Analyst Insight
Environmental, Social, and Governance (ESG) considerations have become increasingly important in the investment landscape. This has been accelerated as climate change and general environmental sustainability discussions intensified with the onset of the coronavirus pandemic. Many have seen the pandemic as an opportunity to rebuild economically and socially in a way that protects public health and preserves the environment, which is termed the “Great Reset”. In the middle of these developments, insert COP26 which is the 2021 United Nations climate change conference. We, therefore, look at what is COP26, what were some key takeaways from the meeting, and lastly some potential investment implications.
What is COP26?
COP26 (Conference of the Parties) is an annual UN Climate change conference inaugurated in 1995 and which brings together signatories to the United Nations Framework Convention on Climate Change (UNFCCC); an international environmental treaty that addresses climate change. This COP is important for two (2) primary reasons. Firstly, it occurs as mentioned prior, during a time where great emphasis is currently being placed on a “great reset” or starting back better. Secondly, it represents the first meeting surrounding performance assessment relating to the Paris Accord which was signed at COP21, with previous meetings since then being primarily focused on implementation issues. It also represents the first meeting since the US rejoined the Paris Agreement and so the actions of the US would have been in intense focus for this meeting.
Key Meeting Takeaways
Fresh Funding Commitment -It was noted that there was a need to improve financing to poorer countries to achieve the targets set by the convention. This was in the context of greater indebtedness due to the pandemic as well as developed nations falling short of their previous US$100 bn a year target by 2020 (commitments tally US$80bn a year). The reaffirmed commitment was a contribution of $100 bn a year between 2020-2025. Of note developing countries lobbied for an increased pivot of funding towards climate adaptability as opposed to clean energy investment. The reason for this being the deleterious effects of climate change such as rising sea levels and more abnormal weather events serve as a more immediate concern for many, particularly small island development states.
Uniform ESG reporting– The establishment by the International Financial Reporting Standards (IFRS) board of an International Sustainability Standards Board (ISSB) is a major step forward towards establishing a single set of ESG reporting standards with a recognizable framework. This announcement was made at COP26 and occurs at a time where there has been increased pressure by regulatory authorities to mandate ESG reporting for public companies in various jurisdictions. (E.g. The Reserve Bank of New Zealand recently made climate-based disclosures mandatory in April 2021 for publicly listed companies as well as large financial institutions and investment managers)
“Phasing Down” of Coal -Another noticeable event at COP26 was the last-minute scramble concerning the wording of the group’s plan for coal. This as India suggested the term “Phase down” instead of “Phase out” to be used in the agreement regarding coal use. The result was an agreement to “phase down” coal use, a notion that was also supported by China and the US.
Investment Implications
Before the meeting, there was a strong push by environmentalists for world leaders to agree to phase out coal. While the terminology was watered down to “phase down” in the final agreement, this still serves as a minor victory for advocates. This is coupled with countries committing to net zero emissions with different individual timelines. The second-order effect of this is a pivot to cleaner energy sources with natural gas being touted as the best transitory option to cleaner energy in the short to medium term. This would of course, bode well for both natural gas producers and sovereigns that export the resource (In a regional example, think Trinidad).
Current trends will continue to boost the demand for sustainable investment options by the public. This was further propelled by the soon to be established normalized reporting standard for ESG related disclosures which would have been one of the major complaints given by global sustainability-conscious investors. Direct implications for investors would include more access to ESG info in which to make their investment decisions as well as increased funds to and hence subsequent higher premiums paid for companies that perform well on ESG metrics. The conscious investor or simply ones looking for an inkling of higher returns might hence try to consider such companies when creating their investment portfolio. While compulsory reporting locally for example might not be a thing in the very short term, domestic exposure to green energy and possibly good ESG includes, for example, MPC clean energy, while internationally there are a host of options.
The resolution in regards to greater funding for climate adaptability bodes well for several sovereigns. This objective includes financing to deal with the impact of more frequent adverse weather events and also climate-smart technologies. The clearest implication of this is the increased ability to raise funds both for insurance against these adverse weather events and also the ability to raise funds via sustainable bonds. The potential benefit of this particularly in a sovereign bond portfolio is the recent acknowledgement by fitch of Jamaica’s catastrophe bond issue. In that release, it was noted that they incorporate natural disaster risk in a country’s Long-Term Foreign-Currency Issuer Default Rating, and as such an environment conducive to such issues will bode well for sovereign issuers and add an extra layer of risk reduction for bondholders.
In conclusion, COP26 is simply the annual United Nations climate change conference. This COP is particularly important as it reviews current progress on past initiatives set out. Key takeaways include a recommitment to US$100 bn per year in climate finance to developing countries, the emergence of possible uniformed ESG reporting, and phasing down of coal and other fossil fuel usage. This presents investment implications such as more space for countries and companies exposed to cleaner energy resources, better ESG scores, and the ability of certain sovereigns to reduce the risk associated with climate change-induced extreme weather events.
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Written by Peter-George Simon, Senior Investment Strategy Analyst |
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