SOURCE: Old MutualDESCRIPTION:
Part One: By, Jon Duncan, Head of Responsible Investment, Old Mutual Investment Group
Who would want to argue with NASA when they say this about climate change?
“97% of climate scientists agree that climate warming trends over the past century are very likely due to human activities, and most of the leading scientific organizations worldwide have issued public statements endorsing this position.”
Yet, some members of the global investment community still debate whether or not the continued burning of fossil fuels is safe for long-term, stable economic growth. At Old Mutual Investment Group, we believe we should defer to the climate experts and assess the associated long-term risks and rewards in order to achieve an appropriate risk-adjusted return on capital.
The issues that are important for investors to consider in respect of climate change include: the current state of intergovernmental negotiations; its long-term physical impacts; the likelihood of assets becoming stranded; the emergence of new technologies and opportunities; current market responses; and, importantly, the timeframes over which these might occur.
This is a brief exploration of how these issues may inform the macrothematic economic outlook, along with more sector- and stock-specific calls.
COP21: SOME BACKGROUND
From 30 November to 11 December 2015, Paris is hosting the 21st meeting of the Conference of the Parties (COP). The goal for COP21 is to set a globally binding agreement that maps out the process for global greenhouse gas (GHG) emissions management from 2020 onwards. Much is at stake – regional geopolitics; access to fossil fuel reserves; economic growth prospects; access to finance; and the costs of managing the biophysical impacts of a changing climate.
An important political dimension to the negotiation process is the concept of ‘common but differentiated responsibilities’ (CDR) between developed and developing nations. This concept acknowledges that developed countries are responsible for the bulk of historical emissions, and is used as the basis for developing countries taking action to reduce emissions, conditional on both financial and technological support from developed countries.
The establishment of the Green Climate Fund is touted as the financial smoothing mechanism for CDR, with a proposed US$100 billion in finance to be made available annually by 2020. The problems are that, so far, only modest pledges have been made by developed countries, and that the governance and distribution mechanisms of the Fund are still nascent. However, we believe that over time, the Fund will become an important component for driving the development of climate-resilient infrastructure in Africa. Some leading infrastructure players are already putting in the effort to become accredited developers, and are working with the relevant authorities to formulate readiness plans.
THE WEIGHT OF IMPACT
In the run-up to COP21, over 140 countries submitted their post-2020 emission reduction plans in the form of Intended Nationally Determined Contributions (INDCs).
Several agencies have analysed the submissions and the initial findings are that it looks like collective efforts could save up to four gigatonnes (Gt) of GHG emissions a year, but this falls short of what is required by science. OXFAM ’s October 2015 report, Fair Shares: A Civil Society Equity Review of INDCs, indicates that the current global commitment will probably fail to keep temperatures below two degrees Celsius (2°C), and that it is more likely that we are on track for 3°C of warming.
The physical implications of a changing climate are not lost on the financial services sector, especially reinsurance firms who are working actively to recalibrate
their disaster risk models. This year, Mercer revised their 2011 Climate Risk study with updated data and models. The study aims to understand:
• How big a risk/return impact climate change could have on a portfolio, and when this might take effect.
• The key downside risks and upside opportunities, and how to manage these considerations to fit within a current investment process.
• What can investors do to be best positioned for resilience to climate change.
The core findings of the research indicate that investors need to view climate change impacts as a new return variable, and that sector impacts will be the most meaningful. Climate policy aside, the report highlights how important it is that investors come to understand the long-range physical impacts of a changing climate.
A valid question is: What can we expect from Paris and why is it important for investors? While expectations are high for a truly global binding agreement to emerge, the reality is that we are still some years away from this, and what we are likely to end up with is a loose piece of text that paves the way for more detailed negotiations.
What the Paris meeting has yielded through the INDC submission deadline, is some insight into how countries are planning to decarbonise their respective long-term growth plans. This is significant in that it evidences that the tilt for capital allocation will be away from carbon-intensive plans towards those that facilitate a transition to a mixed-energy economy. In addition, it appears that businesses now understand that waiting for governments to define a legally binding agreement, and to agree on a global carbon price, is no longer viable.
Rather, leading businesses are working to understand the scale of the related risks and opportunities. This results in a more multifaceted approach which, when set alongside the pace of technological change in the energy sector, changing social norms, and emergent political leadership, means that business leaders are now increasingly positioning their capital allocation initiatives towards a low-carbon economic outcome. These developments bring the idea of a low-carbon future into clear view.
Click here to read Part Two: COP21 and the Effects of Carbon on an Investment Portfolio
Old Mutual Investment Group (Pty) Limited (Reg No 1993/003023/07) is a licensed financial services provider, FSP 604, approved by the Registrar of Financial Services Providers (www.fsb.co.za) to provide intermediary services and advice in terms of the Financial Advisory and Intermediary Services Act 37 of 2002.
 The United Nations Framework Convention on Climate Change (UNFCCC) emerged concurrently with the historic 1992 Earth Summit in Rio. It is an international treaty addressing climate change in a global context. The Conference of the Parties (COP) is the governing body of the UNFCCC, and convenes 196 (as at 31 March 2014) member states to discuss how to mitigate the effects of anthropogenic (human-caused) global warming.
KEYWORDS: Environment and Climate Change, Finance & Socially Responsible Investment, old mutual, COP21 paris, Jon Duncan, investment portfolios