Tackling climate change by the numbers
A data-driven approach to COP26’s ambitious agenda
Carbon emissions are only part of the story. When upwards of 25,000 world leaders, business titans, journalists and activists descend upon Glasgow for the UN Climate Change Conference, fossil fuel emissions will get the lion’s share of the headlines. This 26th meeting of the Conference of the Parties, or COP26, as it has come to be known, marks the moment when the 200 countries that signed the United Nations Framework Convention on Climate Change will present their plans to cut emissions by 2030.
Perhaps as a recognition that the news cycle will likely be dominated by announcements of new electric vehicle (EV) adoption targets, plans to phase-out coal power and new corporate ESG initiatives, the event’s organisers have taken a decidedly more holistic approach to the COP26 agenda. Separating each day of the two-week conference into a specific focus area, the conference is digging into the interconnected and hugely complicated issues that are at the heart of climate change. These include finance; energy; nature; adaptation, loss and damage; and cities, regions and the built environment.
It’s an ambitious agenda that promises to unlock important insights on the role of financial markets, infrastructure investment and development, and future adaptations that will all be necessary in the transition to net zero. To shed some light on the current state-of-affairs across these varied, but highly connected themes, we’ve put together a by-the-numbers breakdown of the cross-cutting issues that will be discussed at COP26.
A recent out-of-office e-mail from a Financial Times editor sums up the current state of cynicism surrounding many corporate ESG initiatives. After explaining that he was on holiday and providing his mobile number for emergencies, the journalist signed off with a warning: “If it’s about anything crypto or ESG related, then I will hang up without warning and make a note of your name in my big book of grudges.”
It was an obvious tongue-in-cheek joke but it also conveyed an underlying sense of fatigue with what has become the talking point of the day on quarterly earnings calls, company press releases and investment prospectuses.
BlackRock’s January 2020 announcement that it would put ESG goals – and risks - at the centre of its investment strategy was a watershed moment. The goal of the announcement was not asset raising but the firm experienced its largest one-day inflow ever, with $1.5 billion in new investments pouring into one fund alone. A new sustainability-focused ETF, received more than $600 million in investment in its first week.
The firm was not the first asset manager to focus on ESG. In fact, according to Refinitiv Lipper data, ESG the top selling ESG classifications have clearly outperformed “conventional” funds over three and five years. But, when the world’s largest asset manager indicated it was squarely behind the idea, the rest of the world listened. Over the course of 2020, as the world was gripped by pandemic, a global reckoning with social justice and a cascade of natural disasters, ESG investing skyrocketed. Following is a snapshot of some of the major ESG investing-related milestones:
- Total assets under management in global ESG-related mutual funds and ETFs reached a record $4.7 trillion in Q2 2021.
- A study of simulated performance of the FTSE All-World Paris-Aligned Benchmarks Indices, showed an average carbon emissions reduction of over 50% compared to the benchmark FTSE All-World Index, with no decline in performance. Emissions at the end of 2019 are also reduced to half their 2009 level.
- Sustainable finance bonds surged 57% year on year to reach $777.6 billion and an all-time first 3 quarter record. While sustainable bond strategies are less developed than sustainable equity strategies, there are strong signs of growth, not least on sovereign bonds, as investors start to price in the cost of required infrastructure changes at a national level to combat the worst of climate change's impact. In the first half of 2021, the number of sustainability bonds issued rose 131 percent compared with the same period in 2020.
- Green bonds, which are financing products specifically designed to support climate or environment related projects, hit $365 billion in the first 3 quarters of 2021. Green bonds have raised more than $100 billion every quarter so far this year - a first half record.
- The number of companies setting a carbon target more than doubled between the Paris and Glasgow climate summits.
- The US green economy, which is comprised of companies with green products and services, has outperformed the US equity market as a whole, as well as more carbon intensive sectors. Likewise, the FTSE Environmental Opportunities Index, which includes companies that derive at least 20% of their revenues from environmental products and services, has outperformed peer group indexes over the last five years.
It’s become clear that investors are much less likely to disregard ESG risks, or maintain they are outside their fiduciary duties, with 43% of compliance and risk professionals indicating that the pandemic has increased the importance of ESG factors for their companies.
