ESG Focus | Nov 30 2021
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COP26 Hands Transition To Big Capital
COP26 may have appeared a fizzer to many observers but the outcomes point to another reality – big capital has got this one – and it’s a whopper.
-Investors to carry the transition until the next COP
-Outcomes focus on market regulation
-China appears set to take the lead
-Morgan Stanley predicts focus to shift to non-climate ESG thematics in 2022
By Sarah Mills
After what appeared to be much ado about nothing, many COP26 observers emerged perplexed: global warming was to be confined to 1.8 degrees Celsius according to the International Energy Agency, not the 1.5C previously mooted; other forecasts put the figure averaging 2.4C; and Europe showed signs of backtracking on gas.
But in a financialised world, it is big capital calling the shots and COP26’s indications of limited global central regulation suggests big capital is confident it can carry the transition from here.
Underscoring this proposition, one of the most material statements of the period emerged not from the COP26 but from the investment community.
The Glasgow Financial Alliance for Net Zero, which represents 450 banks, insurers and other asset managers, and is led by former Bank of England chief Mark Carney and billionaire financier Mike Bloomberg, announced US$130trn in new commitments.
The most material global COP26 outcomes also focused squarely on markets, the implication being that sovereign nations will be more than willing to compete on the regulatory front in the race to transition.
The three most material outcomes from the October/November period for global markets include:
-The unleashing of the world’s carbon markets
-The agreement to establish an international reporting standards board
-The introduction of methane into global climate commitments
The upshot is that these commitments will take a year or two to bed down, and some analysts expect the climate investment theme will be put on hold in FY22 and that big capital will shift its focus to other environmental and social imperatives such as circularity, biodiversity and social themes (more on that later).
Financialisation wins the day
Meanwhile, there are US$130trn big ones in play.
For governments to stay in the transition race they will need to issue debt, and most of the world’s debt is to be directed to sustainable finance.
The notable lack of rich-world support for developing countries at COP26 (save for mitigating physical climate risks) also points to the expectation that investors will drive development in emerging markets.
All this suggests growing momentum towards global financialisation and climate colonisation.
So to assume that weak climate commitments at COP26 reflects an easing of global resolve on climate would be a mistake. Remember, the name of the game is “Who Cares Wins”.
As Bloomberg Green writes: “Public shaming hasn’t seemed to move the needle. But money might”.
Might is an understatement. In the context of the transition, money is might and might is right. And the funds will flow. Forecasts vary wildly but the numbers are massive.
The Energy Transitions Commissions forecasts more than US$1trn in investment is needed to reach net-zero emissions by mid century.
The Organisation for Economic Co-operation and Development says US$6.9trn will be required annually this decade to meet Paris Agreement forecasts.
By 2025, Morgan Stanley estimates sustainability/ESG assets under management will triple to US$6.5trn, representing a compound annual growth rate of 29% between 2020 and 2025.
The expectation is this will be driven by “Beyond Europe, Beyond Environment and Beyond Screening” themes.
2022 may be a year of adjustment for investment management industry
But as usual, timing is critical, and analysts took the mood of COP26 to suggest the transition pace is generally on track and that the focus will be on bedding down the disclosure nets and carbon-market infrastructure over the next year.
Brandywine Global’s Around the Curve in its 2022 ESG Outlook says the legacy of Glasgow depends on whether support for climate change mitigation and adaptation reaches critical mass in 2022.
“COP26 and its resulting agreements should drive 2022 trends within the investment management industry,” posits Around the Curve’s blog.
“We expect net positive improvements across three themes: data, collaboration, and finance … they should benefit from strengthening momentum within the asset management industry next year and beyond.
“Investors do not necessarily need more data providers; we just need standardisation and consensus among them.
“That level of consistency will require extensive co-ordination across the public and private sectors, particularly from entities that collect and report data, whether they are non-governmental organisations, government agencies or corporations.”
So Around the Curve spies opportunities for relevant, timely data to assess risks.
Following the money trail
Brazil, Russia, India, Indonesia and China account for 60% of the world’s emissions.
Given in the US, Australia, and Europe, GPD growth is being achieved regardless of transitioning expenses, some expect climate investment to be directed to the above countries.
As if to underscore this, the European Union, previously the world climate leader, indicated it might rest on its laurels in 2022, going so far as to entertain the prospect of using blue energy (LNG), and opening the door for investors to expand their climate sights to other nations.
The obvious winner from this is China. As the world’s largest consumer of fossil fuels, it offers the highest immediate climate returns.
As the Institute for Energy Economics and Financial Analysis reports in its story ‘EU considers bowing out of gold standard taxonomy – leaving room for China to take the lead’, putting gas in any taxonomy muddies the calculations.
China’s taxonomy – the new Green Bond Endorsed Project Catalogue – in contrast rejects LNG, gas and coal.
This has clear implications for Australia’s resources sector which we discuss in later stories.
“Reading the market, China is showing it knows how to attract private capital,” continues IEEFA.
“Early this year, the People’s Bank of China’s Governor Yi Gang stressed that government funding alone would not be sufficient for China to meet its net zero goals … and therefore market participants must be encouraged to step in and fill the gap.”
This again underscores big capital and government primary agendas at COP26 for investors to carry the transition.
