Implications of COP26 for Alternative Asset Managers

“The old, carbon-burning model of development is a death sentence for our economies and for our planet”

In August 2021, the IPCC’s Sixth Assessment Report laid bare the realities of climate change.¹ The report highlighted how atmospheric CO2 concentrations are higher than at any time in at least 2 million years, while the last five years have been the hottest on record.

Against this backdrop, COP26 was tasked with averting the worst consequences of climate change by securing net zero emissions by mid-century to keep global temperature increases to 1.5C compared with pre-industrial levels. As UN Secretary-General, Antonio Guterres, said ahead of the summit’s opening, “the old, carbon-burning model of development is a death sentence for our economies and for our planet”.

The four core goals of COP26 focused on mitigating climate change, boosting adaptation efforts, mobilising climate finance and increasing global harmonisation. While announcements at the conference signalled progress, notably the inclusion of wording around fossil fuels for the first time in the Glasgow Climate Pact, estimates suggest that we are still on a path of warming of between 1.8C-2.4C.²

Nonetheless, COP26 has played a significant part in highlighting the role that governments and investors will have to play if we are to get anywhere near to achieving our climate ambitions. I see four areas as particularly relevant for investors:

1. UK climate transition plans

The UK Government announced its ambition for the UK to be the world’s first net zero-aligned financial centre. Asset managers, regulated asset owners and listed companies will have to publish climate transition plans that “consider the government’s net zero commitment or provide an explanation if they have not done so.”

Firm-level net zero commitments are not mandatory but will be underpinned by a Transition Plan Taskforce with the ultimate aim of encouraging the allocation of capital to support net zero.

If implemented effectively, I see this playing an important role in allocating capital to sustainable investments and helping to bridge the estimated £50 billion low carbon investment gap for the UK to achieve its climate ambitions.³

The plan should support large financial institutions such as pension funds to invest sustainably by placing further scrutiny on how their asset managers’ investments align with their transition plans. The effective implementation of a Transition Plan Taskforce should bring greater legitimacy to climate transition plans, ultimately leading to more robust and reliable data and reporting.

For alternative asset managers that provide the infrastructure necessary to deliver significant carbon reductions, the multi-year time horizon of this policy should give allocators of capital the regulatory certainty required to invest in these solutions. Longer term, the government intends to move towards making the publication of transition plans mandatory, creating clear winners and losers from an investment perspective between those assets that support the transition to net zero and those that do not.

2. Sustainability reporting consolidation

The formation of the IFRS International Sustainability Standards Board (ISSB) represents a significant step forward in establishing standardised sustainability reporting.

Data availability is widely cited as the biggest challenge to ESG investing.⁴ These challenges are even more profound for alternative asset managers whose assets are typically illiquid and heterogeneous. Until now managers have had to assess which of the myriad sustainability reporting frameworks to report against, taking into consideration the unique nature of each asset and the interoperability of these standards with upcoming sustainable finance disclosure regulation.

As a result, the reporting requirements for alternative asset managers has until now been onerous, requiring significant internal resource and often resulting in data that lack comparability across asset classes.

The ISSB has been formed with the intention to facilitate comparability of sustainability data while also consolidating existing standards such as the Task Force on Climate-Related Financial Disclosures (TCFD) and Value Reporting Foundation (formerly Sustainability Accounting Standards Board, SASB). Their initial focus will be on climate change before expanding the standards to other sustainability factors.

This is a very welcome breakthrough. The successful establishment of a single global baseline language for sustainability reporting should aid asset managers in their reporting processes internally. Furthermore, asset managers can begin to include these baseline, mandatory metrics in contracts with suppliers and investee companies for the ultimate benefit of investors and society more broadly.

Over time, the quality of this data should improve, allowing asset managers to better measure the environmental and social outputs of their investments, and allowing investors to, more easily compare the sustainability performance of their asset managers.

Prototype climate and general disclosure requirements were published in November 2021, and IFRS intends to issue its first climate disclosure standards next year.

3. Glasgow Financial Alliance for Net Zero

Finance Day at COP26 brought the announcement that the Glasgow Financial Alliance for Net Zero (GFANZ), launched in April 2021, now represents over 450 major financial institutions from across 45 countries, controlling assets of over $130 trillion. GFANZ members are required to:

• Reach net zero across all emissions scopes by 2050;
• Set 2030 interim targets that represent “a fair share” of the 50% emissions reductions required; and
• Set and publish a net-zero transition strategy.

