The issue of climate change and achieving “net-zero” emissions is now front-and-center, as governments, companies and financial players become increasingly active in seeking to limit global warming. In November, the “COP26” climate change conference in Glasgow (the “26th Conference of the Parties to the United Nations Framework Convention on Climate Change”) provided a focal point for current efforts, and highlighted the challenges and potential opportunities to work together to solve a crucial issue for the 21st century and beyond.
The conference was the latest in the series of annual meetings that produced the 2015 Paris Agreement, under which countries set the goal of limiting global temperature increases to under 2.0°C above pre-industrial levels (and as close to 1.5°C as possible) by 2050—a level beyond which many believe there could be irreversible damage to the planet and its inhabitants. This was the first such gathering in two years (2020 was skipped due to COVID-19) and the first since the U.S. rejoined the Paris Agreement, so there was considerable anticipation about potential initiatives, along with a degree of skepticism about ultimate impact.
Overall, we would say the results were mixed to positive. Huge gaps persist between countries’ past pledges and real action; however, the event provided some measure of accountability for the world’s biggest emitters and advanced increased ambitions for the future.
Key Developments at COP26
An array of important results emerged from the Glasgow conference:
Finance: We saw the establishment of the Glasgow Finance Alliance for Net-Zero, a network of 450 financial institutions managing a total of $130 trillion pledging net-zero emissions by 2050. A new Sustainability Standards Board was also announced by the International Financial Reporting Standards foundation to provide better measurement and accountability on climate reporting.
Energy: 190 countries and companies agreed to phase out coal power and end support for new plants. At least 23 countries made new commitments, including five of the top 20 coal power-using countries. There were also commitments to scale up clean power and ensure a just transition, while financial institutions made landmark commitments to stop funding “unabated” coal power generation.
Nature and Land Use: More than 100 countries, representing around 85% of the world’s forests, pledged to halt deforestation by 2030, supported by nearly $20 billion in public and private funding. A similar number of countries pledged to reduce methane emissions by at least 30% in the next decade (but, so far, not China, Russia or India).
Adaptation, Loss and Damage: Commitments totaling $232 million were made to the “Adaptation Fund” by several nations to help underdeveloped countries deal with climate impacts—more than double the previous highest figure.
Transportation: The RouteZero campaign brought together commitments from policymakers, auto manufacturers and other stakeholders to shift toward 100% zero-emission vehicles (ZEVs) adoption by the end of the 2030s.
Climate Agreement Highlights
Turning specifically to the COP26 climate pact itself, we saw the following developments:
Nationally Determined Contributions (NDCs): Under the Paris Agreement, nations are required to set forth their NDCs, or actions to reduce climate change, every five years. Because existing commitments do not meet the 1.5°C target, however, NDCs will again be reviewed in 2022.
Coal: Although wording on coal was watered down from “phasing out” to “phasing down,” COP26 is the first agreement at this level to make direct reference to reducing reliance on fossil fuels—a modest but important step.
Adaptation and Climate Finance: Developed nations have fallen short in their 2009 commitment to distribute $100 billion a year in climate finance to the developing world, starting in 2020. Even so, rich nations increased their commitment to $500 billion over the next five years, to be focused on adaptation rather than emissions reduction.
Loss and Damage: COP26 could not agree on funding for loss and damage in the developing world—one of the most contentious ambitions, given the potential liabilities it creates. This was pushed back to next year’s conference.
Carbon Markets: A new framework would enable a carbon offset market open to the public and private sectors, and a separate bilateral system to allow countries to trade credits.
Looking for Follow-Through
Even with the fanfare, there was (and remains) natural skepticism around COP26 and the potential for international cooperation that leads to concrete advances.
In our view, strong action is needed, particularly on NDCs. Climate Action Tracker recently analyzed the policies of 36 countries, as well as the 27-nation European Union, and the data supported that all major economies (making up 80% of global emissions) were behind their pledges to meet the 1.5-degree target by 2050. Although many environmentalists have long hoped for mandates to end the use of thermal coal and internal combustion engines, neither the U.S. nor China, which account for half of global emissions, have taken these steps. The U.S. recently vowed to go carbon-neutral by 2050, but China is still only pledging net-zero emissions by 2060 and India by 2070.
Thus, we believe a key takeaway from COP26 is that the private sector and private capital will likely be critical in leading where policymakers are lagging. On the private front, we believe signs are more hopeful. Many companies are increasingly working to limit their carbon footprint and transitioning to clean energy, while documenting their progress. Meanwhile, asset owners and managers representing $130 trillion in assets, including Neuberger Berman, are now committed to net-zero investing by 2050.
Many of our clients expect us to decarbonize their portfolios, anticipating that these moves will likely change the cost of capital for key sectors and, through the market mechanism, do governments’ work for them.
Natural Alignment: Clients and Sustainability
Although as a matter of public policy and community commitment, we believe strongly in the need to curb emissions dramatically in the coming decades, our position is ultimately based on a client-centric idea that climate will likely have a significant impact on investment return potential in two ways:
First will be the physical impact of climate change itself. Extreme weather events, wildfires, floods and rising sea levels are likely to disrupt certain supply chains and threaten the viability of some capital assets.
