COP 26 - Progress so far

COP (Conference of the Parties) is an annual event that brings governments together to discuss and review how climate change is being managed both at an individual country level as well global level. COP26 marks the 5^th anniversary since the signing of the Paris Agreement, a legally binding treaty, signed by 196 countries, to limit global warming. Given this anniversary expectations are high. The chasm between achieving net zero carbon emissions by 2050 and current plans is vast and underappreciated, but it is not insurmountable. Governments need to deliver ambitious packages of detailed plans, pressing timelines, large scale investment and an integrated system of incentives for corporates and consumers.

So far ambitions have been raised with almost 90% of global emissions now with a net zero target, however tangible actions from those nations that can have the greatest impact are still missing. Most notably, China, India and Russia are missing from both the coal phase-out agreement and the Global Methane Pledge and as highlighted by Carbon Action Tracker.

At time of writing, the current Nationally determined contributions (NDCs) only put us on course to limit warming to about 2.4°C above pre-industrial levels. Nationally determined contributions (NDCs) are at the heart of the Paris Agreement and the achievement of these long-term goals. NDCs embody efforts by each country to reduce national emissions and adapt to the impacts of climate change. This means that even greater efforts will need to be undertaken in the 2^nd quarter of the century unless ambitions are raised and NDCs are reviewed more frequently. While there is an ongoing debate to review NDCs on an annual, which we believe is a must-have, it still remains an ambition versus a concrete action.

While much remains to be seen in terms of action at COP26 and post COP26, there have been some encouraging actions taken as a result.

• Net Zero Asset Manager Commitments by 2030 - The Net Zero Asset Managers Initiative (NZAM) released a progress report which shows for the first time how asset managers are measuring, targeting, and implementing their net zero strategies.  NZAM represents 220 firms responsible for c60% of global AUM who have made a commitment to net zero halve their portfolio emissions by 2030 (scope 1 & 2 initially, but scope 3 soon to follow). This has potentially huge implications for the pricing of assets since it will steer investors away from high carbon sectors. 
   
• New Financing Roadmap - The members of the Glasgow Financial Alliance for Net Zero (GFANZ) presented a new financing roadmap that shows the private sector needs to fund ~70% of the US$2.6trn of global annual decarbonization investments required to meet net zero goals through 2025[1]. GFANZ is also leading efforts to accelerate capital flows into developing regions.  This highlights why the annual US$100bn commitment to developing countries is such a high priority (which is getting closer to reality with Japan’s latest pledge) and will hopefully provided the necessary additional support for the growth of the green bond market and financing of decarbonisation efforts.
   
• Declaration on Forests and Land Use - 120 countries+ covering ~85% of the world's forests have signed the COP26 Glasgow Leaders Declaration on Forests and Land Use. Through the Declaration, world leaders have committed to working collectively to halt and reverse forest loss by 2030. 

The Global Forests Finance Pledge funding includes[1]:

• • • US$12 billion of public climate finance from 2021-2025 via the Global Forest Finance Pledge
    • US$7.2 billion of private sector funding has been mobilised
    • US$1.7 billion from 2021 to 2025 to advance Indigenous Peoples’ and local communities’ forest tenure rights and support their role as guardians of forests and nature
    • US$1.5 billion to protect the forests of the Congo Basin (second largest tropical rainforest in the world)

While it is encouraging to see progress on verbal and financial commitments to halt forest loss, actions remain to be seen. Halting Deforestation can be also difficult to enforce on a local by governments and as such we believe it is critical, to continue to engage with companies on Bioversity Loss and Deforestation. A recent example of a biodiversity engagement we have undertaken can be seen here.  [LG1] 

• Carbon-Based sectoral arrangement - Metals are key to decarbonisation and so the progress made on developing the world’s first “carbon-based sectoral arrangement” on steel and aluminium trade is encouraging even if the implementation date of 2024 is disappointing. This arrangement appears to be a stop-gap to a fuller border adjustment mechanism that would prevent carbon leakage arising as a result of the import of carbon intensive steel from jurisdictions without a carbon price.  Furthermore, GFANZ also named steel as a “priority” sector for engagement due to its importance and the UK, Germany and Canada unveiled plans to create demand for low carbon steel, cement and concrete.  Taken together with targets for greening public procurement, these initiatives should lead to a material uplift in the demand for low carbon materials. We believe this increased focus on the steel sector will have a number of implications for markets; firstly, it should facilitate the issuance of green instruments and support strategic shifts for companies in the sector; secondly it could result in relative outperformance of cleaner steel production (such as Electric Arc Furnaces). 
• Decarbonisation of the automotive sector  - On Transport Day, which fell on the 10th November, 24 nations with 20% of global auto market joined a climate pact to pledge that all new cars and vans will be zero-emission by 2040, or 2035 in leading markets.  The nations are joined by 11 automakers who will work to ensure that the sales of all new cars and vans being zero-emission globally by 2040 and no later than 2035 in “leading” markets.  When taken together with ICE phase-out targets and other national goals, 2/5 of the global auto market has targets that incentivise zero emission vehicles.

What does this mean for investors?

• Investors need focus on real world emissions reduction and the financing to enable to this is needed - A key, if obvious, takeaway for investors and others alike, should be that despite increased climate commitments by many governments, more needs to be done and that this is only possible if there is an even greater focus by investors on real world emissions reduction. Moving the needle on decarbonisation and enabling a path to limit warming to 1.5C requires significant investment and a focus on transitioning, even the harder to abate sectors, which account for around a third of global emissions[2]. A mechanism to do this is to allocate capital to companies across all sectors which are leading in terms of decarbonisation practices and/or are setting ambitious goals to decarbonize.
• Global Debt Markets will play a crucial role in enabling decarbonisation - The private sector needs to fund ~70% of the US$2.6trn of global annual decarbonisation investments required to meet net zero goals through 2025 of which half comes from corporates (both public and private companies). With US$1trn of capital changing hands every day in the bond markets and the ability to provide financing both within the public and private space, bondholders, relative to equity holders, have the potential to play an even more crucial role in financing decarbonisation, both at a corporate and asset level.
• A balanced approach is required - An increasing number of investors have set climate targets, for example 5% or 7% annual emissions targets for their investments, and are required to disclose on these on an annual basis. Meeting this target can be easily be achieved through the exclusion of a few high emitting companies from the universe on an annual basis, or excluding high emitting sectors. In our view, the low carbon transition is sector, asset class and geography agnostic. Taking an approach which ignores the need for these companies or sectors to decarbonise transfers the problem and leaves it open for other non-climate focused investors to invest and the company to continue with business as usual. It does not drive real world emissions reduction. An approach which focusses on rewarding capital to those who are evidencing climate best practices, whether today or in terms of their transition, is the required approach to drive change.