However, as ESG rapidly becomes the most important acronym in finance, many companies are abusing the moniker. This phenomenon of “greenwashing” was recently exposed by the Global Sustainable Investment Alliance, which found that roughly $2 trillion in European ESG assets were erased overnight in March when the European Union introduced new anti-greenwashing rules.
When held up to scrutiny, many of these so-called ESG funds were making environmental claims which were not based on data. Part of the issue is definition: ‘green’ companies requires a rigorous taxonomy to support the growing regulatory oversight of greenness.
Accurate data is the bedrock of the ESG challenge. If investors are to assess the climate risk or opportunity of a particular asset, they need climate-related data that is complete, presented in a way that is comparable and to have a universe of data that is comprehensive across all industries and countries, whether it is data for investors, or for companies listed in capital markets
As COP26 dives into the topic of sustainable investing, data accuracy, consistent disclosures and standardisation around ESG, reporting will be fundamental to moving the world forward.
One full day of the two-week COP26 summit will be devoted to gender issuers, with a particular focus on progress made against the Gender Action Plan launched at COP25. Recognizing that women and girls play a critical role in fighting the climate crisis – and that they have historically been under-represented in global initiatives – the Gender Action Program set out objectives and activities focused on building a more gender-responsive climate action.
Among the plan’s key priorities are to increase the number of women in leadership roles, putting them in position to drive real change. This effort will no doubt dovetail with private sector efforts over the past several years to increase the representation of women in business leadership roles. While measurable progress in increasing workplace diversity and increasing the number of women in C-suite and board-level positions at the world’s largest companies has been stubbornly slow,
% of females on the board globally
that trend is starting to change. With steadily growing numbers of female leaders driving the strategic growth initiatives of the world’s largest corporations, the intersection of female leadership, sustainability and environmental action is a flash point for systemic change.
FTSE Russell has been tracking this trend from the perspective of female representation as corporate board members in its Women on Boards Leadership Index Series. Designed to integrate leadership in gender diversity into a broad market benchmark, the Russell 1000 Women on Boards Leadership Index combines Social Pillar Scores, the percentage of women on corporate boards and stock performance into a single metric. According to its latest update, the Index outperformed its peer Russell 1000 benchmark over 3-year and 5-year time horizons, while producing lower overall volatility.
A similar trend was observed in Refinitiv’s Diversity and Inclusion Top 100 list, which evaluates 11,000 publicly listed companies across 24 diversity- and inclusion-related metrics, including gender diversity, to identify the 100 companies with the strongest, most inclusive cultures. It finds that the US leads in terms of the number of companies on the list with 25 on the Top 100 list, and that the software and IT services sector has the highest overall inclusion scores.
Taken together, metrics like these will be critical to tracking progress, establishing accountability and building quantifiable performance into ESG investment strategies. They will also start to establish an important baseline of leading companies who are taking diversity, equity and inclusion seriously. These leaders will increasingly play a major role in bridging the gap between corporate and environmental goals that will be central to meaningful progress on climate change.
Much like the trend in ESG-related investment vehicles, renewable energy sources have become a topic of great investor interest and steadily increasing scrutiny. As the chart below indicates, the 12-month forward price-to-earnings-ratio for global alternative, or renewable, energy companies is currently 32.4x current earnings. That compares with a forward P/E ratio of 11.9x for the traditional global oil and gas index.
This should send two clear messages to energy companies and investors alike: 1) There is a premium being placed on renewable energy, and 2) but there is still a great deal of money to be made in the traditional oil and gas sector.
That last part may prove sticky for the 200 countries that will be unveiling their 2030 emissions targets at COP26 and those that have pledged to be climate-neutral by 2050.
Data from Refinitiv’s How to spot a cop out at COP-26.
There is no shortage of data showing a concerted trend toward reduced global reliance on fossil fuels, but the persistence of the old way of doing things raises serious questions about whether or not these broad-based climate goals are attainable.