Second are business risks associated with the transition toward global net-zero emissions. Efforts to slow climate change through carbon taxes, regulation, green fiscal spending, energy transitions and changing purchasing behavior are likely to create new winners and losers in business, and new risks and opportunities in investment.
How can investors effectively identify these issues in portfolios? This is a fundamental question that combines high-level assessments of climate trends and specific research observations. As a broad principle, we feel it is important to be well grounded in data, analysis and research in order to accurately assess the potential impact on sectors, companies and portfolios.
A core tool at our disposal is a climate value-at-risk (or CVaR) measure that quantifies climate risk, both in terms of physical impact and transition toward net zero. The CVaR framework seeks to quantify the impact that climate change and the transition to a net-zero economy might have on companies’ equity valuations and bond yields. It helps to identify risks and potential opportunities associated with certain temperature-increase scenarios and translate them into an economic value in present dollars.
CVaR is typically greater among the most carbon-intensive industries such as the energy, utility and certain consumer discretionary sectors, such as airlines. There are pockets of positive CVaR impact, too, for example on companies with significant portfolios of renewable technology patents. Overall, portfolios with the greatest exposure to higher carbon-emitting sectors tend to face greater physical and transition climate risks over time.
Quantitative tools are only part of the assessment of climate vulnerability (and in some cases, potential opportunity). Deep experience and familiarity with a given industry or company on the part of analysts and portfolio managers can provide important context and meaning when it comes to judging trends and assessing the potential trajectory of a given business in the face of climate transition—which can be helpful both in making investment decisions and in dialogue with companies.
Time Appears to Be Running Out
Warming Projected by 2021
Source: Carbon Action Tracker, as of November 2021. For illustrative purposes only. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed.
Engagement on Net Zero
Although exclusion of carbon-heavy industries has been a common tactic among some investors, in our view a purely exclusionary approach will not be enough to meet global climate ambitions. Large financing gaps within the existing energy industry need to be filled to ensure an orderly transition, as volatility in oil and gas pricing has recently shown. But we should also expect more focus on how portfolios actively and measurably contribute to climate solutions.
In our view, the journey to net zero will require substantial technological innovation: For cement production, for example, net zero will likely require the sequestration of half the industry’s emissions using Carbon Capture and Storage (CCS), which remains expensive and unproven at scale; in transportation, the ambition is for nascent green hydrogen to play a key role. Some of these solutions will be investable, some not, and as COP26 has shown, policymakers are likely to subsidize advances in certain areas while nudging capital allocation toward others through regulation and official taxonomies of sustainable activities.
We believe that engagement is a crucial element to our research and investing framework, and one that could be especially vital on the path to net zero. Active engagement, in our experience, can be quite effective in gauging climate risks and moving companies along their net-zero “journey.” By interacting with managements, we can better gauge materiality of those plans and the degree to which they may seek to pivot beyond fossil fuel dependencies. Maintaining an open dialogue on climate can influence decision-making, while the use of proxy voting to stake out public positions on climate disclosure and emissions can also help to foment strategy, to the potential benefit of climate and shareholder value.
Seeking to increase the power of our voice and encourage change, in 2020, we launched NB Votes, an advance proxy vote disclosure initiative in which our firm announces our voting intentions before annual meetings at select companies. In this effort, we have included a broad range of proposals, with a balance of votes in support of and against management recommendations across multiple areas of emphasis (see “Engagement 360°,” Investment Quarterly, Spring 2021). We have been pleased to find that the program has clarified our priorities among companies as well as encouraging other managers to follow suit on amplifying proxy impact.
Energy Transition May Need to Accelerate
World Consumption (Exajoules)
Source: BP Statistical Review, 2021.
The Path Ahead
COP26 offered a climate agenda of great ambition—arguably the most ambitious seen since Paris in 2015. Two years ago, the goal of reaching 1.5°C seemed all but impossible, yet what Glasgow offered was, in our view, a genuine “north star” and path to net zero.
In our view, transitioning away from our current global energy system is of paramount importance, though we need to acknowledge the challenges in doing so. We believe reaching the 1.5°C target will require a reshaping of the entire global economy in less than 30 years, while maintaining economic stability and reducing energy equality across the developing world. Transitions to newer, cleaner energy systems could require significant shifts not only in technology, but in political regulations, and the behavior of users and adopters across the world.
When these parties met in Paris in 2015, the world was on a trajectory toward global temperatures of 4°C to 6°C above pre-industrial levels. Today, the International Energy Agency puts us on a path to 1.8°C, as long as existing commitments are honored; Climate Tracker says 2.4°C.
Over the short term, we hope that COP26 will help deepen our conversations with clients to help them on their own climate journey, but also with the companies we invest in to encourage them to set even more ambitious goals. That said, we believe the benefits of COP26 extend way beyond just the short term for investors.
COP26 was a summit of compromise and balance, keeping finance flowing and boosting adaptation.
Asset owners, managers and insurers representing $130 trillion in assets (including Neuberger Berman) have signed on to initiatives committing them to net zero by 2050. We believe achieving such targets will require significant investment, which means investors and financial institutions, like ourselves, will play an unequivocal part in mobilizing capital toward both private and public sector finance.
We really are only at the start of this very long journey. Many difficult stretches lie ahead, but in our view, asset managers have a pivotal role to play and a huge responsibility to get this right. It is an effort that we at Neuberger Berman feel privileged to be a part of.
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