As we approach the end of COP26, our investment and engagement teams reflect on its outcomes and the path that lies ahead in the fight against climate change.
Silvia Dall’Angelo, Senior Economist
As COP26 approaches its close, the feeling is that it has been a mixed bag. There has been progress in many areas, most notably with respect to deforestation, methane emissions and the involvement of the financial sector. Both the public and private sectors have put forward new commitments, with private initiatives showing dynamism and creativity.
While 90% of the global economy has now pledged net zero over the next 30 to 50 years, ambitions still fall short of the Paris’ goals. According to IEA’s estimates, updated government pledges would put the world on a 1.8°C post-industrial warming trajectory, compared to 2.1°C before COP26, but still above the all-important 1.5° C threshold. In addition, the lack of details underpinning commitments suggests there is a risk COP26 was an exercise in climate change diplomacy, masking a deficit of political capital, a sense that was reinforced by the prominent absence of China’s President Xi. In addition, the divide between advanced and developing economies was largely unaddressed, implying an unfair burden for developing countries.
A bright spot has been the finance industry stepping up its efforts in the fight to climate change, by committing $130tn of capital to achieve a net zero economy by 2050, under the Glasgow Financial Alliance for Net Zero (GFANZ). The headline number – which probably overstates advances – stole the light from advancement in discussions concerning crucial aspects such as the need for harmonised ESG standards and the role of central banks and regulators. In these respects, the IFRS Foundation announced the establishment of a dedicated International Sustainability Standards Board (ISSB), while the Network for Greening the Financial System (NGFS) committed to exploring new and better ways to integrate climate change (and biodiversity) considerations into monetary policy.
At the end of the day, the hope is that what happens in Glasgow does not stay in Glasgow. The conversation needs to continue, broaden and, crucially, yield concrete action. Developments outside and beyond COP26 are the real deal. Going forward, we need more ambition, underpinned by robust and timely implementation – including detailed and actionable plans that can be rigorously monitored against measurable intermediate targets. Also, at the macro level, we need a new framework to assess economic performance that goes beyond GDP and integrates environmental and social standards. This mindset shift is a precondition to ensure we successfully transition to a sustainable world, along the lines of a fair and inclusive process.
Mitch Reznick, Head of Research and Sustainable Fixed Income
US Treasury Secretary Janet Yellen delivered keynote remarks on Finance Day of COP26 in Glasgow on the 3rd of November. After outlining the economic imperative for the global economy to rapidly decarbonise, she offered up a three-decade price tag: $100 to $150 trillion, a number as large as the intimidating challenge of the world cutting its net emissions to zero by 2050. In her address, Yellen admitted that the ability to finance the transition stretches beyond the means of government: “The gap between what governments have and what the world needs is large, and the private sector needs to play a bigger role.” This statement is nothing less than a call for action.
While it would be helpful to see governments like the US deliver into their own promises stretching back to COP21, the asset management industry cannot wait. Our investors do not want us to wait. And, with 20% of all primary investment grade issuance in Green, Social or Sustainability (GSS) format, and the volume of the GSS bond market now at over $1.7tn—a 50% jump year-on-year according to Natixis—the global bond market is making room for sustainability. As fixed income managers, we can do much to deliver into the call to action from the Yellen, the UN, and many others. We can continue to create thematic investment solutions and investment processes that direct capital to companies that earnestly and credibly seek to decarbonise, whilst simultaneously having the potential to deliver superior risk-adjusted returns. Those returns can be found in well-governed companies with vision, who provision for where governments and regulators are directing the global economy to be over the next three decades: net zero and preservation of biodiversity, which emerged as a big topic at COP26 and will become a big issue in sustainable investing going forward.
Fraser Lundie, Head of Credit
The Glasgow COP was always seen to be an invaluable opportunity to action on previously agreed visions. The past fortnight has indeed seen significant progress to galvanise consensus towards common standards and frameworks. Credit market participants will welcome clarity and consistency in this area, noting the significant pledges agreed on coal phase-out, deforestation, methane and emissions. Their absence to date has often hampered the sustainable finance movement, by injecting confusion, encouraging indecision and unfortunately, aiding greenwashing.
