What was achieved at COP26?

Freddie Woolfe, Equities Analyst, Sustainable Investing, reviews what was and wasn’t achieved at the UN’s COP 26 climate summit and the implications for the market.


A key focus for Glasgow was the emissions gaps between current climate policies and country level commitments and the goal of limiting global warming to 1.5 degrees Celsius above pre-industrial levels.


Emissions must fall by 45% by 2030 from the 2010 baseline, whereas existing commitments would increase them by 13.7%. On a temperature basis, current policies are consistent with temperature increases of 2.6-2.7 degrees, with current binding pledges taking that trajectory down to 2.1 degrees.


But importantly, the full set of long-term country level net-zero targets would, if met, get the world to 1.8 degrees. The key therefore is the deliverability and the irreversibility of these targets.


Climate policy pressure increasing


We have long maintained that this decade is key for climate policy development to secure a 1.5 degrees pathway. At the negotiations there was significant emphasis on the emission gap to reach 2030 targets, and the need to get the emission trajectory down significantly. Countries are also being asked to return with updated, more ambitious targets next year, suggesting pressure is ratcheting up significantly in line with the rapidly evolving civil and political focus on the environment.


Co-operation has also been a key theme of the negotiations, with China and the US, the two largest emitters, reiterating their intention to co-operate on climate action, which could be a real game changer.


This increased impetus highlights the evolving risks for those companies that are not aligned with delivering net zero by 2050 but also the opportunities for those that are leading the transition both in how they operate and in how they can help others to decarbonise through their products and services.


Internalising environmental costs


We are strong advocates of financial markets pricing in environmental externalities to direct capital flows in support of real-world decarbonisation. Good progress was made on addressing outstanding points around Article 6 of the Paris Agreement, setting the structure for international carbon offsetting, which ultimately should result in a more coordinated global and effective carbon pricing mechanism. Pleasingly, the scheme will reduce the number of new credits in the market over time; this should play a key role in providing additional incentives to decarbonise as well as offering a global business model for nature-based solutions.


Reducing major drivers of carbon emissions


Another widely noted outcome was the introduction of text in the final agreement on fossil fuel subsidies and coal. There has been much discussion about how this wording was diluted from the initial ambitions, but we mustn’t ignore the progress in even referencing these carbon sources in the text as currently governments plan on producing twice as many fossil fuels as is compatible with the 1.5 degrees carbon budget. We expect this ambition to ramp up over time. Interestingly, during COP Goldman Sachs released its research that the difference in cost of capital between hydrocarbon and renewable projects has widened by over 10 percentage points in the last five years, suggesting the market is aware of the impact of the low carbon transition on these industries.


Important progress was also made on deforestation, with more than 130 countries including Brazil and Indonesia committing to end and reverse deforestation, a major driver of carbon emissions, by 2030. Methane was also a big focus, with over 100 countries pledging to cut methane emissions by 30% by 2030 against the 2020 baseline. This is particularly important as methane has 80 times the warming power of carbon.


A just transition


For the first time the just transition was baked into the agreement, acknowledging the importance of equity in the way that the burden of addressing climate change is spread and making sure that climate policies do not exacerbate the inequalities. It was, however, disappointing that while compensating vulnerable nations for loss and damage caused by climate change has started to enter the dialogue, no further commitments were made on financing by richer nations to lower-income countries.


COP 26 didn’t deliver everything, but a lot of progress was made. The trajectory toward firmer more coordinated climate action is clear. The time frame for achieving this has sped up significantly. We are not yet on the path for 1.5 degrees, but we have significantly increased the momentum behind it. Next year’s negotiations will be important to continue ratcheting up the pressure ahead of the next global stocktake of carbon emissions in 2023.


The imperative for the market to internalise carbon emissions and other environmental issues into the approach to evaluating and valuing companies has never been higher, which we believe creates some exciting investment opportunities in those companies leading the transition to a more sustainable world.


Is a door opening for US-China trade?

Nick Payne, Head of Strategy, Global Emerging Markets Focus, debates whether we could see some movement in US-China trade tariffs, and discusses recent regulatory developments in China.


Joe Biden and Xi Jinping held their first virtual summit last week; while there were no major announcements, the fact it took place could be viewed as a potential positive. Biden and Xi discussed the usual difficult issues, but in terms of more positive takeaways, could a door be opening for tariff negotiations?


Trade tariffs don’t suit either side here; they’re very inflationary and regressive, like a tax on the consumer. JPMorgan data indicates that since tariffs were enforced in 2018, they have cost US consumers almost $130bn, and as much as $45bn year to date. That equates to an effective annual drag of $1500 per US household.


Against a backdrop of unwinding pandemic-era stimulus and higher inflation, tariff negotiations could provide some relief for US consumers, which may appeal more to Biden given US midterm elections next year. It could open the door to better strategic cooperation and competition between the two nations. However, Biden is still walking a tightrope between not wanting to be seen as too soft on China, versus getting rid of something that was from Trump’s era and doesn’t help the US. Is either side brave enough to move?


A more constructive environment has helped in other areas too. For example, the announcement at the COP26 summit which the US and China effectively brokered resulted from some back-channel diplomacy.


Elsewhere in China, there have been some developments in the property sector. While our general views haven’t changed, it appears that the government is going to pursue these regulations with greater vigour than we and the market might have originally thought. The government has proposed some adjustments in terms of its three red line policy (the specific balance sheet conditions developers must meet if they want to take on more debt) relating to debt that can be taken on for M&A purposes. This effectively allows state-owned enterprises that are in good shape to take on debt to begin the clean-up of distressed assets. These are more subtle adjustments than full reserve requirement or interest rate cuts, and we’ve seen some consumer-level tweaks too, in terms of stimulation of mortgage lending.


After a difficult year for Chinese equities, looking to 2022, some movement in terms of US-China trade tariffs, along with an easing of some of this year’s regulatory pain, would be very supportive, especially if accompanied by likely loosening from China while the rest of the world moves to tighten.


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