levels this summer, with regions of persistent high pressure creating heat domes across several southern US states in June, posing health risks to millions of Americans.  

Climate change continues to drive shifts in weather patterns, causing droughts and floods impacting everything from food production to the evolution of plants and animals; biologists have observed flowers blooming earlier and corals forging new relationships with microscopic algae to survive ocean acidification.  

As the climate crisis has evolved, so too has the investor landscape on climate-related issues, according to Sylvain Vanston, Executive Director of Climate Investment Research at MSCI.  

In my experience, the positive evolution of climate awareness began around 2013-2014 when asset owners and some banks started recognising the importance of climate-related issues,” he tells ESG Investor, noting that the finance industry accepted the need for additional attention to climate, alongside the integration of ESG considerations which had been happening for the past 20 years.  

This realisation was partly sparked by the stranded assets debate initiated by Carbon Tracker in 2013, says Vanston, with research conducted by the London School of Economics’ Grantham Research Institute calling on regulators, policymakers and investors to re-evaluate energy business models against carbon budgets, to prevent a US$6 trillion carbon bubble. 

The 2015 Paris Agreement (COP21) also played a key role in highlighting the significance of climate issues, he says; it was evident that many private players, including corporates and investors were striving to enhance their climate commitments leading up to the event.  

Road to COP28 

Despite this evolution in climate awareness, the current rate of emissions growth and the uneven attempts to curb it mean that it is increasingly likely that global temperatures will exceed the 1.5°C target set by the Paris Agreement before 2040, according to UN Intergovernmental Panel on Climate Change’s (IPCC) AR6 Synthesis report, published ahead of COP28 in Dubai on 30 November.  

The scientists have done their job, and it is clear that in the climate debate, all stakeholders, including investors, corporates, and policymakers, need to do more,” says Vanston, who represents MSCI in various organisations such as the Task Force on Climate-related Financial Disclosures (TCFD), Science Based Targets initiative (SBTI) and the Glasgow Financial Alliance for Net Zero (GFANZ).  

According to research by MSCI, nearly half (44%) of listed companies have now set decarbonisation targets, representing an eight-percentage-point increase than was reported in the October 2022 MSCI Net-Zero Tracker, but only 17% of those targets would align with the 1.5°C temperature rise goal. 

However, Vanston admits that addressing the climate crisis is easier said than done, with conflicting interests and incentives at play, particularly between short-term and long-term horizons. 

It is still too early to predict what will happen at COP28, he says, considering the controversies surrounding the event this year, with critics raising eyebrows at the United Arab Emirates’ choice of President to lead the summit. Sultan Al Jaber is CEO of the Abu Dhabi National Oil company – the biggest oil producer in the country and the twelfth largest globally.  

Nevertheless, MSCI will be present at the event as the world takes stock of climate action progress and assesses the policy solutions and broader innovations for addressing climate-related issues.  

“While most people recognise COP as a policy summit, it is crucial to understand that it has evolved into a business summit since COP21,” says Vanston. “This doesn’t imply an army of lobbyists interfering with negotiations, but rather it signifies the need for meaningful interactions and networking opportunities.” 

Policy levers 

Given the urgent need for accelerating climate policy to meet net zero by 2050, Vanston hopes that carbon pricing – placing a fee on CO2 emissions or offering an incentive to emit less – is an item on the agenda at COP28 in November and December.  

“I believe it is the missing piece of the puzzle,” he says. “Fortunately, the EU Carbon Border Adjustment Mechanism (CBAM), along with the carbon ban, is now in place, which should initiate useful policy developments in this field.” 

However, he concedes that carbon pricing has been a topic on the horizon for decades, with discussion hindered by implementation issues, such as carbon leakage, whereby businesses transfer production to countries with laxer emission constraints. 

Vanston also hopes that COP28 will witness a significant clampdown on fossil fuel subsidies, which have grown substantially over the past 18 months due to the energy crisis following Russia’s invasion of Ukraine.  

“It is essential to recognise that this growth is unsustainable.”  

According to analysis from the International Monetary Fund (IMF), fossil fuel subsidies represented US$5.9 trillion, or 6.8% of global GDP, in 2020, and are expected to increase to 7.4% of GDP by 2025 due to rising fuel consumption in emerging markets.  

“COP28 may be the platform where business leaders, including those from the oil and gas industry, finally confront their conflicts and collaborate more effectively with policymakers and environmentalists,” says Vanston.  

“However, it is also possible that the outcome of COP28 could be very disappointing.” 

To address climate risks, Vanston strongly believes that policy engagement is a critical lever for investors to pull, which aligns with proposals put forward by the Net Zero Asset Owner Alliance (NZOAO) to support members and other asset owners in exercising their fiduciary duty by advocating for climate policy action.  

However, while he has mainly observed the call for greater policy engagement from asset owners, he notes that it is a tool that should also be exercised by signatories of the Net Zero Asset Managers initiative (NZAM) and the Net Zero Banking Alliance (NZBA) as well.  

“Going forward, investors must engage with policymakers more forcefully, whether individually or collectively,” he says, adding that, historically, policy engagement has been limited.  

“Engaging with local governments is one thing, but engaging with governments on the other side of the world, especially those with conflicting views, presents its own challenges.” 

