Meagre but maybe meaningful: The key COP27 takeaways for investors

Key points

• COP27 featured crucial discussions on how to implement the climate commitments and pledges made during last year’s conference in Glasgow
• The two weeks of climate talks covered a range of topics, this year focusing largely on financing climate action in developing countries
• The climate agreement fell short on delivering tangible climate action but has paved the way for ambitious initiatives which envision a crucial role for private investors.

We expected the COP27 climate summit to be challenging and, unfortunately, we were not surprised. More than 100 world leaders headed to Sharm el-Sheikh, Egypt, hoping to make progress on commitments made at last year’s conference – but instead we were left with “much homework and little time,” in the words of United Nations (UN) Secretary-General António Guterres. Collectively, we now face genuinely hard choices – notably on financial transfers and real reductions in fossil fuel use – with far-reaching economic, social, behavioural, and political consequences. No wonder many are balking at the obstacles.

The new climate agreement delivered on a breakthrough ‘loss and damage’ fund, designed to help vulnerable countries contend with the devastating effects of climate change, but there were various sticking points that hampered negotiations, many of which remained pretty much unresolved even after close to 40 hours of ‘overtime’.¹

Of course, this year’s attendees had to take on headfirst the challenge of climate change whilst confronting considerable global headwinds, including war in Ukraine, an energy crisis, a new era of aggressive monetary tightening and record-high inflation.

Discussions of climate adaptation and the loss and damage fund took centre stage, but dedicated conference time was also given over to issues like mitigating global biodiversity loss. This resulted in a deforestation pact from the world’s largest rainforest nations as well as a new partnership to fund nature-based solutions.² Investors should expect more to come from the UN Biodiversity Conference in early December.

On ‘Gender Day’, there was a reaffirmed commitment to delivering a Just Transition, focusing on helping women access green jobs and producing gender-sensitive climate sector policies.

Frankly, COP27 did not see the scale of commitments that characterised last year’s conference in Scotland – and even the Glasgow pact had been deemed an uneven outcome at best, especially given the high hopes linked to its timing, mid-way between the ground-breaking Paris Agreement and 2030 – the formal target year for nationally determined contributions (NDCs) to emissions reduction.

Within the final agreement this year, however, there were still some substantial talking points for responsible investors to consider and which could lead to tangible climate action, as well as implications for portfolios, further down the road.

Financing climate action

From day one, the key question was about closing gaps in climate financing for emerging markets. A report that counted climate economist Nicholas Stern as a lead author put the potential annual cost of support from the developed world to cut emissions and cope with the effects of climate change in developing nations at about $1trn per year by 2030.³

Fortunately, there was some headway. The historic ‘loss and damage’ fund needs a lot of work to understand who will pay what and how it will be disbursed, but it should form one part of the solution. Just as important will be talks to set a new annual financing target to replace the now definitely obsolete £100bn a year goal by 2020 that was missed by developed nations. That target was not set in Egypt but the process to deliver it continues.

Investors did get a glimpse at some potential avenues where they might help support those financing needs. A pipeline of climate initiatives worth $120bn was published with the hope that funding may be accessed more quickly.⁴ And as climate ambition grows, we expect to see a greater push to incentivise private capital from all directions.

Multilateral development banks and international financial institutions, under pressure to contribute more to climate action, may look to financing solutions that bring in private investors and bring down the cost of capital.⁵ There were initiatives at COP27 seeking to provide investors with frameworks to reduce the perceived risks.⁶ Meanwhile, a $15bn programme to support mitigation and adaptation projects in Egypt was aimed at creating a scalable model of green financing, and a potential template for attracting private sector investment.⁷

Fossil fuels, “low-emission” energy and renewables

Although a mooted proposal to call for the phasing down of all fossil fuels failed to make the final agreement, it may well be revived at next year’s conference in Dubai. All COP progress (or lack of it) should be seen in the context of the path it may clear.

However, we did see progress on the pledges made by more than 40 countries last year to shift away from coal as an energy source. The US and Japan announced a $20bn funding package to accelerate Indonesia’s transition from coal power to renewable energy and to bring its peak emissions to 2030, instead of 2037.⁸ A similar $8.5bn scheme was announced for South Africa, and another $11bn project for Vietnam – serving as templates for other coal-dependent developing countries.⁹

We have long seen this as a trend for investors to consider and AXA IM has committed to exit from all coal investments in countries that are part of the Organisation for Economic Co-operation and Development (OECD) by the end of this decade, and in the rest of the world by 2040.

Separately, there was much pressure from some African nations to allow the development of gas reserves as a transition fuel (gas when burned produces significantly less emissions than coal for example). That may explain why the phrase “low-emission” energy made it into the final agreement alongside renewables as energy sources of the future. While in many countries, largely in Africa, burning gas would help reduce wood cutting and biodiversity loss, responsible investors may need to be watchful that such a potential loophole is not exploited.