In addition to the price premium on global renewables, virtually every other quantitative and anecdotal metric reinforces the trend that the carbon-based fuel era is limited. Refinitiv data shows that the world’s 1,600 listed fossil-fuel producers saw a median price fall of 25% in 2020, versus a 7% loss for their renewable energy peers. The World Renewable Energy Index continues to climb by leaps and bounds. Large crude oil consumers, such as Finland, have dramatically cut their reliance on oil. Sales of plug-in electric vehicles have surged 160% in the world’s three largest markets: China, the US and Europe. The share of FTSE 100 companies with a net-zero target in place has climbed to 74%, while high emission companies will require clear data and support as they to transition to lower carbon models.
However, for all the facts and figures that can be thrown at the fossil fuel reduction trend, there are also stories like the one about bunker fuel oil, that challenge the feasibility of carbon-neutrality by 2050.
Bunker fuel is a heavy residual fuel oil that is left at the bottom of the barrel in the crude refining process. This thicker, dirtier fuel, which is primarily used by the global maritime shipping industry, contains upwards of 3,500 times more sulphur than the diesel fuel used for cars.
The International Maritime Organization (IMO) has been systematically adopting stricter sulphur limits for the industry, most recently in January 2020 when it required the sulphur content in marine fuel to be reduced to 0.5% from 3.5% by weight. All of the major oil producers have all started offering compliant fuels as an alternative.
Yet, as the chart below indicates, bunker fuel prices – even for the lowest quality fuel with higher sulphur levels – have continued to rise steadily.
Industry sources contacted by the Refinitiv Oil Research Team have suggested that many shippers are getting around the new IMO requirements by installing scrubbers that reduce sulphur oxide emissions, while still allowing them to use the cheaper, dirtier fuel.
Examples like this-where major industries see more upside in regulatory work-arounds than in affecting real, lasting change-will continue to present challenges to the major goals of COP26.
The key to upending that kind of anachronistic thinking is in being able to provide hard data on the upside potential in finding more sustainable ways of doing things. Increasingly, all signs are pointing to the green economy as the catalyst to drive that trend. According to FTSE Russell research, the green economy investment opportunity has a total market cap of roughly $4 trillion, representing an equivalent to 5% of the total listed equity market. By this measure, it has now overtaken the traditional oil and gas sector in terms of its weight in the broader economy.
Add the fact that the cost of C02 emissions continues to drag down the profitability of fossil fuel-reliant industries and it starts to become clear that the incentive structure behind green business is starting to shift. According to the Refinitiv Carbon Market Survey, higher price expectations in key markets is making the cost of CO2 a crucial factor in investment decisions. Respondents expect the price of European emission allowances (EUAs) to keep rising in the coming years and up to 2030. In March, EUAs traded at €40/ton and a majority of respondents predicted a price of €50 per ton in 2022. That level was reached on 4 May.
Slowly but surely, the cost of doing things the old-fashioned way is catching up to the work-arounds and short-cuts, but it is critical to keep reviewing the data that proves this point and spotlights the opportunity to capitalize on growth of the green economy.
Ultimately, the root challenge confronting COP26 delegates as they set out to tackle these incredibly complex issues is the basic law of supply-and-demand. As long as there are financial incentives associated with doing things the wrong way, there will be certain groups that resist what’s best for humanity in exchange for what’s best for their own short-term interests.
Nowhere is that phenomenon on display more prominently than in the area of green crime, where global networks of poachers, illegal loggers and waste traffickers have created a $256 billion annual industry exploiting natural resources. According to the United Nations Environment Program (UNEP) and the International Criminal Police Organization (INTERPOL), wildlife crime along has become one of the top five most lucrative illicit activities, following illegal drugs, human trafficking and illegal arms trade.
Here again, data is central to addressing the challenge. The criminal networks behind these environmental crimes often use legal business structures and complex business ownership models to obscure their illicit activity. Their ability to do this is often made easier by lax approaches to due diligence. Refinitiv research shows that 43% of third parties are not subject to due diligence checks and 60% of respondents are not fully monitoring third parties for ongoing risks.
Tracking the criminal organisations behind these efforts to flout new environmental standards and regulations is just as important as creating those rules in the first place. COP26 delegates who are serious about finding a solution will be eager to use data for more than just citing progress or achieving milestones. They will also get serious about using vast data sets and powerful analytics to address green crime.
One of the most visible and visceral effects of climate change has been the increase in volatile weather and natural disasters. From so-called 100-year storms that seem to rear their heads every year, to widespread drought, wildfire and flooding, our news headlines have been increasingly dominated with images of catastrophic natural events with startling frequency.
