The role and profile of finance as an essential enabler of climate action took a massive step forward at COP26 last year. This year, Wednesday 9 November – Finance Day at COP27 – presented another opportunity for global investors to come together and find ways to address climate change. With that in mind, what happened on Finance Day and what does this all mean for investors?
What were the key themes on Finance Day?
- Investor focus was different to COP26
The focus of finance at COP27 was significantly different to last year. Firstly, COP26 was the first time financial institutions were invited to the table to effect change and there was significant private investor presence, mainly focused on paving a way towards net zero. COP26 brought the launch of the Glasgow Financial Alliance for Net Zero (GFANZ), the world’s largest coalition of financial institutions committed to decarbonisation.
This year, one of the main objectives for the conference overall was the establishment of a financing mechanism for loss, damage and adaptation solutions. By 2050, the economic cost of loss and damage in developing countries is estimated to be around £1 trillion. Countries on the receiving end of the worst impacts of climate change, including small island development states, countries reliant on resource extraction or agriculture, and low- and middle-income countries generally, cannot face these costs alone. COP27 emphasised the ethical responsibility of wealthy nations – the source of most climate pollution – to the global south, whose direct contributions to climate change are comparatively tiny.
Crucial climate talks to develop the financing mechanism extended well past the final day of the conference, until a breakthrough agreement was made. Governments agreed to establish a dedicated fund to assist developing countries to respond to loss and damage.
- Public-private investor collaboration was top of mind
Another key theme was the need for public and private investor collaboration towards climate financing. COP27 saw the launch of the Sharm El-Sheikh Adaptation Agenda, a plan to unite governments and the private sector around adaptation solutions to protect people living in the most climate-vulnerable communities by 2030. The actions are divided across five streams where adaptation investment is required i.e., food and agriculture, water and nature, coastal and oceans, human settlements, and infrastructure. The Agenda calls for £115bn to £250bn from public and private finance to be invested into adaptation globally. There were also calls for the private investor community to integrate physical climate risks into investment decisions and continue to innovate towards financing adaptation, such as developing new climate finance instruments.
Discussions further highlighted the need for a level playing field to ensure private investors can access investment opportunities equally in both emerging and developed markets. This involves establishing structures that mitigate investment risks in developing markets. It was acknowledged that improved dialogue between investors, governments, and development finance initiatives would help in developing these structures.
- Major finance alliances provided sustainable progress updates
We also saw big updates from major finance alliances. As anticipated, GFANZ published guidance for investors on how to develop net zero transition plans, which should help investors navigate how to arrive at net zero. In addition, the Net Zero Asset Managers Initiative (NZAM) grew to a membership of 291 organisations, totalling £46.5trn assets under management, 60% of whom had set targets to address portfolio emissions. The Net Zero Banking Alliance (NZBA), representing 40% of global banking assets, reported 90% of member banks had decarbonisation targets in place, had adopted a policy on coal/and or gas financing and had set targets to reduce emissions in one or both sectors.
What does this mean for investors?
- Investors can benefit from collaboration
Public and private investors will need increasingly to work together as collaboration is the cornerstone for progress on climate change challenges. This may include public-private partnerships, such as through development finance institutions, to secure more money, which benefits the fiscally-constrained public sector to address climate challenges. Private investors may be further incentivised to contribute as such partnerships offer increased diversification and benefit from public sector backing.
One interesting example announced days before the end of COP was a public-private partnership between the U.S, Japan, and private partners to mobilise £17 billion of finance to help Indonesia shut coal-fired power plants and steadily reduce its emissions from the power sector from an anticipated 2030 peak. The financing is expected to be split equally public and private investors. This form of collaboration is beneficial as it allows a) private investors to access innovative financing that matches their investment goals and b) public bodies to ensure they meet their climate targets.
- Innovation helps pave the way
It is obvious that radical progress in service of the 1.5 degree maximum objective will not come from the same approaches that brought us the climate crisis in the first place. Innovation is essential to create new forms of financial instruments that match investors’ goals with the demands for action. This means packaging finance in innovative ways that both caters to the interests of the communities where projects are established and to the investors financing them.
Investors can leverage existing innovative financing mechanisms such as green bonds, which are instruments where the proceeds are invested exclusively in projects that generate climate benefits. These are issued often by corporates or banks. As of 2022, there have been nearly £2 trillion in green bonds issued to date, a near 100-fold increase since 2012, meaning there are plenty of opportunities for impact-driven investors to access such financing.
There are also opportunities to develop new financial instruments. For example, the IMF outlined that environmental impact bonds, which work on a “pay-for-success” model, could finance adaptation building off the track record it has had with social impact bonds. Under this model, a private investor would provide the initial investment towards a public sector project, but the public sector would then purchase the project for an amount linked to the project’s sustainability performance. Private investors receive higher compensation with higher environmental performance – creating an attractive incentive.
- Transparency and accountability are necessary to drive progress
The progress shown by net zero finance alliances is a move in the right direction. However, research by ShareAction highlighted that only 16% of NZBA members had interim emissions targets in place and also criticised their limited use of science-based measures to showcase progress. The UN also urged GFANZ to maintain tighter climate standards to ensure that the progress claimed by investors is authentic and specific.
These two examples highlight the need for investors to eliminate greenwashing. Targets are only as good as the action behind them, so it is more important than ever that transparency and accountability follow suit.
With the responsible investment landscape growing in response to greater urgency to meet our climate needs, investors may find it difficult to keep track of what they can do to maximise opportunities and mitigate risks. Sancroft can work with you as a trusted partner in navigating the complexities best fit for your business. If you are interested to learn about how Sancroft can help you achieve your ESG and responsible investment ambitions, please contact Ilkka.Saarinen@sancroft.com or Judy.Kuszewski@sancroft.com.
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