Adapting to a more aggressive policy environment

global perspectives

Adapting to a more aggressive policy environment

Emma Cusworth - Head of Marketing Strategy

Emma Cusworth

Head of Marketing Strategy

Nobody can predict what is going to happen in the future. The one thing we can say with certainty is that things won’t be the same.

For one, we are likely to see a rapid increase in policy changes in the coming years. Take climate change, for example. Even if we manage to achieve all the pledges countries have currently made on reducing greenhouse gas emissions, we are still looking at 2.6°C to 3.2°C in global warming by the end of the century, according to independent research organisation Our World in Data. To get to where we need to be (well below 2°C based on the objective outlines in the Paris Agreement), we are going to have to bend the curve much faster.

 

Regulation: the “ratchet” effect

What does this mean? According to Carbon Brief, it’s likely to produce a stairway, or “ratchet mechanism” of regulatory action in the coming years. In 2020, for example, countries that have set targets for emissions reductions by 2025 will need to communicate their next round of pledges. Then, in 2023, the global stocktake built into the Paris Agreement process is likely to lead to another steep increase as nations realise more needs to be done (and as another administration inevitably enters the White House). The same process will then be repeated in 2025 and 2028. 
As a result, the regulatory wall is likely to be significantly higher by 2030 as the policy response becomes increasingly aggressive. 

 

Figure 1: The Paris “ratchet mechanism”

Paris-ratchet-effect-image-765px.jpg

Source: Carbon Brief, The Inevitable Policy Response: Act Now, PRI, September 2018

 

Resilience of business models

In the face of such a significant and forced change in their operating environment, many companies across many sectors are going to have to adapt. They are going to have to do so rapidly, or the resilience of many business models we know and invest in today will quickly come into question. We are already seeing this effect in today’s automobile market, for example. 
What about the “$22 trillion in sub-prime carbon assets”, as former US Vice President Al Gore calls them? He estimates that two thirds of fossil fuel assets currently marked on balance sheets will be unburnable as policy changes and the cost of renewables drops. If those assets cannot be used, investors are likely to realise that they are worthless, which may lead to a rapid repricing of energy assets.

 

Value, not values

So, what is the answer? We, as an investment community, need to get better at reflecting long-term structural trends in how we value companies if we want to ensure a speedy and low-cost transition to a more sustainable model.

How do we make that happen? A large part of this is about communication. The language around sustainable investment needs to become more inclusive for mainstream financial markets. Or, in the words of Rodrigo Garcia, Deputy State Treasurer and Chief Investment Officer at the Illinois State Treasury: “The message needs to be value driven, not values driven.”

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