COP27 key takeaways: Scrutiny of net zero is ramping up | Insight Investment

• Window for 1.5C may be closing – with implications for net-zero pledges
• Clampdown on net-zero greenwashing
• 'Loss and damage' and climate adaptation shape conference agenda

The 2022 United Nations Climate Change Conference (or COP27) took place in Sharm El-Sheikh, Egypt, between 6 and 18 November. While expectations for the conference were somewhat muted given the 2022 economic and geopolitical context, and a bigger political push for emissions reduction is unlikely to materialise, important progress has been made in some areas, particularly with regard to disclosures and target-setting, and to loss and damage. These can be expected to have major implications for fixed income investors in the coming year.

David McNeil

Window for 1.5C may be closing – with implications for net-zero pledges

One of the most arresting developments in the lead up to the conference was the claim in October’s UN Environment Programme (UNEP) Emissions Gap Report that there is “no credible pathway” to net zero in place today, given the pace of annual reductions and the scale of cuts needed by 2030. Current trends point to a warming trajectory of 2.4ºC and 2.6ºC by 2100, and only a 45% reduction in emissions by 2030 – with wide-ranging changes to global electricity, industry, transportation, buildings, food and financial systems – would enable the 1.5ºC target to be met. The headline finding is that there is a 50/50 chance that global temperatures will breach the 1.5ºC threshold by 2030¹.

While conference delegates generally avoided such public statements, UN Secretary General António Guterres acknowledged the narrowness of the pathway remaining and the critical importance of the 2030 target. This poses the questions of at what point policymakers are likely to publicly acknowledge that the pathway to 1.5ºC is effectively closed – and what this will mean for corporations and investors with emissions-reduction targets predicated on this pathway. With COP26 in 2021 framed as a conference of new or revised ‘pledges’, COP27 has largely focused on the practical implementation of climate pledges by governments and the private sector.

Clampdown on net-zero greenwashing

The first week of the conference saw the publication of the recommendations of the UN’s expert group set up to ensure the integrity of corporate net-zero pledges². This encompasses 10 standards and criteria that organisations claiming to have a net-zero target should meet, including a requirement that emissions reductions should cover all emissions (including supply chains) and should be accompanied by detailed transition plans outlining alignment of capital investment with net zero. Also, the standards state that companies should not make net-zero pledges while expanding fossil-fuel production or deforestation activities, and should avoid the use of offsets to deliver required emissions reductions. Lobbying against climate policies is also considered inconsistent with net-zero under the recommendations.

The International Organization for Standardization (ISO) similarly published a ‘Net Zero Guidelines’ paper, clarifying expectations around the use of net zero terminology and target setting³. The UK Transition Plan Taskforce⁴ and Glasgow Financial Alliance for Net Zero⁵ also published proposals regarding net-zero transition plan disclosers for financial institutions for corporate net-zero transition plan disclosures for financial institutions – which will be mandated for large firms in high-emission sectors in 2023.

Elsewhere, another major development was the launch of the world’s largest inventory of facility-level emissions data (Climate TRACE)⁶ which combines satellite data with disclosures for more than 70,000 sources of greenhouse gas emissions. This has revealed that the majority of oil and gas companies are significantly underreporting their emissions, largely due to weak monitoring of leaks and flaring.

The trend towards such ‘shadow reporting’ of climate impacts has gained momentum in recent years as remote-sensing technologies have developed, and wider access to free or low-cost resources is likely to significantly increase the scrutiny of both targets and emissions disclosures in 2023.

'Loss and damage' and climate adaptation shape conference agenda

A historic agreement by the UN at the end of the conference promised financial help for less wealthy countries experiencing the negative effects of climate change, with a new fund for ‘loss and damage’ to be set up by the time of the next conference in 2023⁷.

While progress on climate mitigation has lagged, the presidency of Egypt in 2022 sharpened the focus of the conference on the physical risks of climate change and costs and benefits of adaptation in the most vulnerable regions, particularly as the IPCC sixth assessment report underlined that some degree of global warming is now inevitable⁸. The IMF estimates that annual adaptation costs will exceed 1% of GDP for the next 10 years across 50 low-income or developing countries, and a single drought can lower an African country’s medium-term economic growth potential by one percentage point, creating significant government revenue shortfalls⁹. Many of these countries have exhausted fiscal space over the past three years as a consequence of the pandemic and high inflation, so pressure for a ‘loss and damage’ facility, under which developed countries would assist vulnerable emerging markets with the physical costs of climate change, had grown. Limited progress was made at COP26 on this topic, given sensitivities of countries to ongoing liabilities, but ahead of the historic agreement the pausing of debt repayments by affected countries in the event of climate-related disasters had been pledged by the UK, while Germany, Denmark, Belgium, Austria and New Zealand had announced contributions to loss and damage.

Nonetheless, rich nations are expected to continue to lag behind the target of $100bn of overseas climate finance to emerging markets per year, and the bulk of this has historically been in the form of loans rather than grants. Adaptation finance has been dwarfed historically by mitigation spending and the role of the private sector has been limited by the inability of many investment assets to generate returns. Looking ahead, the IMF emphasised the importance of institutional investors expanding their involvement in climate adaptation finance, and asset owners are likely to take growing interest in adaptation finance opportunities as a result of the intense focus at COP27. The G7 announcement of a ‘Global Shield’ ¹⁰(effectively a reinsurance scheme for climate-related damages) was a positive development that could help lower the large share of assets in emerging markets that lack any formal insurance coverage for climate-related perils.