Given the scale of the challenge ahead – estimates suggest as much as $150 trillion is required over the next three decades to ensure an orderly transition to net zero – this initiative represents a laudable attempt to mobilise significant sums of private capital for sustainable outcomes.⁵

The alliance will engage and work with industries to develop “sectoral pathways” to achieving net zero emissions, while also committing signatories to making TCFD disclosures, climate stress-testing and science-based transition plans.

Despite this, given the scale of the initiative and the length of the time horizon suggested, there is the risk that action is pushed out beyond the terms of current management teams, delaying genuine decarbonisation while financed emissions continue to increase. In addition, the coalition includes some of the world’s most significant financiers of fossil fuels, many of whom have not disclosed plans to either reduce or decarbonise these investments.

Signatories have two to three years to set their net zero plan. That is significant given estimates suggest that the earth has less than 11 years left if it is to reduce carbon such that it limits global warming to 1.5C. Change cannot all happen close to the 2030 deadline, emission reductions need to happen progressively and the initial first step has to be on preventing emissions from rising.

4. Institutions with over $8.7tn in AUM vow to stop financing deforestation

Deforestation was central to the debate at COP26. As part of Nature Day, 33 major financial institutions with more than $8.7 trillion in AUM committed to stop financing deforestation driven by agricultural commodities by 2025. Furthermore, more than 100 world leaders promised to end and reverse deforestation by 2030, pledging £14bn of public and private funds.

The announcement mirrors previous voluntary deforestation pledges such as the 2014 New York Declaration of Forests, which also committed to end deforestation by 2030 and halve forest destruction by 2020. Despite this, in 2020-21, deforestation increased in the Amazon by 22%, with a forest area the size of the UK being lost each year globally.⁶

Ending deforestation is a crucial part of avoiding the worst effects of climate change. Deforestation announcements at COP26, alongside other measures such as agricultural policy reform and investment in agriculture innovations will place greater scrutiny on the impact of nations and corporations on nature, while also incentivising solutions to natural capital restoration.

Alternative asset managers can play a significant role in increasing the supply of sustainable timber elsewhere in the world through investments in sustainable forestry, reducing demands on precious ecosystems such as the Amazon. Perhaps one of the most important legacies of COP26 could be in mobilising greater levels of investment towards activities that prevent deforestation. This includes sustainable forestry and alternative agricultural practices such as the production of alternative proteins that reduce reliance on importing food from regions at high risk of deforestation.

Nations will now review their commitments ahead of COP27 in Egypt with the intention to “keep 1.5C alive”. With that figure still far from reach, COP26 commitments from nations and organisations must not just be kept, but also act as a springboard upon which ambitions are raised in the immediate future. This includes the private sector which must now step up to ensure capital is allocated to investments that benefit both people and planet.

^{[1] AR6 Climate Change 2021: The Physical Science Basis — IPCC
[2] COP26 conclusion (europa.eu)
[3] The-Sixth-Carbon-Budget-The-UKs-path-to-Net-Zero.pdf (theccc.org.uk)
[4] See, for example, EY survey Why data remains the biggest ESG investing challenge for asset managers | EY – Global
[5] Based on range of estimates for 1.5 degrees C aligned net-zero scenarios from IEA, NGFS, IRENA and BloombergNEF. GFANZ-Progress-Report.pdf (bbhub.io)
[6] Brazil: Amazon sees worst deforestation levels in 15 years – BBC News; World losing area of forest the size of the UK each year, report finds | Deforestation | The Guardian}

All views expressed are those of Jonathan Walker, Sustainable Investment Manager, and the Sustainable Investment team.

Jonathan Walker
Sustainable Investment Manager

Jonathan joined Gresham House as Sustainable Investment Manager in August 2021. Before joining Gresham House, Jonathan worked at Morgan Stanley for six years, most recently as a research analyst within the Sustainability Research team ranked number one for SRI research in the 2020 European Institutional Investor survey. His primary areas of focus included cross-sector sustainability research and European sustainable finance regulation, as well as working closely with the firm’s institutional clients on incorporating ESG into their investment processes. Prior to this Jonathan worked as a stock-covering analyst in Morgan Stanley’s Property Research team with particular focus on pan-European industrial and logistics property. He started his career as a European equity trader. Jonathan holds a first-class degree in English Literature from the University of Bristol and is a CFA charter holder.