“China is ready to take the reins from the EU,” says IEEFA before noting that even Russia’s Green Taxonomy published late November appears to exclude blue energy.
Others expect the G3 will continue to attract capital
Not all analysts agree.
Around the Curve suggests the G3 – Europe, Japan and the US – is a logical destination over the next few years, given their emissions profile.
This has some merit, especially given the unpredictability of Chinese markets; and China has every incentive to fund its own transition, but a transition of this scale represents a banquet of opportunity.
Morgan Stanley anticipates a climate catch-up in the US and Asia in the private sector, relative to European peers.
Most analysts expect the US will turn to private investment to fund its transition given the continued usefulness of the transition as a political football.
US President Biden’s various funding packages have already been watered down, suggesting shareholders are expected to do some heavy lifting.
But the US has always put its faith in private capital to drive change and one way or another, the money will find its way from the government to Wall Street.
Around the Curve expects the Big 4 US banks, whose loan books currently have a huge bias to fossil fuels, are likely to lead the charge.
Big capital is likely to tap them on the shoulder (remember those US$130trn big ones) and given the scale of bias, any percentage swing is likely to be significant.
In Europe, Morgan Stanley expects decarbonisation will continue to drive growth in renewables, electric vehicles, hydrogen, carbon capture storage and energy efficiency for 30 years but the broker also expects a lack of climate catalysts in 2022 will be stock specific and based on best-in-class execution.
Morgan Stanley augurs the rise of circularity, social and other themes
Morgan Stanley expects climate stocks may suffer from a lack of catalysts in 2022, but observes these stocks have outperformed in the past two years.
The broker spies tailwinds for nascent decarbonisation technologies and other successful enablers of decarbonisation as winners become more evident.
Morgan Stanley also expects 2022 will be a quieter year for climate policy as the US plays climate catch-up, and stakeholder capitalism and ESG engagement intensifies alongside ESG disclosure and regulation – again underscoring the COP26 agenda.
This is further supported by expectations mandatory Sustainable Finance Disclosure Regulation will draw strong net inflows to Europe and more sustainable fund launches.
Morgan Stanley also forecasts strong growth in the green bond market and rapid development of a sustainability-linked bond market in 2022.
ESG-labelled debt issuance is forecast to rise to US$1.475trn in 2022, up from $1trn in 2021. (Interestingly, the world’s first nuclear green bond was issued in late November.)
Flows into ESG funds hit US$533bn between January and October 2021. This compares with US$331bn for all of 2020 – putting the market on track for an annual doubling.
Non-climate ESG themes in the spotlight
As climate regulatory focus eases up, governments are expected to switch their focus to other critical ESG themes, most notably, biodiversity, circularity, pollution prevention and protection and restoration of water and marine resources and systems. (See a link to our story on Huon Aquaculture below.)
The European Commission, meanwhile, is adopting 35 sustainable fisheries and aquaculture criteria, published this month, for corporate and investor disclosure, with immediate implementation.
So it seems Europe is not really falling behind the ESG curve, but preparing for the broader ESG regime.
The European Union, meanwhile, is developing a social taxonomy, which will include metrics such as health and safety, privacy and cybersecurity frameworks; this is likely to support software companies that support these aims.
Morgan Stanley reports China’s carbon-peaking action plan has introduced targets to achieve a circular economy: including recycling volume of scrap steel, copper, aluminium, lead, zinc, plastic, rubber and glass by 2025.
The nation is trying to kill two birds with one stone, honing its circularity focus on its manufacturing industry.
Again, this has big repercussions for Australia’s resource stocks, which we discuss in a separate story.
China and the US are also funding social initiatives.
In the US, analysts spy positive revenue-based investment implications for sectors such as digital inclusion; affordable healthcare and housing, arising from US President Biden’s infrastructure plan, which focuses on “inclusive growth”.
In China, Morgan Stanley says the nation is shifting from “Growth First” to “Balancing Growth and Sustainability” and this should benefit innovative biotech, pharmaceutical and med-tech companies, and commercial insurance companies.
Globally, when it comes to sustainable fishing, aquaculture, water and marine protection; Morgan Stanley says material sectors include capital goods, tech hardware/software and utilities, as well as big users of water such as pharmaceuticals, chemicals, metals and mining.
On the pollution theme, material exposures are spied in construction, oil and gas, pharmaceuticals, tech hardware/software, transport and utilities.
On circularity, the broker highlights technology software sectors that improve circularity within assets, plastic manufacturing and packaging, bio-based and carbon-capture solutions, and general recycling plays.
The biodiversity thematic is also expected to kick in and exposed industries include beverages, technology hardware and software, construction, real estate, food, leisure, and solutions that support the protection and restoration of biodiversity and ecosystems.
Climate narrative alive and well
The low-key COP26 would lead sceptics to question the climate-change narrative.
But, even were climate change merely a pretext for building the fourth industrial revolution on renewable and circular technology (which in many books is a good thing), having invested so much money in the narrative, big capital is unlikely to let it die.
The evidence suggests that what we are observing is merely a consolidation phase of the transition.
But what investors are really seeking is guidance on preferred climate solutions.
Perhaps that will come from the next COP.
FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future:
https://www.fnarena.com/index.php/financial-news/daily-financial-news/category/esg-focus/
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