Holistic engagement 

Speaking at the Climate Investment Summit hosted by the London Stock Exchange as part of London Climate Action Week, Kristina Church, Global Head of Sustainable Solutions at BNY Mellon, told onlookers how a fragmented policy environment for the net zero transition requires investors to adopt a holistic approach to engagement.  

Vanston shares similar sentiments, noting that investors must shift their focus from solely addressing the shortcomings of the supply side of the oil and gas industry to also engaging with demand side.  

He notes that while engagement with the supply side of the market has been ongoing, investors should also proactively engage with demand side sectors such as technology, textiles, and food services. 

“These industries need to be more actively involved in the efforts to combat climate change,” he says. “We have primarily concentrated on the oil and gas industry, but the outcomes have been disappointingly limited, particularly with recent target reversals.  

“It may be necessary to reconsider our approach.” 

The NZAOA has called for a more systemic approach to stewardship to avoid energy dislocations and increased policy ambition to rapidly reduce oil and gas demand and increase the supply and availability of renewable alternatives. 

“As diversified owners of broad swaths of the economy, any constriction of energy supply without a tandem reduction in demand or increase in alternative supply simply leads to energy dislocations,” Jake Barnett, Co-Lead of NZAOA’s engagement track, told ESG Investor earlier this year.   

“The NZAOA is sensitive to energy dislocations because they hurt regular folks and erode public trust and support for broad climate action that we need.” 

However, for some investors the limited progress of the oil and gas industry on climate forced them to cut ties with the sector.  

In June, the Church of England Pensions Board (CoEPB) and Church Commissioners announced that they will divest from oil and gas firms for failing to align with climate goals. The Church Commissioners, which manages the CoE’s £10.3 billion (US$13.2 billion) endowment fund, had previously excluded 20 oil and gas majors from its investment portfolio, but will now be further excluding BP, Ecopetrol, Eni, Equinor, ExxonMobil, Occidental Petroleum, Pemex, Repsol, Sasol, Shell and Total, having concluded that “none are aligned with the goals of the Paris Climate Agreement”. 

When asked if the case for divesting from hard-to-abate sectors was building, Vanston was quick to note that the engagement versus divestment debate has been raging for many years but believes that “blanket divestment” is not the solution.  

“When banks, shareholders, and insurers withdraw their support, businesses are compelled to reconsider their operations,” he says. “However, individual, specific, and isolated divestments do not make a significant difference due to the abundance of liquidity in the market. On the other hand, engaging indefinitely without achieving meaningful results is also not the answer.” 

For Vanston, there are intermediate steps that can be taken before opting to divest, such as escalation and adjusting weightings, adding that it is also crucial that investors be specific in engagement efforts, addressing issues like unconventional oil and gas and Greenfield projects. 

“Age of adaptation” 

Research by MSCI highlighted that climate adaptation costs could quadruple in a 3°C world – which is close to the world’s current trajectory – but so far investors have prioritised investment into addressing climate mitigation, due to difficulties in identifying the associated risks and opportunities with climate adaptation. 

According to Vanston, the topic of adaptation is poised to be highly significant in the coming years as the world has entered the “age of adaptation”.  

Consequently, the growth of adaptation finance will be essential, he says, noting that based on his experience, apart from a few specific cases, the private business case for adaptation is not as clear as it is for mitigation. 

Often, adapting to climate change becomes a responsibility of governments and relies on nationwide solidarity mechanisms in which private investors can play a role, such as through blended finance,” he says. “The business case for adaptation is not as straightforward as financing renewables or electric vehicles (EVs), presenting a different equation for investors.” 

Additionally, there is a significant concern regarding the availability of adaptation funding in emerging countries, he says, adding that “somewhat disappointingly” large asset owners tend to be cautious about investing in frontier markets for a myriad of reasons.  

“Alternative mechanisms need to be established to address this issue.” 

Green shoots 

The financial benefits we all get from nature are monumental. Analysis by the World Economic Forum found that over half of the world’s GDP – US$44 trillion – is moderately or highly dependent on nature and its services. As nature loses its capacity to provide such services, industries and supply chains could be significantly disrupted, particularly in sectors like food production, pharmaceuticals and timber.    

A major outcome from the UN Biodiversity Conference (COP15) held in December last year was the adoption of the Global Biodiversity Framework (GBF), which set out four overarching global goals and 23 targets to address ongoing biodiversity loss. Following the adoption of the GBF, the Taskforce on Nature-related Financial Disclosures (TNFD) said the release of its finalised framework in September will further assist firms in assessing and reporting on biodiversity and nature-related risks.   

According to Vanston, since COP15 interest from investors regarding biodiversity and nature-related risks has been growing significantly, prompting MSCI to establish a partnership with data and analytics provider NatureAlpha. The partnership aims to provide solutions for investors seeking to track the biodiversity and nature risks, footprints and dependencies of their investments.  

“It is evident that many of them will voluntarily report against the TNFD guidelines next year,” he says, adding that if the “theory of change” implemented by the TCFD is replicated by the TNFD, it is likely that jurisdictions will adopt its guidelines to some extent within the next two to three years.  

“Implementing the TNFD guidelines is challenging as they involve assessing complex factors beyond just carbon emissions, such as various pressures on biodiversity,” he says, adding that matching asset operations with geocoded data and conducting geospatial analysis is crucial, making the entire process significantly more intricate.  

“This is why the TNFD guidelines and the LEAP approach (where ‘L’ stands for locate) are incredibly important and cleverly designed.”

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