Chris Kaminker, Group Head, Sustainable Investment Research, Strategy & Stewardship, Lombard Odier
- The cumulative pledges that have been announced, if fully implemented, would be sufficient to limit warming to 1.8C. This is the first time that we’ve moved the dial sufficiently to bring these pledges in line with the objectives of the Paris Agreement, keeping warming below 2C. The ultimate objective is to keep warming below 1.5C. A further ramp-up of ambition is still needed to achieve that, and the gap is significant. To achieve this, the draft agreement calls on countries to announce even stronger pledges before the end of 2022, to align national plans to keeping warming to 1.5C. Crucially, this will require not only net zero targets for 2050, but stronger interim targets.
- Going into COP, Boris Johnson introduced a slogan of “coal, cars, cash and trees”, as representing the four priorities for COP:
o The phaseout of coal is perhaps regarded as the most vital, most urgent policy step needed to keep the objective of limiting warming to no more than 1.5C in sight. More than 40 countries have pledged to phaseout coal by the 2030s and 2040s. Yet the absentees are perhaps as striking as the signatories, with the US, China, India and Australia not yet having signed onto the pledge. But, with cost of renewables falling, simple economics may outweigh the impact of policy, with a rapid succession of bankruptcies of coal plants even during the last US administration.
o As regards cash, COP26 has often been billed as the “finance COP”. The new Glasgow Financial Alliance to Net Zero brings together asset owners and managers with a reported USD 130 trillion in assets (albeit this would include some double counting). While only a small portion of this would be dedicated to green solutions, specifically, the transition to a net zero economy requires not only investment in low carbon technologies, but also the large-scale realignment of the wider economy and, by extension, of investment portfolios – and it is here where the GFANZ alliance may become hugely impactful.
o As for trees, climate change is driven not only by energy-related emissions, but also those generated by changes in land use – including those linked to deforestation. Ceasing deforestation, and investment in reforestation, has garnered growing momentum owing to the recognition of not only the comparatively low cost of this intervention, but also its associated benefits to the wider environment, biodiversity and the communities that depend on it. World leaders and 30 financial institutions – including Lombard Odier – have signed pledges to ensure a halt to deforestation, as well as financial support for specific focus areas, such as the Congo basin.
o As for cars, most striking perhaps has been the predominance of electric vehicles used in and around Glasgow by participants motivated to set the right tone. The relative cost of electric vehicles has already rapidly increased, but a new Breakthrough Agenda is seeking to further bring forward the tipping point at which electric vehicles and other green technologies displace incumbent alternatives. The first five breakthroughs targeted include clean electricity, electric vehicles, green steel, hydrogen and sustainable farming – providing a glimpse of the technologies that will characterise the Net Zero economy.
- For investors, this only reinforces our longstanding belief that we need to urgently understand, identify and address carbon risks in portfolios. Understanding transitional risks and opportunities, physical risks, and liability risks, is vital, and is become more acute. As more financial institutions begin to assess their alignment to the transition, to the Paris Agreement, and to new government pledges, the thinking and sophistication of the market will rapidly evolve – away from a simplistic focus on simply avoiding sectors that are high-emitting today, to identifying the specific roadmaps each sector faces and identifying those companies making genuine progress towards these. That, in turn, will shift views on companies, and how assets are priced by the markets.
- Regulatory requirements will intensify. In October, the TCFD released new guidance recommending all financial institutions disclose their alignment to a well below 2C scenario. This type of assessment requires new mindsets, but also new capabilities – such as forward-looking assessment tools. Already, nine jurisdictions have either already included TCFD reporting regulations as part of their frameworks, or are proposing to do so. At the same time, as governments move from target-setting to the more difficult task of implementing these, increased policy guidance and new regulatory frameworks will emerge to set the pace, track and incentivise progress, and penalise those lagging behind.
- Overall, we need to recognise that the transition to a net zero economy is both the largest economic transformation of our lifetime, and also one that will need to unfold at an astonishing speed. Transitions happen slowly at first, and then all at once, and as investors we cannot delay understanding our own exposure as a matter of urgency. We have seen past transitions unfold in the past: as new technologies emerge and decrease in cost, incumbent technologies are rapidly replaced, and those taking too long to transition are displaced. The climate transition represents the latest – but arguably the largest-scale – replacement of an incumbent, fossil-fuel driven economy by a greener, electrified alternative that is both cleaner and, ultimately, economically superior.
- LOIM is a signatory of the Net Zero Asset Managers’ Initiative, and has been an active contributor to the development of relevant investor frameworks. We have been a leading contributor to the development of so-called Implied Temperature Rise metrics, which assess alignment of investments to the Paris Agreement. By March we will be setting specific targets for the decarbonisation of LOIM portfolios.
- We also put out the following article, estimating that today only 25% of large caps are aligned to a <2C scenario, and only 6% to <1.5C. These figures were generated using our proprietary temperature alignment methodology, closely aligned to the best practices identified by the independent Portfolio Alignment Team that was commissioned by the TCFD. While many companies are setting decarbonisation targets, a company setting a net zero target does not necessarily make it well-aligned, unless those targets are independently verified, backed up by interim commitments, and a clear plan for implementation. For the finance industry, the recognition of the gap between ambition and the real economy also implies that the challenge is less about pouring all our capital into the 6% of companies already well-aligned, than it is about progressively seeking to improve the alignment of the remaining 94%.