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COP 26 Outcomes That Are Shaping The Future Of Sustainable Finance

November 18, 2021 – Nearly 200 nations concluded their annual climate change negotiations at the 26th Conference of the Parties (COP 26) meeting in Glasgow recently, where the aim was to commit to further and faster greenhouse gas emissions reductions so as to limit temperature rise to 1.5 degrees Celsius above pre-industrial levels.

Despite a sprawling agenda with highs and lows, the overarching headlines coming out of the two-week meeting do provide meaningful inputs for financial institutions as they develop low carbon transition strategies. Key elements include nearly unanimous global agreement on the net zero by 2050 target, the rules for a global carbon market, the tightening of financing for coal and other fossil fuels, and the investment needs of emerging markets to leapfrog onto renewables and adapt to harsh new climate realities.

We have a deal: Glasgow Climate Pact

Policy uncertainty is a key factor in climate risk scenarios undertaken by financial institutions. By the end of COP 26, 90 per cent of the world’s economy was covered by a net zero target compared to only 30 per cent at the beginning of 2020. Although the final deal was not as ambitious as climate leaders and scientists had hoped, it does represent a giant step forward from the Paris Agreement of 2015 on many fronts. Parties locked into a deal that would see 45 per cent emissions reductions by 2030 and systems to support greater scrutiny and transparency on progress.

Coal is the dirtiest of the fossil fuels but it is also the most available to fast-industrializing economies like China and India who did not support original proposals to “phase out” coal and end financing citing its importance to economic growth and financial stability. But enough coal producing nations and financiers have agreed to move away from production, and to cut public finance for coal developments at home and abroad to have made a dent in the trajectory of the industry. The spotlight was also turned to fossil fuel subsidies. It is estimated that G20 nations spent US $600 billion supporting the fossil fuel sector just last year, Canada among them with an estimated $18 billion, despite decade-long promises to reduce these.

These developments are helpful to banks and pensions because they provide further confidence on the direction of travel for the low carbon economy, narrow the scope of possible scenarios by increasing certainty in some areas, and demonstrate how the financial flows for fossil fuels are likely to change within the decade. The overall commitment to net zero emissions by nearly every nation on earth also means improved consistency and a level playing field for mid and long-term planning.

Financial sector show of force

In a first for any multi-lateral process in history, private sector finance was a central part of the agenda. The Glasgow Financial Alliance for Net Zero (GFANZ) was endorsed by 450 banks, insurance companies, asset owners and asset managers representing US $130 trillion – or about 40 per cent of all assets under management globally. Signatories, including Canada’s big six banks, pledged to align financing with the net zero by 2050 target by reducing funding for high emissions industries and upping their investment in renewable energy and clean technology. Participating firms agreed to set interim targets every five years and annually report on progress.

In theory, this means that the money needed to make the low carbon transition, as committed by governments, is generally available. In practice, this will be the space to watch as the difficult task of aligning portfolios plays out over the next few years ahead of the first major milestone – 45 per cent emissions reductions by 2030. We can expect low carbon transition strategies, increased issuer engagement and improved transparency from participating financial firms in the short term.

In the sidelines of COP 26, the International Financial Reporting Standards Foundation announced the formation of the International Sustainability Standards Board (ISSB). This new body will build on existing and widely accepted voluntary standards and develop a global standard for reporting on climate-related financial risks, and expand to include other social and environmental issues over time.

There are some key success factors that are needed at the global level if financiers are going to be successful in achieving net zero portfolio emissions – such as a carbon market, reporting standards, and consistency in cutting emissions across all countries – most of which also came to fruition at COP 26 to some extent.

Global carbon market kicks off

The present carbon market is worth about US$250 million but is fragmented across dozens of schemes, unregulated with opaque pricing and uncertain impact. In order to drive down emissions and raise funds for innovation and adaptation, the rules for a global emissions trading system have finally been agreed after years of stalling.

The system negotiated in Glasgow is not perfect, but is an important foundational building block in a market that could be worth US$100 billion by the end of the decade. The measures agreed should help eliminate fraud, flush out low quality credits, end the double counting of credits, and verify that the credit-generating projects have actually removed carbon from the atmosphere.

Private companies can generate credits that can be further traded by investing in projects that cut emissions such as replacing coal with renewable energy, restoring nature or building carbon capture systems. This is expected to channel a surge of funds into low carbon transition projects that generate credits which are then purchased by those looking to compensate for their emissions. The EU emissions trading market surged to an all-time high on its first day of trading after the global deal was struck signaling high demand.

Interesting side deals: methane, forests

In the pursuit of net zero financing, lenders and investors are seeking new markets and opportunities in the low carbon space. To this end, 100 countries agreed to cut methane emissions by 30 per cent by 2030 – including Canada. This is particularly challenging for economies with strong agricultural sectors, such as Brazil, who did also sign on. Bringing this pledge to life through innovation in agriculture and waste management sectors is an upside opportunity specifically in Canada where potent greenhouse gas methane accounts for about 13 per cent of total emissions.

Canada was also among the 100 countries who agreed to halt and reverse deforestation by 2030, along with big economies such as the US, Brazil, Russia, Indonesia and DR Congo who together house 85% of the worlds’ forests. It comes with a $19 billion funding commitment where more than half originates from private finance. The public-private financing arrangement involves at least 30 major financial institutions and demonstrates a new class of opportunity in pursuit of net zero and the importance of nature based solutions.

Complex climate geopolitics

The moral implications and dichotomy between historical emitters with industrialized economies who have caused most of the pollution over the past century, and the fast-industrializing economies who are being asked to curb their use of the same fuels that enabled the economic development and wealth of industrialized nations was laid bare at COP 26. Group of 20 (G20) powers are at odds about whether industrialized countries such as the US, Canada and the EU should pay for countries like India, China and Indonesia not to further utilize coal to power their economies. These are debates that did not conclude at COP 26 and are likely to remain at the forefront of G20 discussions and global trade negotiations. The US and China surprised delegates with co-announcement on climate cooperation, although the world’s two biggest emitters did not share details. This came in the context of US criticism of China for not showing up to COP 26 in force, and bigger picture complexities in their overarching relationship.

Vulnerable nations, such as small island states, have not materially contributed to climate change but are on the front lines of its destruction. They once again did not secure the funding they have been promised for nearly a decade to build resilience and adapt to the realities of a warmer world. The promise is for US$100 billion a year for the next decade to finance this support. With governments falling short, there may be expectation and opportunity for private finance to help fill the gap.

In sum, it has been estimated that the pledges and targets made at COP26 would get us to 2.4 degrees Celsius above pre-industrial levels, falling short of the 1.5 degree Celsius target but a major improvement from the pledges made in Paris in 2015. Countries agreed to return in one years’ time with ever-more ambitious plans when they meet at COP27 in Egypt in 2022. Only time will tell if countries and the financial sector will be able to turn their ambitions into action in time to avoid the worst impacts of climate change.