At the COP26 conference in November, Glasgow was at the centre of the world. Political and business leaders along with royalty descended on the Scottish city to strengthen their commitment to fighting climate change. Wealthier nations agreed to help fund emerging economies efforts to decarbonise, while huge compromises were made to get almost 200 parties to agree to the Glasgow Climate Pact. COP26 president Alok Sharma presented the deal with tears in his eyes as he apologised for the agreement not being robust enough.
“It is difficult to get too excited about COP when the chief negotiator cries at the end of it,” says Lloyd McAllister, head of ESG research at Newton Investment Management. Joking aside, it appears that institutional investors do not see November’s conference as a turning point in the fight against climate change.
“In terms of impact, there is an element of inevitable disappointment about COP26,” says John Mulligan, director and climate change lead at the World Gold Council. “Institutional investors love milestones and measurement and metrics, but COPs struggle with those because they reflect the aggregate negotiated position of the world’s governments, often resulting in softer outcomes,” he adds.
For Catherine Ogden, a sustainability and responsible investment manager at LGIM, institutional investors and their managers did not feel a huge impact from the agreements made at COP on the day the conference closed, yet their influence will be felt for years to come. “We will be held accountable by our clients and our clients will be held accountable by the regulator,” she adds. “There will be a trickledown effect.”
However, McAllister highlights one immediate benefit. “Prior to the UK hosting COP, 30% of global emissions had net-zero targets; it is now 80%,” he adds. “The ambition has been raised, which is step one in achieving the 1.5-degrees target. Now comes the hard part of fast delivery.”
This fast delivery will be difficult, and if it is achieved, it will probably be led by the financial sector. “Technology and investment are likely to play a stronger role than government intervention,” McAllister says. “It is a difficult situation for politicians to solve, because it involves the raising of food and transport costs, which is politically unattractive.”
Off to work we go
The International Energy Agency has calculated that if all the pledges made at COP26 are achieved then global temperature rises would be limited to 1.8-degrees by 2100. “Those are just the pledges; the implementation is what’s needed,” says Margaret Childe, head of ESG research and integration, Canada at Manulife Investment Management.
“There is no indication that we will see the necessary actions coming out of these commitments,” she adds. “In fact, post the negotiations in Kyoto, Copenhagen and Paris, we saw a steady increase in greenhouse gas emissions. “We are not currently on track for an annual greenhouse gas emissions reduction of 7%, which is what’s needed between now and 2030,” Childe says. “1.5-degrees is achievable, but the magnitude of the action necessary is significant.”
It looks like cutting greenhouse gas emissions in half by 2030 and achieving net zero 20 years later is going to be tough. So, those pledging to achieve carbon neutrality in less than three decades have a lot of work to do and will need the support of those managing vast pots of private capital.
Indeed, government commitments made at COP26 probably put us on track for a 2.4-degrees climate target, which only falls to 1.8-degrees once all pledges and proposed reductions are considered. “So, even in the most positive scenario of all the consequences of COP, we are not fully on track for 1.5-degrees,” Mulligan says. “We need to do more and accelerate it.”
The financial community understands their role here. “Positive progress is being made, but there is a recognition that more needs to be done,” Ogden says. “We would not be having this conversation if the problem had been sorted in one conference.” It is clear that pension schemes and those they appoint as stewards of their capital have a key role to play. “Asset owners expect their managers to play a positive role in the transition, rather than sit on the fence or hinder it,” McAllister says. “The message from COP is that asset managers need to do more.”
Down or out?
One of the biggest headlines from COP26 involved coal-powered energy. Following much discussion between various governments, the agreement was to ‘phase down’ rather than ‘phase out’ the use of coal. Mulligan is disappointed by the policy.“
All the science says we have to phase out coal as soon as we can,” he adds. “But there is also the question of how to support this in a fair and practical way – to enable heavy users of coal to address the challenge of moving to cleaner energy without sacrificing too much.” Such language is common when it comes to carbon-reduction plans. “Language plays a key role in this transition,” McAllister says. “It is amazing that two words that are relatively close in meaning can cause such tension.”
He uses the example of oil companies renaming ‘product emissions’ as ‘customer emissions’. “There is a lot of this going on. “For me, ‘phase down’ is appropriate,” he adds. “If you are phasing down on one side, there needs to be a ‘phase up’ on the opposite side of substitution technologies, which are not yet scalable or affordable,” he adds.
LGIM has called on governments to phase out coal-based energy, so they are disappointed by the agreement to ‘phase down’. “Having clarity that people can get behind is always preferable,” says Caroline Ramscar, head of sustainability solutions at LGIM. “It is difficult to change behaviours, whereas clarity from the top would provide stronger clear messages signals to investors.”
This was not the only agreement struck at COP. Other commitments include 20 countries pledging to stop funding fossil fuels overseas as well as the signing of a hard agreement to reduce deforestation by the end of the decade.
