The global agreement on climate change signed last year in mid-December in Paris will determine the world’s response to this unprecedented challenge for decades to come. It was the historic agreement, the culmination of four years of tough talks, and of 20 years of ongoing negotiations, and there were clear risks that the meeting might fail. But while government delegations and ministers cheered, the implications of the accord were immediately the focus of investors and businesses around the world. They will be the ones to translate these high-level goals into actions. For investors, Paris was not the end-point but a beginning.
Even as the ink dried, new questions were being asked. How will the commitments, on emissions and temperature rises, be worked out in practice and in government policy? And how will this affect investment, and companies’ ability to manage the risks and opportunities of climate change and the low-carbon transition?
Lord Stern of Brentford, author of the landmark review of the economics of climate change, says businesses and financial institutions must start planning now, if they have not already begun to do so. “There is a clear signal here that they will have to follow”, he says. This means all businesses – not just those that may seem most obviously affected, such as the energy industries, but the entire private and public sectors, which must work out the implications of what a low-carbon transformation means for them.
It is important to note how much more robust the agreement reached was than many had feared it would be. Not only did it include economy-wide temperature goals and commitments on emissions but it was – unlike the partial agreement reached in Copenhagen in 2009 – passed under the United Nations process, with the consensus of all 196 countries present, under a legally binding framework. And the commitments that countries have made will be held to account every five years, ensuring that the world is on track to achieve these stated aims.
These factors greatly strengthened the Paris Accord in the eyes of the financial world, making the implications unignorable, according to Stephanie Pfeifer, ChiefExecutive of the Institutional Investors Group on Climate Change, which comprises 120 European investment companies with €13 trillion in funds under management.
She says, “Investors called on governments before and during COP 21 to provide an unequivocal signal sufficient to accelerate the low-carbon transition. By setting a long-term goal for net zero emissions in the second half of the century, and putting in place a five-year review cycle, this agreement provides an unequivocal signal for investors to help escalate the development of low-carbon infrastructure.”
Governments will have to work hard on policies and credible plans for meeting their new commitments on the climate. But investors cannot wait for those policies to be fully formed – a process that could take years – before examining the likely effects on their portfolios. Even before the Paris negotiations began, financial institutions were working on that, says Michael Wilkins, Managing Director of Infrastructure Finance and Head of Environmental Research at Standard & Poor’s rating service. “This is a growing area of investor interest, looking at exposure to fossil fuels especially, and now to decarbonisation”, he says. Owing in large part to the focus on the climate that the Paris meeting engendered, these issues have “come much further up the agenda” than previously. In February, Moody’s Investor Service said the new agreement could prompt the amount of bonds issued in 2016 to finance low-carbon projects to exceed $50 billion.
Some institutions, including pension funds, have come under pressure from activists and some shareholders to divest from fossil fuels. This is part of the emerging strategy of calculating climate risk for portfolios, based on their exposure to fossil fuels and to the policies that are likely to come from governments in future to encourage the move to a low-carbon economy.
Financial market regulators will also have a major role to play, if companies are to be forced to disclose how the need to decarbonise will affect them, adds Wilkins. “I think we will see more regulation on disclosing climate risk”, he says, but this could take years to put in place. “There is still a sense that the implications of transition regulation for the global economy due to climate change have not yet been fully digested.”
That will mean regulators grappling with issues of greenhouse gas emissions, the effects of climate change – such as droughts, floods, heatwaves, sea level rises and fiercer storms – and finding risk models and metrics for companies to follow, so that shareholders can make like-for-like comparisons. At present, some companies have their own risk calculations, but these are not necessarily consistent across sectors.
But given the speeds at which markets move today, few will be waiting for regulators to do the job for them. Across the financial sector in response to Paris, “change is likely to be swift”, says Donald MacDonald, trustee director of BTPS, the UK’s largest corporate pension scheme. He predicts that pension funds will be in the vanguard: “As pension funds recognise their fiduciary duty to address climate risk in all parts of their portfolios, they will, where necessary, reallocate investment away from high-carbon-related activity likely to destroy substantial shareholder value in a remarkably short time.”
Companies must be prepared for what this reallocation, spurred by the long-term nature of the Paris agreement, will mean for them.
Fiona Harvey is Environment Correspondent for the Guardian.
Image credit: United Nations Photo