On a related, and more positive note, more than 150 countries have now joined the Global Methane Pledge, originally launched during COP26, with the aim to reduce methane emissions by 30% by 2030 compared to 2020 levels.¹⁰ Methane (essentially natural gas in its unburned form) is one of the most powerful greenhouse gases and 95% of countries now have methane in their national plans to reduce emissions.¹¹

There were also some positive noises around green hydrogen – created through electrolysis using renewable energy – something we have explored as a potentially interesting investment theme. Egypt and Norway launched a project to construct a 100MW-capacity green hydrogen plant in Ain Sokhna, Egypt,¹² while the technology was earmarked as a crucial route to decarbonise the shipping sector by 2050.¹³

Carbon offsets and credits

The creation of a carbon market and the circulation of carbon credits has long been potentially helpful for companies with difficult transition pathways – and an intriguing theme for investors. However, the idea is fraught with concerns about verification and reliability.

This year, a framework for how carbon markets could work sought to address the scrutiny they have received since COP26. These measures will attempt to improve the quality and integrity of carbon markets, and ultimately, enable developing nations to channel more finance into their clean energy transitions. Securities regulators also made recommendations to improve transparency and regulation in voluntary carbon markets.¹⁴

One of biggest commitments from the US during COP27 was a carbon offset scheme, the Energy Transition Accelerator, which officials hope will drive billions of dollars from the private sector into the economies of developing countries working to shift to renewable power sources like wind or solar.¹⁵ Another plan, the African Carbon Market Initiative (ACMI) aspires to create a thriving voluntary carbon market across the continent, producing 300 million high-integrity carbon credits each year by 2030.¹⁶

It remains crucial here to reiterate the hierarchy of first reducing, then avoiding emissions – and then, and only then, offsetting emissions. A well designed and reliable carbon credit market is part of the energy transition toolbox, but it should not be an excuse not to cut emissions.

Regulation, data, and standards

Climate-aware investments, and environmental, social and governance (ESG) investing more generally, rely on high-quality, repeatable data so that active, responsible asset managers can build portfolios that reflect clients’ sustainability priorities. No surprise then that discussions of transparency and accountability featured heavily at COP27, with a general acknowledgement that better regulation, data and standards would help ensure effective climate action.

Greenwashing – where climate action falls short of the rhetoric – saw scrutiny following an onslaught of reports that revealed a majority of countries and companies with climate pledges lacked concrete ways to measure and implement them.¹⁷ A report from a UN High-Level Expert Group sought to address that with a credibility guide for net-zero pledges, outlining standards required to deliver measurable emission reductions.¹⁸

Meanwhile, former US Vice President Al Gore launched Climate TRACE, a global emissions database which will provide information on more than 70,000 sites of emission, including companies in China, the US and India.¹⁹

This is just the kind of information that can give responsible investors potentially crucial insights into climate risks. We are already able to assess and adapt to those risks in portfolios, but such initiatives will only expand and enhance the availability of climate metrics and help investors direct finance to impactful projects whilst benefitting from potential long-term returns.

Hard work to come

This year’s final agreement has fallen short in many ways – and the 2015 goal to limit global temperature increases to 1.5˚C above pre-industrial times was left hanging in the balance.²⁰ While featuring a list of ambitious goals, the COP27 text is concerningly light on tangible plans of action and appears to have deferred the real work to next year’s conference. Even the breakthrough ‘loss and damage’ fund has left more questions than answers.

We will also need to keep watching developments in mitigation efforts. The ‘mitigation work programme’, which held up negotiations this year, was “adopted” in the final COP27 agreement and calls for countries to deploy clear targets, plans and metrics to deliver on climate commitments. It takes a step towards achieving actual emission reductions, though the proof will be in how the programme is implemented.

We must mention progress made outside of COP27. While the US appears to have been light on its climate commitments this year, the historic Inflation Reduction Act (IRA) from August did herald something of a sea change in the economics of industrial decarbonisation. Driven by government policy and economic opportunities, the Act has already begun spurring the private sector to decarbonise hard-to-abate sectors – with some $500bn in new spending and tax breaks designed to bolster clean energy investment, cut healthcare costs, and raise tax revenues.²¹ The European Union (EU) and its member states ought to think hard about a similar logic to support the ambitions expressed in the “Fit for 55”²² and REPowerEU plans.²³

A key message from the Act and from COP27 is that investors are clearly central to any viable plan to finance our transition to a more sustainable era. The pathway to net zero and beyond is still clear even if this latest meeting has failed to smooth out the bumps as it might have, and we expect policy support and consumer momentum to continue incentivising potentially profitable investment in climate initiatives worldwide.