Addressing Global Climate Change

COP26 Takeaways

Five key insights from the United Nation’s COP26 climate summit

November 2021

It is clear from COP26 that such a large-scale process of discussion and compromise entails a lot of complexity. 

Exciting progress occurred, such as the deal between China and the United States to work together on reducing emissions, the new framework for a global carbon market, and the Glasgow Climate Pact. At the same time, there is sentiment that progress fell short of expectations, exemplified by the struggle to agree to the phase out of coal even though some of the groundwork had been laid.

While other attendees will have their own takeaways, here we highlight five that are important for investors and the financial industry:

  1. The first step to facilitating the corporate transition to net zero is now well underway.

    The least attention grabbing headline at COP26 will turn out to be a critical breakthrough for investors and the corporate world. The establishment of the International Sustainability Standards Board (ISSB) is among the most significant outputs of the conference so far. Managed by the International Financial Reporting Standards (IFRS) body based in Germany, the ISSB will develop baseline global standards for environmental, social and governance (ESG) and sustainability reporting. A working draft of climate related disclosures has already been produced for vetting over coming months with a release targeted in the latter half of 2022. The key development here is that a consensus of investor-focused sustainability disclosure organizations support the ISSB (the Climate Disclosure Standards board and the Value Reporting Foundation have merged with the ISSB). We now have a realistic path to achieve a single global standard. That said, it is unlikely that the ISSB standards will be made mandatory for companies without a degree of political influence on the metrics in question, potentially pushing them towards a broader stakeholder model and away from a narrower shareholder and creditor focus. One side effect of ISSB may be greater pressure on ESG data providers to add value to the ISSB data-set in new ways.

  2. Attention will focus on how to achieve net zero commitments with downside risk of being left behind.

    COP26 has helped to shift the focus from making promises to delivering on promises. And as some players progress towards meeting their commitments, others will face increased pressure to keep up. So for the first time the risk of being left behind is becoming real and visible. Investors who joined in the Glasgow Financial Alliance for Net Zero along with State Street Global Advisors, representing a collective US$130 trillion of assets, are faced with opportunities and challenges. The net zero approach of the Net Zero Asset Management Initiative goes beyond simple divestment. It requires delivering credible decarbonization plans, policy advocacy, and rigorous stewardship practices. Addressing scope three emissions is certainly an element that will require special attention in that context. If all portfolio companies do that, then asset managers can have confidence that their portfolio is well positioned against climate risk and that they are on a solid path to the net zero goal. However, business plans are only slowly emerging and so the path to net zero for global index portfolios will most likely not be straight forward. In several sectors, technology does not yet exist to operate businesses without emitting carbon. That means active engagement with public companies will be more important than ever.

  3. There is growing recognition that climate risk is not just about emissions.

    A key deal struck at the outset of COP26 was the commitment by more than 100 world leaders, including Canada, Brazil, Russia, China, Indonesia, the Democratic Republic of the Congo, the United States and the United Kingdom, to end and reverse deforestation by 2030. Despite some dissatisfaction with the terms from Indonesia after signing, the deal remains significant. Not only because reforestation helps with decarbonization, but because the deal puts a spotlight on the use of natural resources in commercial activity. There will be implications for the corporate and financial sectors as a result. For example, it will put greater pressure on companies with activities linked to deforestation to find alternatives and investors will be called on to actively engage with those companies on delivering credible transition plans. At the same time, the spotlight on deforestation could encourage growing efforts to measure, disclose, and reduce the commercial usage of the world’s natural capital. For example, the Taskforce on Nature-related Financial Disclosure (TNFD) is up and running (State Street is a member of the TNFD forum). Experience from TCFD may accelerate development of disclosure standards related to natural capital. Meanwhile others like the Sustainable Markets Initiative (SMI) are actively encouraging investments in natural capital.

  4. We could be on the verge of a breakthrough on coal.

    A deal announced at the beginning of the meetings between France, Germany, the US, UK and the European Union to partner and help fund South Africa’s transition away from coal could turn out to be the breakthrough of COP26. More than 70 percent of South Africa’s power is generated from burning coal (a similar percentage as Poland, India and a number of other middle income and emerging economies). Yet, South Africa has a power deficit with rolling blackouts causing industry and individual hardship and this is holding back the republic’s economic growth. And it is a critical sector for employment with over 200,000 workers. Why does this deal matter? The countries that signed on to the deal have pledged US$8.5 billion to act in combination with other sources such as private capital to achieve South Africa’s transition away from coal. Many asset owners, managers, and investment banks agree that this is one of the potentially most impactful transitions we can work on. While it will involve tough choices, especially the idea of ownership or financing brown assets within the South African power system as political, financial, and technical challenges. But if this can work in South Africa, the model can be transported to the many other countries that drive the carbon emissions by burning thermal coal and significant progress can be made in reducing global emissions.

  5. There is greater pressure on private markets to be part of the solution.

    COP26 has fueled growing discussion about the yawning gap in disclosure and accountability between listed and unlisted companies. Private markets offer many potential benefits because of the short lines of communication between owner and manager, the relatively light touch of regulation and the ability to make changes to a business with fewer concerns about short term results. This could make de-carbonizing decisions easier (and attractive in light of potential sale of businesses into the public markets). Nevertheless, there is a perception that general partners are less focused than they should be, and that pressure from the limited partners is diffuse and ineffective partly because there is little data to measure. Many of the most significant private equity businesses have come together within the SMI to evaluate how they can make a greater contribution to sustainability, but the real breakthrough will require a more universal commitment to data disclosure, along similar lines to listed companies – commitment that might arise as a result of pressure from limited partners, regulators or both. Central banks may be helpful in this regard given their lens on banks’ lending and climate exposures.