COP28 will come at a critical time following the recent conclusion of the IPCC’s report, which concluded that ‘the pace and scale of climate action are insufficient to tackle climate change’.
It is clear that progress remains insufficient; so, what could be done to allow the financial sector to effectively play its part in reaching net zero?
In 2015, the Paris Agreement acknowledged a vital piece of the puzzle by signalling the need to look at all finance (public and private, domestic and international) to ensure that it supports the transition to a low-greenhouse-gas-emission, climate-resilient world.
Significant progress has been achieved since, with many financial sector players making voluntary commitments to progressively implement net-zero methodologies across the assets they manage, and with the development of new regulatory tools aimed at supporting them in those efforts, including with the Green Deal from the European Union.
The challenge remains immense, in an increasingly complex geopolitical landscape. We have seen intense counter-lobbying from corporates, which has undermined progress on decarbonising the real economy.
The notion of fiduciary duty in this context has become more contentious amid political tensions in the US, and time horizons have become a key discussion point. While the financial impacts of climate change due to transition and physical risks are becoming increasingly obvious, support for shareholder proposals, including on environmental issues, has materially declined as part of the 2023 Annual General Meetings of several large North American corporations including in the oil and gas sector. Illustrating a fragmentation of the world, climate resolutions have seen increased support in the European Union during the last AGM season.
As a financial player committed to supporting climate progress, which we believe to be consistent with the long-term interests of investors, we are concerned about the direction of travel. If the financial sector can act as a powerful catalyst in the fight against climate change, it requires other key stakeholders to act simultaneously – with policymakers needing to continue to accelerate on the real economy policy side. If no progress is achieved there, the risk is that asset managers may be forced to invest in a narrower set of sectors to deliver on quantitative net-zero commitments and in the process lose influence over the decarbonisation pathways of the most heavily emitting companies. The result will be decarbonised portfolios without real-world decarbonisation.
COP28 is not going to be a silver bullet to these problems, but we would like to see greater momentum generated in two particular areas.
First, more action is neede to make meaningful headway on reducing emissions in the real economy. In 2023, the Inflation Reduction Act in the US, or the European Green Deal Industrial Plan have demonstrated that some progress is being made to incentivise the development of greener solutions. But much more ambition is needed to push companies away from ‘brown’ activities and to get them to define transition plans consistent with the goals of the Paris Agreement. That might be difficult politically, as the ESG backlash in both the US and EU shows, but it is urgently required to reduce the green premium faster.
Second, a clearer framework is needed to guide shareholder engagement and ensure it can effectively support the transition, with the proper processes, disclosures, and supervision to ensure it is sound enough. Shareholder engagement is key in delivering net-zero targets. Having such framework at EU level will be key and they could clarify what actually constitutes shareholder engagement; what represents sufficient transparency on those activities; what the governance behind it looks like; and what the escalation mechanisms involve when corporates fail to act with sufficient haste. It should also clarify that it relies on an obligation of means, not results.
The UK Stewardship Code could be a good model here. That has brought more consistency in terms of the expected outcomes from shareholder engagement, as well as greater transparency with an effective supervision from the Financial Reporting Council. There is no real equivalent framework at the EU level. Having more clarity around what is expected when it comes to stewardship and engagement can only deliver better, more consistent outcomes.
Policy action remains, however, vital.
Shareholder engagement can put pressure on corporates with transition strategies not robust or ambitious enough, but its likelihood of success is much greater when it is combined with incentives from policymakers.
The financial sector is an important catalyst in the race to net zero, but it cannot act alone. Our hope is that COP28 recognises this and, in a more complex environment that governments and policymakers continue to put in place the support required to help investors effect faster, more meaningful change.