Financial markets look to COP for guidance, but will transition anyway
Investors need to know pace of change, but direction is clear
As world leaders gathered in Glasgow on Monday for the beginning of COP26 — the climate change conference billed as the most important since the Paris Agreement in 2015 — capital markets participants are still optimistic that significant advances can be made, even if the needed breakthrough leading to a wide step-up in ambition is looking less likely.
The financial sector has thrown its intellectual and messaging weight very strongly behind this COP for at least the past year, with a crescendo of alliances, joint statements and targets being announced.
Part of the point is to make it clear to politicians that they cannot hide behind the argument that climate action would be damaging to the economy.
Financial institutions are now looking to politicians to deliver. “Contrary to some views, many ESG investors don’t think they can resolve the world’s problems themselves, but do look for governmental cooperation, guidance and regulation to help address the climate emergency," said Arthur Krebbers, head of sustainable finance for corporates at NatWest Markets in Amsterdam. “There is still a disconnect between the aspirations in the ESG finance community and the earliest newsflow.”
Presidents Xi Jinping of China, Vladimir Putin of Russia and Jair Bolsonaro of Brazil are not expected to attend the summit, though there are still rumours Xi might appear.
That in itself will make reaching agreement more difficult, especially on the central issues of how fast countries should cut their carbon emissions, and how the cost of doing so should be distributed among rich and poor nations.
In recent weeks China has signalled unwillingness to change its plan of reaching peak emissions by 2030 and net zero by 2060 — which would still allow the world’s largest emitter to keep increasing its pollution, making the goal of limiting global warming even to 2°C all but unachievable.
The G20 summit in Rome at the weekend did not produce the gains climate campaigners had hoped for — and that may be an easier negotiating forum than COP, which includes many more countries, especially from the developing world.
“Certainly, the progress post-Rome is not necessarily where we would want it to be,” said Farnam Bidgoli, head of ESG solutions EMEA at HSBC in London.
But market participants take some comfort from the fact that the conference has four tracks — climate change mitigation, adaptation, finance and collaboration.
Bidgoli said agreements could be reached on each set of issues separately, without depending on the others, “so we could end up with some wins, even if progress in other areas might be slower”.
The Paris Agreement unleashed a wave of consciousness about sustainability in financial markets. The hype around COP26 means its most enthusiastic promoters have at times hoped for a similar burst of energy.
But Jacob Michaelsen, head of sustainable finance advisory at Nordea Markets in Copenhagen, said this would be “a much more complex and multi-faceted COP than the one six years ago”.
“I don’t think we need a new consciousness,” he said — awareness had already been created by Al Gore’s film An Inconvenient Truth, the Paris Agreement and Greta Thunberg. “They are all the foundations we need,” he said. “It’s much more about building on it as fast as we can.”
The complexity of this COP would come partly from the difficult issues at the level of realpolitik, he said, and partly from scientific advances.
“There is now greater evidence on the secondary effects of climate change on biodiversity and natural habitats,” Michaelsen said. “We know financial markets need to have a greater appreciation for that.”
Citing comments by David Attenborough, Michaelsen said “we still have time to get back on track and put actions in place to limit climate change, but it’s as a result of some of the costs having being borne by the natural habitat”.
The big issue
For now, however, the most vital issue on which markets are hoping to see political progress is the pace of emissions reductions — the primary aim of the mitigation track of Cop 26. Despite the discouraging noises from China, some market participants are relatively optimistic.
“On the mitigation aspect, the run-up, in terms of targets being set, has been really positive,” said Bidgoli. “We’re better placed because of the acceleration of private sector commitments in the business race to net zero. Saudi Arabia has set a net zero target, and so has the UAE. These are all quite promising signals. What we’re waiting to see is if we can get progress on common timeframes and common reporting frameworks.”
Negotiators hope countries will agree to harmonise the timetables for their nationally determined contributions (NDCs) so that they are updated every five years with increasing ambition, and ideally that progress begins to converge towards net zero in 2050.
So far China and now Saudi Arabia are aiming for net zero in 2060 and on Monday Thailand said it would achieve this by 2065.
