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Ninety One launches the Net Zero Sovereign Index

Ninety One claims the race to net zero is not a race between countries. It is a race against time.

If the world is to achieve net zero at a speed comparable with the Paris Agreement’s goals, investors’ current approaches to allocating capital must change. The latest whitepaper by Ninety One, No one left behind: Building an inclusive transition for emerging markets, examines the flaws in asset managers’ and owners’ interpretations of net-zero which has led them to set portfolio-level carbon targets which will stymie global net zero ambitions. In response to these issues, Ninety One has launched the Net Zero Sovereign Index, which provides sovereign-debt investors with a high calibre, independently verified assessment of Paris alignment.

A successful net-zero transition requires swift action and adaptations in many other areas, including regulation, consumer habits, technology and – most pertinently for investors – capital allocation.  The acute risk in capital-allocation models is that emerging markets will be starved of the finance they need to transition to net-zero, in turn making it harder for the global economy to shift to a ‘decarbonised’ model. Current net-zero approaches can have major negative economic and social impacts on some of the world’s least advantaged communities, which are often the most vulnerable to the impacts of climate change.  No net-zero in some parts of the world means no net-zero everywhere.

Peter Eerdmans, Head of Fixed Income at Ninety One, says: “With the UN declaring its latest climate report a ‘code red for humanity’, there can no longer be any doubt that we must act quickly to address climate change. The first step in tackling this problem is for investors to get better at assessing whether an investment or portfolio is aligned with a credible net-zero pathway that works for all of the world’s 7.9 billion people. As a firm that has strong roots in an emerging market, we understand this more than most”.

Emerging markets are disproportionately exposed to climate change. What is needed is a more thoughtful and forward-looking approach to net zero, one that gives due consideration to the context in which each country operates, its potential to contribute to the world’s collective net-zero ambition, and its specific transition pathway.

Net Zero Sovereign Index

The Net Zero Sovereign Index, covers 115 countries across emerging and developed markets, and is the first index which incorporates the full range of emerging markets. Building on the Climate & Nature Sovereign Index (launched in 2020), the Net Zero Sovereign Index aims to support sovereign-bond investors’ engagements with governments, so that they can hold public officials to account and encourage positive change.

Eerdmans, continues: “Investors need better measures to decide what is the right and fair way to build net-zero-aligned portfolios.  We developed the Net Zero Sovereign Index to address the growing need among asset owners and managers for the means to show that their sovereign bond portfolios are Paris-aligned and on a credible path to net zero. We believe the index provides greater capacity to support a fair transition for emerging markets and will help sovereign-debt investors hold governments to account for their climate policies and actions.”

Initial findings

Developed and emerging markets register a divergent range of outcomes in the index. The United States is the standout worst developed-market performer, reflecting very high emission and energy usage levels, which translate into very weak pathways scores, given the low starting point and limited progress to date. The United Kingdom and Denmark are the two strongest developed-market performers in the index.  Developed Asia generally scores poorly, with Japan in the middle of the pack and Korea and Singapore weighed down by low levels of renewables and high energy usage.

Emerging markets rank higher than many might have expected, with eight out of the top 10 countries in our index. This reflects the fact that many of these countries are embracing the energy transition and, importantly, are currently able to mobilise capital to support decarbonisation efforts, but investment must be continued and increased to ensure these efforts are sustainable.  However, the index also highlights several emerging-markets stragglers which are a long way off the momentum required to achieve decarbonisation. These countries require time, encouragement, and incentives, rather than any immediate withdrawal of capital. As such countries adopt the right approach, finance can be deployed to encourage good outcomes.

Financing an inclusive transition

Eerdmans states: “Asset owners need to commit capital to transition finance- both in dedicated allocations and the way they measure and monitor progress against climate goals in their core portfolios. Moreover, asset managers must develop suitable vehicles with the integrity and framework to provide comfort that committing to transition is not greenwashing.”

Creating financial instruments that help capital allocators align portfolios with a real-world, inclusive decarbonisation – i.e., instruments that channel capital to companies and projects that move the global economy closer to carbon neutrality and that enable poorer nations the opportunity to participate in the net-zero transition is imperative.

Where to focus: Electricity

Many emerging markets, including India, South Africa and Indonesia, still rely heavily on coal for electricity production, with fossil fuel accounting for 25-40% of total carbon emissions.  Transport accounts for a further 9-18%. Since electric vehicles need a clean energy grid to deliver the benefit, by cutting emissions from electricity production it is possible to tackle 40-50% of total emissions in many emerging markets.

Four major funding streams need to be developed to clean up electricity generation in the developing world:

  1. Available capital must be scaled up for renewable energy roll-out
  2. Sizeable investment needs to be directed towards expanding transmission infrastructure
  3. Incentives for state utilities to accelerate the closure of high-emitting plants
  4. Funding for a fair transition for employees and communities at risk from removing reliance on fossil fuels

Eerdmans concludes: “Time is indeed short, and asset owners and managers cannot delay. But we must also be certain that our first steps are in the right direction. The race to net zero is not a race between countries. It is a race against time.”

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