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Reading the final decision of COP27 is like reading a thesaurus entry for non-committal verbs. The COP parties “noted with serious concern”, “called upon”, “reiterated”, and “highlighted” – but only once did they commit to language around actually “resolving” the growing issues around climate change. And if you dig a little deeper, this “resolution” is merely a reiteration of previously agreed action from Kyoto and Paris to “implement ambitious, just, equitable and inclusive transitions to low-emission and climate-resilient development”.
It is no wonder that the net zero movement sometimes gets tarred with a “virtue signalling” label. The hypocrisy of billionaires preaching austerity comes to life on a country level: developed nations that have built up their standard of living via a carbon-led economy now tell emerging economies they cannot do the same.
There has been much reporting that this COP led to a “breakthrough decision” to establish a loss and damage fund to assist developing nations in adapting to the adverse effects of climate change.
Again, it is imperative we scratch beneath the surface. This “breakthrough decision” was merely an agreement to “consider” funding arrangements. The details of who will fund said arrangement, how much will be funded and who the recipients will be, remain to be seen.
Nor did countries “ratchet up” their ambitions or nationally determined contributions as was the hope of many and noted in the original Paris Agreement text as the necessary path to net zero. So much for the “implementation COP”.
In the face of governmental inaction, the role of private finance becomes ever more critical, highlighted by the UN Report released in the middle of COP27: Integrity Matters: Net Zero Commitments by Businesses, Financial Institutions, Cities and Regions. We agree with the spirit of this report that private sector actors who make net zero pledges must be held responsible for making good on those pledges.
The recommendation for financial institutions to immediately end “(i) lending, (ii) underwriting, and (iii) investments in any company planning new coal infrastructure, power plants and mines” caught our eye for three reasons: regulatory and financial constraints; the imperfection of divestment; and continued demand for coal.
For Australian institutional investors to implement such a recommendation, a number of large companies on the ASX (at time of writing) would need to be immediately divested. Some of these are pure play, while for others coal makes up a minuscule proportion of their business. These companies and their peers make up a significant portion of the ASX Top 200 listed companies. They have performed well in recent times and divesting is no easy task for a fiduciary who is managing money on someone else’s behalf.
Not all beneficiaries have identical views. Some would suggest they are failing in their fiduciary duty if they have exposure to coal, while others would argue the opposite view altogether. Depending on their perspective and timeframe – both could be right.
This does not mean investors cannot comply with the UN proposal, particularly if it is well reasoned and they believe in the best financial interests. Equally there is an opportunity here for the laws and regulations around fiduciary duty to be clarified for this context.
The idea of immediately ceasing to provide funding to a company that is undertaking expansionary coal projects is compelling in its simplicity.
However, if an Australian institutional investor decided to divest out of say, a pure play coal company, that does not mark the end of the production of that pipeline. The stock would be purchased elsewhere and the coal expansion would continue. The end result is largely the same, albeit with perhaps disruption to timelines and scale.
Even if divestment “worked” in the sense that the company went out of business, it’s likely that someone else would then take over that mine and sell coal if there is demand.
There are too many financial actors globally that would step in as buyers of a divested coal company (in the absence of any government intervention limiting this behaviour). In some cases, governments might even step in to increase the use of coal to sure-up energy security rather than speeding up the transition and reducing its use.
The unlikelihood of divestment working has seen the industry favouring engagement for real world emissions reductions in investee companies over divestment.
Over the past year, there has barely been an asset manager we have met with that has not made a claim about the quality of their engagement program with hard-to-abate sectors.
Unfortunately in our experience it is the exception, rather than the rule, to find a fund manager with an engagement program that is credibly designed to reduce emissions by shifting their investee companies to act in alignment with science-based targets for net zero.
Uplifting the asset management industry’s engagement capabilities (and asset owners incentivising this behaviour) is one potential path to limiting investment in expansionary coal activities.
The thing that will kill the coal industry is demand destruction. All projections show a dampening of demand as the energy mix transitions, but the reality remains that owning coal has been extremely profitable in recent times.
The most effective means of dampening coal use will result from a combination of measures: if the energy mix can be changed, intensity measures improved, and alternative energy projects continue to be supported.
Where does this leave investors? Collective action is gaining traction in sustainable finance circles as the necessary answer to the intractable systemic challenge of climate change. In practice, we believe this may play out in the following ways.
Engagement and collaboration: Investors should look to engage with market actors such as companies or investment managers (potentially collaboratively) to improve cut-through and efficiency, and to ensure they have appropriate plans to transition and are taking steps that demonstrate delivery on that plan.
Policy advocacy: The most efficient route to net zero in the real world is one where public policy supports and guides the required economic transition. Additionally, policy certainty (rather than uncertainty) assists in making long-term investment decisions like those required to decarbonise the economy. We encourage investors to see what role may be appropriate to assist in developing this policy certainty, which could include participating in collaborative initiatives that focus on this area.
Measurement and monitoring: Carbon data is imperfect, but understanding material exposures and risks can help investors determine the strategy best suited to their needs, alongside also helping to identify where engagement resources and effort should be focused.
Climate solutions: Investors can play an important role in mitigating climate change by directing capital to climate solutions. Climate solutions can also potentially serve as a climate change hedge for investors’ portfolios, as “greener” solutions increase in value and offset the decline in value of some “brown” investments over time.
Climate transition: This involves the concept of investing in “brown” companies, such as energy utilities, and working with them to transition. This could initially increase a portfolio’s emissions. However, working with the companies to transition can be designed to improve shareholder returns and ultimately deliver a better long-term climate impact (and portfolio impact) over time.
Not all investors – whether asset owners or asset managers – need to have identical net zero approaches.
What is going to be more impactful for long-term outcomes is having a real-world perspective.
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