Unlike previous COPs, the finance community was out in force in Glasgow this year and made sure they had a seat at the table. In almost every conversation, there was emphasis placed on the cooperation required between the public and private sectors and how we move from the “why” to the “how” to implement policies and practices to meet the Paris targets.
There is an industry-wide understanding of financial services’ collective role in addressing climate change and broad acknowledgement that ESG is a fundamental consideration in all investment decision-making. Having a clear ESG approach, investment philosophy and position is a basic hygiene factor for an investment company. This was evidenced by Federated Hermes research, released on the eve of COP26, which found that 88% of institutional investors say that ESG factors are now more important than financial metrics to evaluate the long-term attractiveness of a company.
For the financial community, the focus at COP26 and the World Climate Summit (also known as Investment COP) was on fostering partnerships across multiple stakeholders – companies, investors, governments, regulators and local communities – to ensure that they can play the most effective role in the fight against climate change.
Here are a five key financial services take-outs from Glasgow:
- The importance of consistent measurement frameworks dominated multiple panel discussions.
The industry broadly agreed that a unified global taxonomy is crucial in enabling investors to achieve 1.5 degree portfolios. Helpful steps are already being taken, such as the formation of the new International Sustainability Standards Board (ISSB) - described by one investor as “a game changer whose importance is not being fully appreciated” - which aims to develop a comprehensive global baseline of high-quality sustainability disclosure standards to meet investors’ information needs. The introduction of a global baseline taxonomy is critical to enabling financial institutions to make a tangible impact in addressing climate change and other sustainability priorities sooner rather than later.
However, as Sir Douglas Flint, Chairman of abrdn, noted at ICOP, regulators tried for years to align global accountancy frameworks without 100% success. His message, endorsed by many other investors and ESG specialists, is that that global warming won’t wait and investors cannot procrastinate; in his view, it is better for investors to pursue climate targets within a system which is 70% or 80% efficient, rather than to wait for “the perfect, globally consistent framework”. - Tensions remain around the perceived trade-off between investors’ fiduciary duty to their clients and their environmental responsibilities – with many attendees calling for a rethink in the ways that investors should report their performance.
If investors are expected to support companies in their energy transition by allocating capital to those which may need to make significant capital expenditure on shifting their business model and investing in technology and new skills, they may need to accept lower dividend payments or weaker near-term performance.
Asset owners, therefore, need to be encouraged to think longer term rather than punishing investors for failing to beat short term benchmarks. Some voices at the Investment COP argued that this shift necessitates the removal of the traditional one, three and five year performance reporting.
Another opinion on the same debate came from Rebeca Minguela, CEO of Clarity AI, a tech platform that delivers insights to investors and corporates on the social and environmental impact of companies. Noting that investors typically report against the two dimensions of risk and return, she advocates for the inclusion of a third factor – “impact”. If funds are measured – simply and numerically – in terms of their risk, return and impact profiles, it would ensure that ESG is truly embedded as a primary consideration in the investment process at the outset. - Although broadly supportive, investors are concerned about the negative unintended consequences of climate regulation.
Many shared concerns that if regulatory and reporting frameworks are inflexible, investors will be forced to divest from companies that they feel not only deliver good returns but are also making huge strides in addressing climate change. For example, if a portfolio is required to hit an average temperature of 1.5 degrees, some mining or industrial companies will become “un-investible”. Implementing these targets without factoring in some nuance would mean that, in the short term, investors could be forced to divest from energy and mining companies even if they believe in the company’s investment case and that they are delivering on a strategy of tackling climate change. - There is a need for investors to consider the impact of the environmental transition on capital markets
A prevalent theme throughout Cop26 was the influence of capital markets on the environment, especially around fossil fuel linked assets and the responsibility of active managers to drive these companies forward on their path to decarbonisation. The issue mentioned by far fewer people was the impact of the environmental transition on capital markets. As companies collectively work towards net zero, investors will need to keep a close eye on the inflationary surprises prompted by upward pressure on the cost of doing business in a more environmentally friendly manner or, as Principal Global Investors termed it, “en-flation”. For example, there will no doubt be a race for climate talent across companies in all sectors and hiring this talent will be expensive. Companies will also need to invest heavily in R&D and the constant innovation required in a climate conscious world could initially weigh on company balance sheets. - All actors need to carefully consider the role Western economies play in enabling a net zero transition in developing markets.
Recent research from Cambridge and Exeter Universities found that $11 to 14 trillion of assets are set to be stranded by 2036, a statistic which emphasises the urgent need for investors to look for opportunities for decarbonisation. However, while decarbonisation strategies are fairly advanced in developed countries, much more effort is required in emerging markets where environmental projects are smaller scale and often have more problematic credit ratings. If we are to meet the Paris goals, helping emerging markets on their path to net zero is a huge priority. Investors and governments need to do their due diligence on projects, work with local communities and workers on ground, and harness international pools of capital to deliver green financing solutions in these regions.
However, Dr Nina Seega, Research Director at the Cambridge Institute of Sustainable Leadership (CISL), made the point that, in Europe, we are slowly but surely moving towards a post-covid scenario. By contrast, many emerging economies such as Africa, are still in the midst of Covid. Her view is that neither the public nor private sectors can expect adequate financing to be channelled successfully into green emerging market projects without more vaccine equality. If communities are still struggling with Covid in an informal economy where the nature of the labour market makes working from home inviable, it is nearly impossible to make the necessary steps towards a net zero future. Other mechanisms, outside finance, are required to help emerging markets on this journey and the financial and regulatory communities must acknowledge that flexibility and tolerance is required in helping them get there.