COP26:Building a Private Finance System for Net Zero

The transition to Net Zero is creating the greatest commercial opportunity of our age, argues Mark Carney, UN Special Envoy for Climate Action and Finance and the Prime Minister’s Finance Adviser for COP26.

Globally, the benefits of shifting to a low -carbon pathway are estimated at $26 trillion by 2030 compared to our current high-carbon pathway. But shifting the global energy system towards a well- below 2°C pathway requires a significant redirection of global investment flows. The scale of the investment opportunity is significant, with commensurate returns for those that back the technology and infrastructure of a zero- carbon future. Over the next three decades, the total required investments in the energy sector alone will be $3.5 trillion per year, while almost $50-135 billion per year will need to flow to carbon capture and biofuel technology.

Research and development of new technologies offer a prospect of high returns; doubling of investments in this area could generate returns of $20 billion per annum. Specific regions offer enormous opportunities: Eastern Europe, Central Asia, the Middle East, and North Africa could support up to $1 trillion in climate-related investments.

More than 6 billion people will live in urban areas and 400  million homes are expected to be built in the next decade which will require green technology and infrastructure to align with a net zero, resilient transition. This is not only a huge opportunity for investors, but also a way for countries to attract international capital and build back better and greener from COVID.

  • All companies will adjust business models to align with net zero pathways.
  • Value will be driven by identifying the leaders and laggards, as well as the most important general-purpose technologies that will overcome choke points in the transition.

To identify these opportunities and assess the transition readiness of companies, the financial sector needs information on scientifically feasible transition paths by sector. This information will help expose which companies will seize the opportunities in the transition to a net zero world and which will cease to exist.

Right frameworks

Despite major progress in recent years, more is required to build the right frameworks for the private sector to do what it does best: allocate capital to manage risks and seize opportunities.

Ultimately, the speed with which the new sustainable financial system develops will be decided by the ambitions of governments’ climate policies. Governments can reinforce the efforts in the private sector by setting clear and credible climate policies, which will provide more certainty to the market, crowd in private investment and ensure that private financial markets pull forward adjustments from the future. This will minimise costs and smooth adjustments.

The significant private, voluntary momentum in recent years is welcome, but it needs global coordination to agree the core frameworks for reporting climate risks and opportunities, and for assessing transition alignment of both users and suppliers of capital. There are multiple standards (for example there are over 1,000 ESG metrics), which can lead to confusion, indecision and greenwashing. The public sector has a clear coordinating role to harness the energy of the private sector and a set of common standards in reporting, risk management and measuring return.

Building a private financial system for net zero

Listed companies in countries with net zero targets will increasingly need to:

  • Set targets for net zero (including Scope 1,2 and 3 emissions);
  • Publish comprehensive and credible transition plans for achieving these targets;
  • Set short-term milestones for investors to monitor progress against these plans; and
  • Detail governance of these plans, including how effective board oversight is ensured and how compensation is tied to their achievement.

The window for action is finite. Sustainable financing is moving mainstream, but the world is still collectively well behind the curve. As one illustration, estimates from Japan’s GPIF (the world’s largest pension fund) suggests that the assets it holds shows that temperatures are on track to rise more than 3 degrees from pre-industrial levels across most asset classes.

Public expectations are running ahead of action. In the absence of a clear, positive, targeted and coordinated agenda, demands will grow for simplistic solutions such as wholesale divestment and protectionism that will undermine a smooth transition and fail to achieve our climate goals. As one illustration of this, in 2020, AXA calculated the emissions of its 2019 investment portfolio (corporate debt, equities and sovereign debt) and the implied contribution to global temperature increases, and found that, even post divestment of coal and oil sands, the portfolio contributed to 2.8 degrees of warming, significantly above the 2 degree target.

Finally, international private financial flows to emerging and developing countries are still limited but are critical to supporting the transition in these countries.

The benefits of improving reporting, risk management and return measures in advanced economies will also accrue to emerging and developing economies. Reporting emissions and conducting scenario analysis on a Scope 3 basis will create incentives to invest to decarbonise across the supply chain, including in developing countries. And companies will increasingly need to show how they plan to meet their net zero targets, and the role of offsets as they make the transition.

The above is an extract from Mark Carney’s seminal report, BUILDING A PRIVATE FINANCE SYSTEM FOR NET ZERO Priorities for private finance for COP26. To read the full report click here.

More than 6 billion people will live in urban areas and 400  million homes are expected to be built in the next decade which will require green technology and infrastructure to align with a net zero, resilient transition. This is not only a huge opportunity for investors, but also a way for countries to attract international capital and build back better and greener from COVID.

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