More than ever, Finance and Asset Management have been at the forefront of discussions which are key to facilitating the onboarding of externalities. The Glasgow Financial Alliance for Net Zero drives further direction of lending away from coal mines and related power stations. Energy, Utility and Basic Industry sectors are definitively on watch, but no segment of the market can afford to be passive. Markets love certainty, and with it, comes the ability to plan in a strategic and long-term manner. With a plan, companies can borrow the trillions of debt financing required for uses such as the energy transition, carbon capture, and biofuel technology. And, fixed income asset managers such as ourselves can allocate investment capital to fund this.
COP26 will continue to drive an ever more nuanced marketplace – rewarding companies with a keener eye on climate related risks and opportunities through the lens of governance, strategy and risk management. Companies will increasingly have their decarbonisation strategies analysed with science-based targets (or SBTs), with many signing up via the SBT Initiative. Holistic financial and sustainability analysis is key to delivering positive outcomes. This can be aided through active engagement. As metrics and targets become better understood, so too will the differentiation between corporates, financials and sovereigns, leaving active asset managers with a wealth of opportunity to add value.
Louise Dudley, Global Equities Portfolio Manager
We have seen countries and the private sector making positive commitments that go beyond previous ambitions. This provides greater momentum behind the race to zero, but the pathways remain unclear. While there remains a wide range of policy ambitions, this makes it more challenging for global companies and investors. We support further climate policy and regulation. Net zero commitments from companies have been rampant over the last 18 months, but still a minority, even for companies in climate critical sectors. Transition plans are critical for companies and as investors we will be pushing to accelerate the delivery of these, along with robust, meaningful targets to support long term value creation. The successes of the Climate Action 100 initiative support the case for collaborative investor engagement and the additional coalitions including the finance pledge on ending deforestation will accelerate action in this area. The TFND framework will ensure companies are accurately and transparently reporting on the risks with investors.
This COP has highlighted greater consumer awareness of climate implications and companies are eager to deliver into these sustainable aims. In particular, within agriculture and the food system we expect to see an increasing number of sustainable investment opportunities. We also view technology companies as key to delivering low carbon digital solutions within the broader economy, working with customers to enable a fast transition to a low carbon economy. While focusing on reducing emissions, we are also interested in the developments of carbon removal technologies. This is an area which requires greater funding and targets.
Achieving our climate goals and delivering on the numerous pledges announced at COP will require massive efforts from all stakeholder to accelerate action.
COP26 was successful in placing nature and biodiversity at the heart of the climate agenda. Over 120 countries covering more than 90% of the world’s forests have now endorsed the Glasgow Leaders’ Declaration on Forests & Land Use committing to work collectively to halt and reverse forest loss and land degradation by 2030. This landmark announcement was also championed by over 30 financial institutions, including the international Business of Federated Hermes, representing (US) $8.7 trillion in AuM committed to work towards eliminating agricultural commodity-driven deforestation risks in their investment and lending portfolios by 2025. If fully funded, these commitments could reduce emissions by 3.5 gigatonnes by 2030, more than the 3Gts promised in existing nationally determined contributions (according to the ETC).
Collaboration and partnerships will be crucial to achieving a 1.5°C pathway and in supporting the transition to a sustainable agricultural sector and in protecting and restoring forests and other critical and often overlooked marine ecosystems.
We believe all these efforts and commitments need to be supported by globally consistent and comparable performance metrics and disclosures, to enhance decision-making, trust, and accountability. We therefore strongly welcome the announcement of the formation of a new International Sustainability Standards Board (ISSB) to develop rigorous and globally accepted standards for sustainability reporting that can be adopted worldwide, so that sustainability related risks and opportunities can be appropriately assessed by investors. Going forward, we hope the ISSB will expand beyond its initial focus on enterprise value to embrace the concept of double materiality and examine how climate risks connect with a wider range of environmental and social factors.
