COP26: Spotlight on the finance community
As COP26 approaches, attention focuses on the finance sector and their role at the summit.
By Kathy Grenville
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Ambitions for COP26 are high.
Five years on from the historic Paris Agreement, countries are obliged to review and ideally ratchet up their Nationally Determined Contributions (NDCs) to set us more firmly on the path to net zero by 2050.
While some countries including the UK, the EU Member States, Norway, and Chile have put forward net zero decarbonisation commitments, it is unlikely that the new set of NDCs will deliver the 1.5˚C trajectory in Glasgow.
Given this and given the important role it played in supporting Paris, the financial sector also needs to have a central role at COP26 in accelerating the transition to a low carbon economy.
This point was underlined at the official launch of the COP26 private finance agenda at the end of February. Mark Carney, outgoing Governor of the Bank of England, newly appointed UN Special Envoy for Climate Action and Finance and the Prime Minister’s Finance Adviser for COP26, set out the private finance strategy focused on a whole economy transformation.
The three Rs – Reporting, Risk Management and Returns
Reporting – a powerful catalyst for action and necessary input for climate risk management - is the first part of the five-point strategy.
The Task Force on Climate-related Financial Disclosure (TCFD) recommendations have become the standard framework for companies to disclose consistent and useful information on risks and opportunities.
However, while the percentage of companies disclosing climate-related information has increased, disclosure of scenario-based analysis is still limited, making full integration of forward-looking climate risks challenging for investors as we undertake our own scenario analysis. The intention to agree potential paths to mandatory reporting at domestic and international levels are therefore very welcome.
Reporting, and the availability of key data, also underpins the Risk Management pillar. Assessing the resilience of companies’ strategies to net zero transition through stress tests is central to navigating the low carbon transition.
Effective scenario analysis is not just a tool for managing climate risk but also a tool for mitigating climate risk. If used to re-direct capital to those companies delivering the actions we need for the low-carbon transition.
Given that nearly 50% of those surveyed by the TCFD said they were not using scenario-based analysis, either because there were no standard scenarios or assumptions or because the process was too complex or costly. The intention to develop open source, business-relevant reference scenarios for regulators, financial firms and businesses to test strategic resilience will be an important enabler.
The third ‘R’ is Returns. This includes enabling investors to make informed decisions on whether companies and portfolios are transition ready. While the focus may still be on risk management, evaluating the scale of the opportunity is just as important.
As Governor Carney outlined, ‘Every company, every bank, every insurer and investor will have to adjust their business model. This could turn an existential risk into the greatest commercial opportunity of our time.’
Harnessing the impact of development finance institutions and promoting innovative finance solutions, complete the five-point strategy.
Policy driving forward
Government action is essential to delivering this finance agenda and securing the whole economy transformation we need. Climate policy and regulation, alongside technology, have the potential to be the dominant drivers of the low carbon transition.
Alok Sharma MP, COP26 President and Secretary of State for Business, Energy and Industrial Strategy set out the government’s vision for COP26, highlighting the opportunities presented by a fair transition to a low carbon future.
The UK has already committed to a net zero target, however achieving this will require clear sector decarbonisation pathways, reflecting on the interconnectedness of, for example, our energy, mobility and industrial sectors.
It will also require a more joined-up approach to new policy and regulation across the wider economy. Imposing a ‘net zero test’ for new policies could provide the mechanism to help governments examine, on a case-by-case basis, what impact a new measure will have: negative, positive or neutral. This will help ensure all new policy measures support the transition.
An effective carbon price would also be helpful in terms of impacting the cost and therefore allocation of capital – but carbon pricing can be implicit, such as through minimum efficiency standards, as well as explicit.
A little less conversation… a little more action please
Throughout the event, there was a clear and welcome call to action to all those in the room. Investors support governments raising ambition towards net zero and delivering on the Paris Agreement.
But if we are to be successful, the public and private sectors will need to work together, with finance taking a central role in a whole economy transformation.
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