COP27 outcomes and implications for investors
The path to climate security remains unclear and what we have witnessed from the negotiations in Egypt over the last two weeks is that governments still need to come together on big themes needed to shape an orderly transition. One key focus from the very start in Sharm El-Sheikh was around the concept of loss and damage (financial support from rich nations to compensate poorer ones for climate change related loss and damage). This is in stark contrast to prior COPs¹ which have focused on adaptation and mitigation. Loss and damage are a harsh reminder that climate change is here, and unfortunately some nations find themselves in the eye on the storm with insufficient financial support to cope with the devastating effects (floods in Pakistan and Nigeria being recent examples).
The results of COP27
While the COP27 final agreement included an unexpected breakthrough on loss and damage, there was disappointment elsewhere:
- Loss and damage: The most meaningful outcome of the conference was an agreement to create a new fund to address the loss and damage caused by global warming. However, the fund structure must be negotiated, and actual fund commitments have not been made yet
- Climate finance for adaptation: The agreement encourages the overhaul of multilateral development banks to speed up and increase funding for renewable-energy projects and infrastructure in developing countries to adapt to the effects of climate change
- Keeping 1.5 alive: While countries agreed to preserve the cuts to greenhouse gas emissions outlined in Glasgow, the effort to secure larger commitments to cut emissions fell flat. European officials hoped to coalesce around a goal of peaking global emissions by 2025, a step that scientists say is needed to limit warming to 1.5 degrees and avoid the worst impacts of climate change. That language didn’t survive the negotiations and current climate policies put the world on track for around 2.7c degrees of warming by 2100
- Phase out/down of coal and fossil fuels: Participants aimed to secure clear follow through on the phase down of coal and phase out of fossil fuels, but neither was in the final agreement. In fact, critics went as far as saying that the text instead clearly protects oil and gas petrostates and the fossil-fuel industries.
- Evolve to become a climate-aware investor
There is resounding scientific evidence that climate change is real. The Intergovernmental Panel on Climate Change (IPCC), which is the leading authority and most credible source of climate change research, published its sixth annual review (AR6) earlier this year and it outlined in stark terms the challenges climate change poses globally to every aspect of our society and economy. It compiles the latest knowledge on climate change, the threats we’re already facing today, and what we can do to limit further temperature rises.
Investors need to evolve to become climate-aware investors, if they haven’t already done so, to manage both the risks and opportunities climate change presents. We advise investors to consider the three steps below when adapting a framework:
Identification of climate risks is both a first step and an ongoing process as new risks and opportunities will emerge over time. There are two distinct categories of climate related risks: transition risks (arising from a shift to a low-carbon economy) and physical risks (arising from rising temperature and weather events).
Climate risks can be assessed via top-down scenario analysis (the consideration of outcomes under different climate paths such as an orderly or disorderly transition) and bottom-up climate metrics (such as carbon footprint measures as well as alignment to net zero).
Once identification and assessment of climate related risks and opportunities has been achieved, those risks need to be managed. The management of risks can be achieved via multiple levers:
- Scheme level strategic initiatives (such as making a net zero commitment)
- Manager monitoring, engagement and assessment (if management of assets are delegated to an external investment manager)
- Defining climate-related metrics and targets
- Active ownership and collaboration
- Allocation to climate solutions (discussed later in this blog)
- Scheme level strategic initiatives (such as making a net zero commitment)
The next step to being a climate aware investor is to consider joining the net zero movement by setting a meaningful net zero target for assets under management. We have seen a growing number of commitments by financial institutions as well as asset owners via the Glasgow Financial Alliance for Net Zero (GFANZ). GFANZ was established ahead of COP26 and is a global coalition of leading financial institutions committed to accelerating the decarbonization of the economy. It is made up of multiple subgroups, and membership now stands at 550 institutions with more than US$150 trillion in assets under management. While the group has come under pressure for its position on fossil fuels, this should not distract from the wider goal to increase awareness and encourage action. We have defined four steps to help institutional investors set and implement a net zero target:
Step 1: Making the commitment
Once a decision to join the net zero movement has been made, the first step is to make an official commitment. There is a range of organizations through which an asset owner can make a commitment including the Paris Aligned Investment Initiative or the UN-convened Net-Zero Asset Owner Alliance.
Step 2: Leverage a target setting framework
The next step is to select a target setting framework to achieve the commitment from a growing number of industry recognized frameworks such as the net zero investment framework implementation guide, the UN-convened net zero asset owner alliance target setting protocol, and the Science Based Target Initiative (SBTi) framework. An understanding of each is required to select the most appropriate for the investor’s circumstances.
Step 3: Implementation
Once a framework has been selected, investors must implement the recommendations of the framework. Note that the recommendation of each will differ but typically includes setting carbon emissions targets, asset alignment targets and engagement targets. Typically, these will be mandated to the underlying investment manager responsible for managing the assets.
Step 4: Reporting and monitoring
The final step is to ensure ongoing reporting and monitoring of the targets. We encourage investors who are thinking about making a net zero commitment to focus on real world outcomes which can be achieved by having a good understating of their assets under management, identifying poor performing positions and actively engaging. The role of engagement to effect real world outcomes.
Biodiversity is the variety of animals, plants, fungi and even microorganisms like bacteria that make up our natural world. The organisms work together to support everything in nature that we need to survive; food, clean water, medicine and shelter.
