Is ESG investment delivering on COP26 pledges?

While last year’s COP26 didn’t result in the firm commitments needed to meet the goals of the Paris Agreement, there were some successes – not least the promise by the recently established Glasgow Financial Alliance for Net Zero (GFANZ) to use USD 130 trillion of private capital to accelerate the transition to a net-zero economy.

But one year on, and with COP27 having kicked off, what progress has been made, and what more needs to be done – particularly by asset managers?

COP26: a brief recap

UN Climate Change Executive Secretary Patricia Espinosa reflected that COP26 “built a bridge between good intentions and measurable actions to lower emissions, increase resilience and provide much-needed finance”.

The theme of private capital was omnipresent throughout the conference, with parties recognising the vast amount of investment needed to drive decarbonisation. One of the biggest perceived successes was the announcement by GFANZ that USD 130 trillion of private capital from its members would be committed to accelerate the transition to net-zero.

Financing is not only necessary for reducing emissions but for adaptation as communities address the impacts of climate change that are already being felt. Adaptation moved up the agenda at COP26, with developed countries called upon to meet the original annual USD 100 billion pledge to support the most vulnerable countries made under the Paris Agreement.

There was also an agreement to move more quickly towards the implementation of the Paris Agreement by revisiting and strengthening the 2030 targets in countries’ nationally determined contributions (NDCs) by the end of 2022.

“GFANZ has made significant progress, particularly in terms of setting out expectations for real economy transition plans, and also in terms of the call for action on the mobilisation of finance for emerging markets." 

James Close, Head of Climate Change at NatWest

However, there was no agreement to phase out the use of coal – the wording used instead was to phase “down” its use. Avoiding coal is one of the key requirements for the target, to limit global warming to 1.5°C above pre-industrial levels, to be reached. The last-minute amendment is an example of the complexity of bringing nations from around the world together towards one goal and, on a micro-scale, demonstrates the importance of communication and collaboration across industries.

The climate crisis deepens

The scale of the climate crisis has been laid bare in 2022, making clear the need to press ahead with the commitments made at COP26. This year Europe sizzled through its hottest summer in 500 years, vast tracts of Pakistan have been submerged by huge floods, Cuba suffered days of complete blackout after Hurricane Ian and there have been severe forest fires around the world.

And it looks like the situation will get far worse. According to the UN, the world is currently on track for temperatures to rise by 3.2°C above pre-industrial averages by the end of the century, which would lead to far more destructive climate impacts than the 2°C rise that we are currently trying to avoid.  

Meanwhile, it was announced that global CO₂ emissions hit an all-time high in 2021, rising by 6% to 36.3 billion tonnes. Coal accounted for 40% of the overall increase in emissions as high natural gas prices resulted in companies and countries turning to coal to meet their energy needs.

But climate action takes a back seat

Despite this year’s extreme weather events and the good intentions laid out at COP26, global events have brought the challenges in meeting short-term needs and long-term commitments to the fore. Reduced gas supply to Europe has led to concerns about energy security and affordability – two sides of the energy trilemma – with the added fear of increased upwards inflationary pressure.

To meet their short-term energy needs, several European countries have responded by making greater use of liquefied natural gas, increasing oil and gas exploration and recommissioning coal-fired power plants – between January and August this year, the EU imported 35% more coal than over the same period in 2021.

Meanwhile, the spike in energy prices has forced governments across Europe to provide hundreds of billions in funding to protect households and businesses from rising energy prices. This means there is less money available to spend on reaching climate targets.

Problems at GFANZ

GFANZ’s promise that it would use the USD 130 trillion of assets that its members manage to achieve a net-zero economy by 2050 was one of the most heralded aspects of COP26. However, over the past year there have been allegations that despite its impressive pledges there has been a lack of climate action taken by some of its most prominent members.

This year Race to Zero, a global campaign to build momentum towards a decarbonised economy, imposed a rule stating that GFANZ members would not be able to finance any more coal or unabated oil and gas projects, and that they would have to reduce portfolio emissions. This led to two major pension funds leaving the alliance, claiming that they did not have the necessary resources to remain involved. At the time of writing, there is speculation that three major US banks – JP Morgan, Morgan Stanley and Bank of America – will leave, and a number of unnamed Canadian banks are also threatening to leave due to legal concerns.

So was GFANZ merely a marketing tool? James Close, Head of Climate Change at NatWest, doesn’t think so: “GFANZ has made significant progress, particularly in terms of setting out expectations for real economy transition plans, and also in terms of the call for action on the mobilisation of finance for emerging markets. There’s still a lot to do to live up to the ambitions set out in Glasgow, but some of the tensions we’ve seen show GFANZ is more than just a marketing tool – it has a meaning and people are thinking carefully about the commitments they’re making”.

Why isn’t the world making faster progress towards net zero?

It’s clear that the world is moving too slowly towards decarbonisation. One reason for this is not enough private capital is being channelled into investments making a positive impact: Swiss Re has calculated that over USD 270 trillion needs to be invested in climate solutions if the world is to meet its 2050 net-zero targets.

This might seem strange from an investment perspective as there’s lots of news about how asset owners and managers alike are increasingly turning to ESG strategies. In fact, a recent report from PwC stated that assets under management in ESG-related strategies are forecast to increase from USD 18.4 trillion in 2021 to USD 33.9 trillion by 2026, by which time they will account for 21.5% of total assets under management.

But do these ESG strategies do enough? MSCI defines ESG investing as‘the consideration of environmental, social and governance factors alongside financial factors in the decision-making process’. However, integrating ESG risks and opportunities is quite different to adopting an impact investment approach, which aims to allocate capital to support positive social or environmental benefits. Impact strategies account for a far smaller proportion of assets under management, so intentionality will be vital in the adoption of ESG across the investment community.

Backing this up, a recent study by investment consultant XPS Pensions Group found that while 81% of asset managers support the Net Zero Asset Managers Initiative, only 22% have credible plans in place to support their net-zero commitments.

Another problem is greenwashing. There’s growing concern that some asset managers are responding to investors’ rapidly increasing appetite for responsible investment strategies by making misleading claims about their products’ sustainability credentials. It has also been suggested that some asset managers have been cherry-picking data to back up their claims about moving to net-zero portfolios.

How can we get around the issue of greenwashing? According to James Close, “First, reporting must be transparent so that we can hold asset managers to account. Second, we need more standardised, better-quality data so we can evaluate whether firms’ decisions are consistent with their sustainability aims. But fund managers mustn’t use bad data as an excuse – perfectionism can’t be the enemy of progress”.

Where do we go from here?

COP27 has begun, with a focus on implementation finance and how developed countries can provide loss and damage financing to the countries that are worst affected by climate change. However, there’s still lots of work to do to make good on the promises made at COP26.

2022 has identified many of the challenges involved in delivering a just transition at pace, and how the industry and countries respond to obstacles will be vital for success – for example, the current focus on energy security might actually accelerate the decarbonisation of the grid. It’s important that the world picks up the pace from here. As James Close puts it, “The opportunity is there to be ambitious as possible. It’s great to see asset owners like Aviva commit to 2040 net zero targets as it signals there are things we can already do to get ahead of the game. The more we do now, the greater the benefits in the future”.