But this agreement is a sign of why expectations of the events has been low. “The end of the decade is quite late,” Mulligan says. “Ending deforestation sooner would have a more positive climate impact and send a stronger signal,” “This is a key theme that emerged at COP26: the need to pull our horizons – and decisions and actions – nearer. “The agenda at COP26 was shaped by net zero 2050, but large institutional investor groups were vocal in wanting nearerterm action,” he adds.
“The problem is that 2050 is beyond the scope of many investment strategies. Bringing it closer means acting sooner.” Such action means investors using their influence as asset owners to create the change needed. “COP26 has made the direction of travel more official,” Childe says. “We are heading towards a low-carbon economy, but we have significant legacy investments to deal with. This is why investors need to engage with the fossil fuel industry to make that transition,” she adds.
One positive from COP26 was that the rules for creating a carbon pricing market were approved, which could see costs rise for those with high carbon footprints. “The carbon trading arena is at least a little clearer after COP26,” Mulligan says.
Such a market has been difficult to create, a task made tougher given recent events. “It is politically challenging to get carbon pricing off the ground, and it has been made harder because of Covid, rising inflation and societal discontent at government intervention in people’s lives,” McAllister says. “From an economics perspective, the simplest way to fix a market failure like pricing pollution is to tax it and let the market reallocate capital,” he adds. “It is that simple, which is why it is crucial that this framework gets off the ground.”
An additional benefit of a carbon market would be that more funds will flow into developing cleaner technologies. “It is going to provide more capital into green technologies because the returns from non-clean tech will fall,” McAllister says.
The agreement on the rules for such a market could be huge in reducing global warming. “It is an important missing piece in meeting institutional investor demand for carbon pricing,” Childe says. She points to action to develop a carbon market being taken by the EU and China, but the US, which is home to around half of the globe’s capital markets, needs to move in this direction. “We will see how carbon pricing develops, and it has to develop,” Childe adds.
For Childe, technology is not the only solution. While it is important for removing carbon from our atmosphere, we need to look at all solutions, including those which are nature-based, such as timberland and agriculture, which have tremendous potential to sequester carbon. “Technology yes, but all sources of carbon removal need to be investigated from the outset and factored into climate mitigation strategies,” she adds. “And first and foremost, we need to focus on significant emissions reduction.”
It is clear that human intervention is not the only way to solve anthropogenic climate change. “Historically, the focus has been on energy systems, but there is a growing recognition that agriculture and land use change have a significant impact on reaching our carbon goals,” Ogden says. “Deforestation commitments made by governments and financial institutions puts that recognition at a higher level and should lead to increased scrutiny in this area.”
It appears that awareness of how to solve the problem is spreading beyond asset managers and consultants. “There is a greater interest in the implications of deforestation and biodiversity among trustees,” Ramscar says. “That is playing out in meetings where we are increasingly being asked about our engagements in this area.”
However, the rules being agreed is the first step in a long journey. “Post-COP, whilst some progress has been made, there are still no meaningful steps taken towards global carbon pricing,” Ramscar says. “That is critical. We need to quantify the problem to incentivise consumers and producers on the path to net zero. There is still a lot of work to be done.” This is not just about pricing carbon emissions.“
There are now stricter rules to reduce double counting and, hopefully, improve the levels of transparency and liquidity in voluntary carbon markets,” Mulligan says. “And a portion of the money derived from offsets will be directed towards climate adaptation in developing nations. “The opportunity is truly revolutionary and substantial, but you also need to balance the risks that a complex and volatile landscape that rapid, potentially disorderly transition will impose on investors,” he adds.
Leave no one behind
Millions of people round the world work in the coal and oil industries, so net zero puts their livelihoods at risk. A just transition means companies need to re-skill and re-tool their workforces to avoid stranding them as the world shifts to cleaner energies. “Renewables and green energy require less people than legacy energy systems, so governments need to think carefully about the social impacts of the transition.” McAllister says. “The transition is likely to be quite volatile in some places,” he adds.
Ogden says that a just transition is an important part of the net-zero pathway. “Achieving a balance between a just transition and the imperatives of a net-zero transition needs work,” she adds. But decarbonising economies and not leaving people behind cannot be achieved through setting a single policy. “A just transition means many things,” Mulligan says. “It can mean policies to protect longer-term employment domestically, but it also means how we all help implement a transition to net zero which is seen as globally fair, including consideration of vulnerable developing nations.”
Joining the club
Other important highlights included India committing to decarbonising its economy for the first time. While welcomed, the timeframe of its pledge has left some disappointed. “It has committed to net-zero emissions by 2070, but, importantly, that direction of travel has at least now been solidified,” Childe says.
The announcement from India, along with commitments by China, have been welcomed by McAllister for providing a degree of regulatory certainty. “That should trigger investments into those emerging markets,” he says. But, perhaps showing that climate change is a political issue producing softer outcomes, McAllister gives an interesting conclusion to the conference in Glasgow. “It is amazing that it has taken 26 COP meetings to write down that burning fossil fuels is the primary cause of global warming,” he says.