Although neither Brazil, India nor China was indicating that it wished to make big steps forward in its NDC at this COP, Bidgoli said “what’s positive is that significant players in the private sector in all three countries have started to set net zero commitments for 2050”. India’s Tata Chemicals and UltraTech Cement, Brazilian meat packer JBS and Chinese computer maker Lenovo Group had all set ambitious pathways, she said.
These commitments were “at least partly due to institutional shareholder pressure”.
Michaelsen said that although on China “pessimists might have the upper hand”, there was still hope the US could “surprise on the upside”.
“The US also have gone into COP underperforming — they are trying to wrap climate change issues into their broader infrastructure bill — but the Biden administration is planning to come to COP with a series of announcements,” he said.
On climate change adaptation, the ultimate prize is to define a global goal. “That’s probably the most challenging thing to get to,” said Bidgoli, “but there are also less lofty aspects — about capacity building and sharing of technology between developed and developing countries. We could see progress made there.”
COP26 has been dubbed “the finance Cop” because of expectations that this is an area where progress could be made.
At the Copenhagen COP in 2009, widely regarded as a failure, rich countries pledged to “channel” $100bn a year of climate finance to developing states by 2020. They have missed the target, to the anger of the developing world, especially as $100bn is a small fraction of what is estimated to be the real need.
Despite their support for climate diplomacy, rich states like the UK and particularly the US have been reluctant to put money behind it. Worse, there is still no agreement on how to measure climate finance.
Participants are not getting their hopes up for game-changing progress here.
“What we are pushing to see is better definitions of what can be included within climate finance, so there is a signal that can be passed to the private sector,” said Bidgoli.
In that context, a significant announcement is due on Thursday by the European Commission and China’s joint working group on aligning their green Taxonomies.
This COP is unlikely to be one where big changes are made to the regulations that increasingly govern sustainable finance, but there will be an update from the IFRS Foundation on its progress with developing international sustainability accounting standards.
Krebbers said “a feasible path is that policymakers wait for the IFRS Foundation to run its course with its proposed sustainability reporting regime. [That would be] similar to the approach with the TCFD — start with various market stakeholders developing voluntary standards and then governments can provide further support.”
The area where governments could be more forceful, Krebbers said, was “the openness and transparency of data. ESG data is still relatively hard to come by. There is an argument for considering certain ESG information as a public good, that needs to be made freely available.”
The EU is expected to push for ESG data to be made available in standardised, machine-readable formats. ESG rating agencies guard their proprietary information and scores closely.
With or without you
Capital markets are eager for politicians to show leadership at COP26, on many fronts. “The private sector has been quite clear on the need for more certainty when it comes to policy setting, so they can act accordingly,” Bidgoli said.
The thirst to invest in the green transition is evident — as is the vast scale of the need.
But the barriers to achieving that financing are still palpable day to day, said Bidgoli. “There is a gap between the technologies the private sector is willing to finance and the technologies needed to unlock net zero,” she said. “That’s why the $100bn and the implementation plans behind net zero in countries like the UK, US and the EU are so important. The private sector needs to be able to rely on a degree of support for technologies that are not currently economically viable.”
If clarity could be achieved in international negotations, Bidgoli said, “that will eventually come into the private sector”.
Michaelsen said: “All the studies show we are still not financing enough, but financing can only happen if the investments happen in the first place. Investments are done by governments, asset owners, asset managers and corporates. These actors will need to commit to investments so we can go about financing them.”
Nevertheless, even if this COP produces little progress, the trajectory for markets is clear.
“Some would argue sustainable finance was already running extraordinarily hot, but there is capacity in the market to do more,” Michaelsen said.
Governments setting the direction would lend great confidence and accelerate the transition, but in the absence of that, markets, helped by NGOs, are defining pathways themselves.
Michaelsen pointed to the “momentous” take-up of Science-Based Targets in the past year. “For sure the power of financial markets have helped move that needle,” he said.
Debt markets, for a long time ignorant of SBTs, have now embraced them.
“Many sustainability-linked loans are now tied to SBTs and nearly all have CO2 targets,” he said. “In the bond market there’s a clear preference for climate targets and it’s much easier to sell your story if it’s linked to an SBT. In a few years I’m convinced this will become the norm.”