Climate change is a major driver of biodiversity erosion, and loss of biodiversity also accelerates climate change processes, as the capacity of degraded ecosystems to assimilate and store CO2 tends to decrease. To fight climate change, one must also curb the loss of biodiversity (and pollution)—together known as the triple planetary crisis4. Industries which depend on diverse ecosystems, particularly construction, agriculture, and food and beverage production, are particularly vulnerable to biodiversity loss.
At COP26 in Glasgow, more than 140 countries agreed to “collectively halt and reverse forest loss and land degradation by 2030.” While deforestation made headlines during COP27, there was no formal agreement made this year. Instead, just 20 countries (including the UK, Japan, Pakistan and the Republic of Congo) launched a partnership with the aim to build a long-term strategy and accountability mechanisms.
We expect the discussion to continue at the UN Biodiversity Conference, also known as COP15, taking place in Montreal next month. This conference will convene governments from around the world to agree to a new set of goals for nature over the next decade. The framework being worked on (also known as the post-2020 global biodiversity framework) is expected to include wide-ranging steps to tackle the causes of biodiversity loss worldwide.
On a related note, the Taskforce on Nature-related Financial Disclosures (TNFD) which was announced in July 2020 is continuing to make progress. Its mission is to develop and deliver a risk management and disclosure framework for organizations to report and act on evolving nature-related risks, with the aim of supporting a shift in global financial flows away from nature-negative outcomes and toward nature-positive outcomes. The release of the full framework (currently in draft and has many similar elements to the TCFD) is expected in September 2023.
Core elements of TNFD framework
Source: Based on V0.3 of the TNFD beta framework
Institutional investors can play their part by advocating for greater transparency through frameworks like the TNFD, which will be released next year. In addition, there is a growing number of nature-aware investment solutions which we discuss next below.
Climate change will offer investors a broad set of opportunities as demand for clean energy, carbon capture and avoidance enablement technologies, and sustainable products and solutions grows.
Experts estimate that about US$4 trillion a year needs to be invested in renewable energy until 2030—including investment in technology and infrastructure—to enable us to reach net zero emissions by 2050. Furthermore, a global transformation to a low-carbon economy, one that limits emissions from production and consumption, is expected to require investments of at least US$4-6 trillion a year, on top of the energy specific investments. We expect growth in climate-aware investments across all major asset classes, including debt and equity opportunities across public and private markets.
Indeed, through Q3, venture capital investors allocated US$10.7 billion in funding to startups developing solutions to capture and store carbon and reduce emissions, putting deal making in this area on track to surpass last year's record of US$13.6 billion. The opportunities in climate tech cross the energy, transport, buildings and infrastructure, carbon and climate, industrial, and agriculture industries. Private markets are especially exciting because they offer the ability to allocate capital directly to infrastructure, technology, or strategies that align with a lower carbon economy.
Investors are also taking advantage of rising green bond inventories. According to the Climate Bonds Initiative, annual green bond issuance rose 75% in 2021 on prior year volumes, reaching a cumulative total market of US$1.6 trillion. While the new issue market including green bonds has declined in general for 2022, we expect the appetite for green bonds to remain strong.
Finally, climate- and environmentally-focused public equity funds are offering an increasingly diverse set of themes and investment approaches including:
- Strategies that invest in companies with practices that protect and leverage natural capital through trends like the circular economy, resource efficiency, and zero waste
- Funds that focus on finding carbon-intensive companies with a realistic pathway to move to cleaner operations in the future; and of course
- Energy-focused environmental mandates targeting companies that generate rising revenues from clean energy, energy efficiency, clean tech, and sustainable transportation
As companies and markets adapt to climate change, we believe that engagement and active ownership remain critical tools to achieving investment objectives across investment types. As a baseline, investors are asking companies to report on emissions and natural capital usage via frameworks like the TCFD and TNFD, referenced above. For high carbon emitters, investor advocacy includes target and strategy setting in line with the Paris Agreement. Progress is real, but collaborative groups such as Climate Action 100+ have publicly acknowledged that too often companies issuing emissions commitments lack credible transition plans.
In response, we expect investors to lean in on engagement. In fact, we note a small but rising number of equity strategies adopting a systematic approach to engagement with the explicit aim of unlocking measurable alpha from companies that can de-risk on material environmental issues.
On the other hand, climate-conscious investors will also need to identify industries and companies that have little or no future in a low-carbon economy. While this year’s COP failed to advance the effort to phase out coal and fossil fuels, transition and stranded asset risk for these industries remain high, and in some cases, exclusion may prove the most financially sound decision.
The bottom line
In summary, as climate change reshapes the investment landscape, we believe that there are tangible steps that investors can take to become more climate-aware today. Meanwhile, the global policy response will remain a perennial effort. In the near term, we expect key details of the COP27 agreement to be ironed out. We also expect the UN Biodiversity Conference to pick up where COP27 left off with an aim to establish a new set of goals for nature. Finally, given the unmet targets of COP27, we have no doubt of high anticipation for COP28, which will be hosted by the petrostate nation of the United Arab Emirates next November.
1Conference of the parties of the UNFCCC (United Nations Framework Convention on Climate Change) also known as the United Nations Climate Change Conference
2 IIncluding the European Union, UK, Singapore, Canada, New Zealand, Japan, Brazil, Hong Kong, Switzerland and South Africa,
3 Source: FT.com: https://www.ft.com/content/26aa3014-6dad-4acb-b88a-c065bf8f5707
4 The triple planetary crisis refers to the three main interlinked issues that humanity currently faces: climate change, pollution and biodiversity loss. Each of these issues has its own causes and effects and each issue needs to be resolved if we are to have a viable future on this planet.