The climate challenge – a race to zero

A number of developments at the COP26 climate change summit in Glasgow gave grounds for optimism. These include deeper cooperation between China and the US and a pledge by the financial services sector to harness its resources to help with the global transition to net zero emissions. In the wake of Fidelity’s Sustainable World Summit, questions are being asked about how markets will react to net zero demands and whether inflation should be feared?

Missed the Summit? Watch the replay

Mark Carney, UN Special Envoy for Climate and Finance and now co-chair of the Glasgow Financial Alliance for Net Zero (GFANZ), observes that “one of the important issues is the cost of any transition to net zero.” But adds, “there is no easy answer.” Essentially, fund managers must be disciplined and determine whether any decisions they make will help limit global warming to 1.5 degrees Celsius above pre-industrial temperature levels.

A glass half full

COP26 was never going to be the final act of the climate drama. But neither was it a prelude. Instead, it represents the latest stage of a longer-term process. Certainly, challenges remain, most notably with energy transition and scaling up finance for emerging and developing economies. Overall, Carney’s assessment of the Glasgow summit is positive. “Expectations were high,” he says, but added that his “glass is half full.”

First, the agreements pertaining to the net zero transition and limiting global warming to 1.5 degrees Celsius were critical. Carney also highlights “a big movement” in country-specific objectives. “Two years ago, less than a third of global emissions were covered by net zero. Post-Glasgow, it is over 90 per cent,” he explains[1]. Also, the private sector appeared to scale up with more focused objectives.

Reducing carbon emissions across all industry sectors will cost trillions of dollars, and “we are only beginning to scratch the surface,” says Carney. He concedes that the number is enormous but breaks it down into more manageable terms by stating that the transition to net zero will require “an extra two percentage points of GDP in investment per year over the next 25-30 years[2].”

Market incentives

From an asset management perspective, Carney says that the sector should aim for net zero portfolios by 2050 and focus on a 50 per cent reduction in fund-holding-related emissions by the end of this decade. The industry should also provide annual emissions reports, so investors and other stakeholders can track their progress. As Carney mentions, one of the main benefits of having a financial sector committed to net zero and beyond is that it creates credibility. In turn, this generates investment and, ultimately, the capital required for the transition.

Understanding the price of net zero is vital for the sector. But, as Carney admits, this is sometimes a challenge. Not only do the costs vary by sector, but it also requires making judgments around specific opportunities and companies, determining whether they can follow the path to 1.5 degrees Celsius.  

However, Carney notes that the investigative work of the industry is sometimes constrained by a lack of information about the carbon transition plans of businesses. That said, he also believes this situation will improve reasonably quickly thanks to the work of the International Sustainability Standards Board (ISSB) and GFANZ.  “A significant moment came earlier this year when UK finance minister Rishi Sunak announced that larger listed British firms will need to publish their transition plans,” demonstrates Carney[3]. Looking ahead, he believes this process will become more mainstream to encompass smaller and medium-sized firms.

Supportive government policies will also add momentum. Carney cites Britain’s moratorium on the sale of new vehicles powered by internal combustion engines by 2030 and China’s push towards zero-emission vehicles by the same year[4][5]. These examples will help establish a more accurate cost for the shift to net zero that will feed through to the financial sector.

Get out of jail free – not quite

Turning to carbon offsetting and this is not what Carney calls a “get out of jail free card.” He characterises it as a factor that extends carbon budgets and allows companies to compensate for the emissions they still produce.

Since COP26, there are signs that carbon offsetting is becoming more structured and could be worth US$100-US$150 billion a year, potentially more if it catalyses broader investment in nature-based solutions[6]. “Having a view on the price of carbon and carbon mitigation is a skill,” he says, which will be required for effective portfolio construction.

Furthermore, he points to directionally correct pricing on the periphery, for instance, the cost of replacing coal with renewables. “Ultimately, carbon is going to have a price,” he clarifies, which will reward companies following the most appropriate transitional pathway.

Inflationary factors

“Over the medium to longer-term, the switch to a more sustainable economy will be disinflationary,” says Carney. But in the near term, there will be “something akin to an investment boom” that could add as much as two percentage points to global GDP[7],” he continues. This represents a structural change in the economy that could affect virtually every sector.

“When you get these supply-shape shifts alongside strong demand, it does lead to inflation,” he says, “even if the upside is growth in real jobs.”  Nonetheless, this shouldn’t be overly concerning, as Carney makes it clear that “central banks can handle that”.