How COP26 creates more urgency for investors

Investors should prepare for a greater sense of urgency and pressure to meet net-zero targets in their portfolio decision-making, say industry experts post-COP26.
How COP26 creates more urgency for investors

A last-minute wording change to an agreement to "phase down" instead of "phase out" fossil fuels meant the two-week COP26 conference ended on a flat note. But climate industry experts said that the substantial behind-the-scenes work to hammer out agreements on issues such as deforestation and methane emissions should not be overlooked. 

An end to the era of coal may be some years away, but COP26 at least put it on the agenda for the first time, the experts said.

“In short, climate risk has become a compulsory activity,” Gordon Noble, Sydney-based partnership manager at the Institute for Sustainable Futures, told AsianInvestor.

Gordon Noble, 
Institute for Sustainable Futures

“It represents a fundamental shift. For the last 15 years, investors have engaged around responsible investment on a voluntary basis. Regulators have frankly been sitting on their hands," he said. 

"This has contributed to cherry picking and the balkanisation of sustainability, as proponents gathered behind various banners such as ESG and impact. Regulators are now moving in a systemic and structured manner in all areas of financial system regulation. This includes, most importantly, prudential supervision."

Charles Yonts, Hong Kong-based head of Asian ESG research at Macquarie, told AsianInvestor he saw a great deal of momentum for change coming out of Glasgow.

“The emphasis on urgency is incredibly encouraging. The narrative has really switched from 2050 goals to 2030 over the past six months, and it accelerated in Glasgow. While a lot of the plans are still hazy, they will come into focus over the next year, alongside the roadmaps that actually drive corporate performance.”

As climate factors become formalised within an asset owner's responsibilities, investors will need to look more closely at how the government mandates, regulatory changes and resultant capital flows will affect their allocation decisions, according to Christopher Kaminker, head of sustainable investment strategy at Lombard Odier.

“The thinking and sophistication of the market will rapidly evolve, away from a 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,” said Kaminker.

A joint report from KPMG, CAIA Association and Create-Research, released ahead of COP26 and titled ‘Can capital markets help save the planet?’ stated that a green investment portfolio has not so far equated to a green planet, because capital markets cannot easily detect the risks and opportunities until they are clear on how public policy will create hard incentives as well as punitive sanctions.

Louise Davidson, ACSI

Investors are acutely aware they are operating in an environment long on commitment but often short on detail, according to Louise Davidson, chief executive of the Australian Council of Superannuation Investors (ACSI). But she is encouraged by the recent developments.

“As representatives of long-term investors, we have seen a clear trend of companies in exposed industries adopting net zero targets and disclosing pathways towards decarbonising their businesses.”

The phasing out of coal is regarded as the most vital policy step needed to keep to the objective of limiting warming to no more than 1.5 degrees Celsius. At COP26, more than 40 countries pledged to phase out coal by the 2030s and 2040s. But Australia – along with the US, China, India - isn’t one of them, yet.

Davidson said action on climate change was an enormous opportunity for Australia.

“The Investor Group on Climate Change estimates that strong climate policies will unlock more than A$130 billion in fresh investments by 2030. The Business Council of Australia estimated Australia stands to reap an economic dividend of A$890 billion and 195,000 jobs over the next 50 years.”

Failing to keep pace with international developments presents investment risk and could see capital allocated to other markets, she added.

“Superannuation funds are invested across the economy and the country’s transition to a decarbonising economy impacts the financial outcomes of super fund beneficiaries.”

According to Gordon Noble, if there is one document that pulls together the threads of COP26, it is the G20 Sustainable Finance Roadmap, which outlines the direction financial system regulators will be taking over the next few years to integrate climate risk into all aspects of finance.

This is where the serious work starts for investors. Noble suggests they look closely at the prototype climate disclosure document produced by IFRS Technical Readiness Working Group.

Fiona Donnelly, Hong Kong-based business sustainability consultant at Redlinks, said the challenge is to highlight where coal, methane and deforestation sit in portfolios and operations, “so that they can start to develop approaches and modify processes to align to net zero. Progress on targets will be under more scrutiny."

One of the most significant aspects of COP26 was that financial system regulators put on a united front, said Noble.

"In the noise, the aligning of the world’s financial system went largely unnoticed. But the outcomes are going to be felt. Regulators through the G20, and endorsed at COP26, have now entered the stage and they won’t be going away. For investment managers, there is a need to turn attention to focus on what regulators ask. This won’t be a request. It is an order."

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