From a historical perspective, COP26 looks set to deliver the most ambitious set of government targets to date, with all commitments capable of being very close to limiting climate change to below 2°C, which is a significant improvement on the approximately 4°C of a decade or so ago. However, national targets are no longer the only element, with approximately a third of all G20 listed companies having net zero targets. Investors have arguably been the foremost progressive business voice in driving forward climate goals and the latest GFANZ commitments indicate a majority of asset managers now committed to net zero investment goals. It is now incumbent on investors to give the mandate to companies to pursue net zero goals with targets aligned to 1.5°C and help bridge the gap between national targets and the required reductions.
The various sectoral agreements published on coal, methane, deforestation, automotive and fast fashion will help investors provide a further welcome anchor upon which to engage companies to either sign-up to the statements for the first time or deliver on these over coming years.
Infrastructure is at the heart of the transition to Net Zero. We, as investment managers representing institutional investors, can contribute as stewards of our existing assets, influencing hundreds of small decisions every day, and by investing in innovative solutions. We are part of Mark Carney’s £130tn and we intend to live up to expectations.
At our Further Faster conference and others, we have been impressed by the diversity of expertise within and amongst organisations. We now have engineers, ecologists, chemists, lawyers and the broader finance community talking and listening to each other. Knowledge and ideas are being shared. We are also pleased by the integrated discussion of previously siloed concepts –climate, nature, wellbeing and justice. Discussion amongst private sector participants is increasingly holistic. We strongly believe that brave thought leadership is critical to making progress. Innovative solutions are being developed across sectors at an increasing pace.
There is clear consensus that we need to stop talking and act now. We also recognise that action requires collaboration, across all levels within the public, private and third sectors. We need to keep talking to each other, in order to collectively achieve the right outcomes. There is a clear risk that we, as the finance community, remain in a bubble. In particular, at COP26 and outside of it – direct community, employee and wider public engagement is lacking, and is essential if a just transition is to be achieved.
Collaboration of course requires trust – which will be underpinned by private sector transparency and disclosure. There is no question in our industry that transparency is important. More interesting is a slowly growing consensus that selective presentation of positive impact and achievements actively erodes trust. As businesses, we have to be brave enough to be transparent about negative impacts, failure and challenges, to increase trust and succeed in the longer term.
To date, there has been a clear sense that we can’t wait for policy coherence or global consensus to take aggressive action. More recently, the obvious gap between countries’ long term goals and short term or interim targets, which indicates we are headed for 2.4°C, rather than 1.8°C, is concerning. Infrastructure is policy driven by, and to a great extent policy dependent. We remain more concerned than ever that the UK government isn’t being ambitious enough in the near term. It is failing to send the important policy signals that the economy requires to make the critical long term decisions that will shape future infrastructure provision in a Net Zero world.
We are particularly concerned at the scale of the challenge in hard to abate sectors – steel, cement and concrete – and the pace of change. Smart innovative solutions, to capture and remove carbon are desperately needed, but progress is slow. The decarbonisation of industry is a particular challenge for an infrastructure sector currently dependent on these materials.
Bigger picture, we are surprised that the idea that perpetual growth is consistent with living within planetary boundaries isn’t challenged more. Reduction in demand and consumption is such a key part of the solution and a key challenge in infrastructure, where demand and growth can often equal revenue. Both mindset and revenue model shifts are required to address this challenge.
Finally, we are aware that we represent only part of the financing and funding equation. Where public sector funds are required alongside, or to enable, private sector investment, to assist developing countries or support vulnerable populations, where are those funds coming from? How do we, as the corporate community, contribute to the pot? Fair tax, as part of business’ social contribution – as part of the ‘S’ in ESG – must come into the mainstream conversation.
It’s easy to become overwhelmed by the science, technology and the scale of the required global change. It would be easy to forget how much we can do right now. In private infrastructure, we know we can influence governance structures, establish sustainability committees, integrate sustainability into strategy, and push companies to set and disclose clear short and medium term decarbonisation targets. We can influence thousands of decisions day to day across our portfolio and we will continue to do that.