Luisa Florez, Head of Qualitative ESG Research at AXA Investment Managers (AXA IM) and Laurence Devivier, Senior RI Economist at the company, comment on the implications for investors of the recent COP21 agreement.
Why COP21 was a success:
An agreement to a Climate Change ‘Paris Accord’ that includes the largest contributors to greenhouse gas emissions (China and the USA), clearly reflects a worldwide awareness of the long-term risk of climate change on the environment and our economies.
· We think it is reasonable to expect that the agreement will be ratified on 22 April 2016 because a large consensus on the subject has emerged, notably with China who are responsible for 27% of total emissions.
This agreement is a binding obligation, meaning that individual countries must set an emissions reduction target to be reviewed every 5 years. While there are no sanctions when targets are not reached, there are two major forces related to the binding obligation: the transparency and the upward revision every 5 years of the National Determined Contribution (NDC) targets. The latter point should put pressure on countries to implement a low carbon transition, even in the absence of sanctions.
Given that current policies place the world on a path towards +3.6°C warming above pre-industrial levels, the common objective to keep global warming below 2°C by the end of the century (plus a more ambitious target “to limit the temperature increase to 1.5°C (1)”) means that NDCs have to be upgraded as soon as possible to match objectives with reality.
The agreement has reaffirmed the goal for USD 100 billion per year by 2020 to be mobilised and appropriated for developing countries to encourage emission reductions and adaptation to the physical consequences of climate change, in particular in the less developed economies and island countries. There are numerous companies, sectors and asset classes that will benefit from this investment.
Impact on investors:
While the focus of 2015 was on carbon divestment, it is our expectation that from 2016 onwards, the perspective will change and investors will be looking at the emerging investment opportunities and governance implications. In our view, the following three themes will influence investment decisions:
1. The evolution of carbon-intensive sectors. The agreement sends a clear message to companies operating in the power generation, energy, transport, buildings and industrial sectors that change is required. We do not expect this to have immediate impact on pricing or asset allocation and rather see this as an issue that analysts and investors will incorporate into their research and fundamental analysis to assess how companies choose to respond to the evolving landscape.
2. Identifying opportunities to finance the transition to a low carbon economy. Public and private investors will be a key source of capital for investment in new technologies that support energy efficiency or that provide new sources of energy. Working off an assumption that the population will continue to consume the same level of energy, investment will be directed at either reducing the carbon intensity of current sources of energy, or replacing this demand with new sources. The opportunity is widespread and will impact many different sectors, regions and asset classes. For example, renewables such as wind will require infrastructure investment along with innovative solutions for storage and transport. While in the past some of these opportunities were supported by government subsidies, this agreement has made the support more explicit and will need to rely on capital from all investor segments in order to implement this transition at the target pace.
3. Greater engagement and higher governance standards. The financial stability board (FSB), which was established following the global financial crisis to monitor and assess vulnerabilities affecting the global financial system, will be pushing companies to disclose their climate-related risks. This policy will increase transparency for investors, which in turn will support fundamental analysis and make ESG analysis and scoring more robust. While the momentum for this kind of disclosure had been established before COP21 through active engagement by the investment community, this decision by the FSB makes these measures more concrete. Interestingly, the French government introduced new and unique regulation requiring institutional investors to align their investment decisions with the 2°C scenario. While only general guidelines were provided, it is expected that over the next two years, best practice will emerge and will shape the way reporting will evolve in the future. While France was the only country to make the direct link with investors, institutional investors in other countries will certainly be keeping a close eye on the reporting, governance and investment implications of this regulation.