15 December, 2021 / Opinion
Understanding COP26 pledges
By Nachu Chockalingham, senior credit portfolio manager, Federated Hermes
Federated Hermes' Nachu Chockalingham takes a closer look at the finance industry's commitments
The phrase ‘good COP, bad COP’ has been used extensively over the past two weeks to assess the recent Glasgow summit. The key positives were:
•net-zero commitments being set by some high-profile emerging market countries (India by 2070 and Russia and Saudi Arabia by 2060);
• a new methane pledge to cut emissions by 30% by 2030;
• a plan to end deforestation also by 2030;
• an agreement to end the use of coal (although not signed by India, China or the US); and
• various pledges in the transportation sector.
What is still not clear is how all these pledges will be funded, but we do know there will be greater need for both the public and private sectors to work closely together. Janet Yellen, the US treasury secretary, said: “The gap between what governments have and what the world needs is large, and the private sector needs to play a bigger role.”
The International Energy Agency believes there must be at least a $150trn (£111.6trn) spent over the next 30 years ($5trn a year) to achieve net zero. This will need to be funded from a variety of sources including government debt, corporate bond and loan issuance, and carbon taxes. We expect to see tougher US and EU rules on climate risk reporting shortly, which will help to channel more funds to areas that need it. Here’s where funding could come from:
It has been encouraging to see high-profile sovereign green bond deals from the EU and the UK attract record investor demand. The EU’s recently issued €12bn (£10.1bn) 15-year maturity green bond is the largest green bond issued to date and will help to finance member states’ environmentally beneficial projects.
This bond is the first in the EU’s €250bn programme of green bond sales earmarked for the coming years. We hope such interest is set to grow. It will represent a small portion of the overall funding needed, but collaborative action is crucial.
While, for now, it appears the EU is steering the way forward on the green transition with record financial commitments and regulatory change, it will only be a matter of time before such policies are more heavily replicated in the US and in emerging markets.
As more government loans and grants fall into some key sectors, notably energy, transportation, utilities and real estate, we would expect the cost of green capital to continue to fall. Such support provides assurance of the government’s long-term commitment to emerging green technologies, which reduces the risks associated with investing in them and in turn lowers hurdle rates, thus driving down the cost of capital.
As such, the ‘greenness’ of governments’ budgets, in particular the EU one for now, will unlock further opportunities in green financing, including the issuance of more green bonds, loans, asset-backed securities and sustainability-linked debt. This means the probability of simultaneously financing positive environmental change, while also creating economic value, is increasingly likely with the ‘greening’ of government budgets.
The Glasgow Financial Alliance for Net Zero will continue to drive capital away from heavy-polluting sectors and companies to those adapting their businesses for a low-carbon world. As a result, COP26 will continue to drive an ever-more nuanced marketplace – rewarding companies with a keen eye on climate-related risks and opportunities through the lens of governance, strategy and risk management.
Companies will face greater investor scrutiny on their climate disclosure, decarbonisation targets and pathways. As carbon metrics become better understood, so too will differentiation between corporates, financials and sovereigns, leaving active asset managers a wealth of opportunity to add value for their investors both financially and environmentally
Part of the Bonhill Group.