The knock-on effects of these events on world economies have been less visible. Recent research from FTSE Russell examined just that, tracking potential impacts to the World Government Bond Index (WGBI) under different environmental risk scenarios.The research finds that in the worst case – a so-called “hot house world scenario,” in which physical damage causes debt-to-GDP ratios to rise while employment and incomes fall – tens of GDP percentage points could be at risk.
According to the research, the impact of this hothouse scenario would be felt hardest in equatorial and southern European regions, with Malaysia, South Africa, Mexico, Portugal, Italy, Greece and Spain all potentially defaulting by 2050.
The organisers of the UN Climate Change Conference have been vocal in their recognition that climate change will have a disproportionate effect on developing nations. They have been clear that developing countries need to manage increasing impacts of climate change on their citizens lives, but the true scale of these impacts cannot be overstated. COP26 is about much more than emissions targets and warmer temperatures – the issues being discussed represent a threat to the very solvency for some of the world’s major economies.
One element sure to capture the headlines is the as-yet unfulfilled pledge by wealthy countries to finance the net zero transition in emerging economies to the tune of $100 billion per year. According to a report by the OECD, in not one of the eleven years since this pledge as made has this been met. Not only is such financing badly needed in emerging economies, but it would also create good faith in the broader negotiations, encouraging emerging economies to set more ambitious targets.
In our recent Sustainable Infrastructure Investment Report, we described the trend toward sustainable infrastructure investment as a “green rush”— a movement that had the power to create an entirely new asset class and address many of the root causes of climate change along the way. Ultimately, by tracking the efforts of major world economies and some of the largest institutional investors to reimagine utilities, transportation networks and our city centers as efficient, sustainable resources, we reasoned that the world could be on a precipice of a revolution.
The numbers are surprisingly large. According to projects tracked by Refinitiv, in 2020 alone, $272 billion was invested in sustainable infrastructure projects, nearly double the levels seen a decade ago. The largest growth has come from wind projects, where $55.3 billion was invested last year. Globally, roughly 35% of all new infrastructure projects announced last year were sustainable, up from just 10% a decade ago.
Infrastructure was once a quiet backwater of government finance dominated by capital-intensive projects with reliable returns but it has become one of the hottest investment categories around. Add the attention that massive infrastructure plans being unveiled in the US, Canada and EU will place on the sector, and it becomes clear that infrastructure may just be the most critical link in the COP26 agenda.
With the power to address major root cause problems like clean power generation, mobility and global trade and an attractive set of incentives for private sector investors, sustainable infrastructure brings together many of the most important elements of climate risk in a single theme. This area – more than headline emissions targets or jarring doomsday scenarios – is where the real solutions will be found.
COP26’s far-reaching agenda, the urgency of its mission and the desire among most participants to make headlines will no doubt result in many bold pronouncements that fit neatly into 280-character sound bites. We will be encouraged by many, disheartened by some and likely confused by others, but we need to look beyond the gut reactions and short-term news cycle if an event like this is going to have any real impact.
We need to keep scouring the data, tracking progress against stated goals and – importantly – unearthing outliers and anomalies that are indicative of burgeoning problems. We have made tremendous progress on so many fronts, but, as the data clearly shows, there is so much left to be done. Along the way, there will be some big wins, setbacks and surprises. The key is being able to identify which is which early enough to know when it’s time to double-down or adjust course.
We must never lose sight of the fact that the stakes are much bigger than financial incentivisation, short term trends in mutual fund flows or individual corporate strategy. They are literally life and death. Brand new research from FTSE Russell starts to put those stakes in context by analyzing the efforts of every major country to reduce national emissions and adapt to the impacts of climate change. It finds that, if left unchecked, a country like Australia, which has not set a net zero target, will continue on a warming trend of 4.1°C. Likewise, Saudi Arabia, which has also not set a net zero target, is on track to warm by 6.6°C. These massive temperature swings would have an unparalleled and cataclysmic adverse effect on the environment.
COP26 in November is the most significant climate summit since the 2015 Paris Agreement. The London Stock Exchange Group (LSEG) is acting at speed, together with financial institutions, policymakers and companies to achieve climate-related goals.