investment insights

    A fair COP – Deep-dive into five areas for progress

    A fair COP – Deep-dive into five areas for progress
    Stéphane Monier - Chief Investment Officer<br/> Lombard Odier Private Bank

    Stéphane Monier

    Chief Investment Officer
    Lombard Odier Private Bank

    Key takeaways

    • Translating net-zero targets into action is tricky. The airline industry illustrates the challenges. Sweden has made good progress in reducing emissions, Iceland in carbon capture
    • The current energy crunch shows how destabilising the transition from fossil fuels could be, and the need for careful management
    • COP26 is a unique opportunity to advance a fair, global carbon price
    • We would welcome the adoption of the TCFD’s recommendations globally. Mandatory reporting of climate-related risk – as for large UK pension funds – and moves by central banks to consider climate risks in their collateral and monetary policy, should be expanded
    • Putting a fair price on the use of natural resources, and expanding the role of nature in capturing carbon emissions, are under-explored areas in the net-zero transition

    In the remaining days before COP26, we explore five areas for progress at the climate talks: moving from net-zero targets to reality, the shift away from oil and gas, pricing carbon fairly, agreeing common investment frameworks and harnessing nature as our net-zero ally.


    Priority 1: Moving from net-zero targets to reality

    This October, global airlines committed to reaching net-zero emissions by 20501, an important step for one of the world’s toughest industries to decarbonise. Yet the move from a pledge to a plan of action is vague at best. The International Air Transport Association’s roadmap relies on the use of nascent technologies (e.g. electric and hydrogen aircraft), 65% of emissions reductions from using sustainable fuels (where annual demand would exceed current supply by a factor of around 4500), and the balance from carbon offsets. Yet far from being unique, airlines’ challenges reflect many of the same issues faced by other industries worldwide: the difficulty in translating net-zero targets into net-zero action. For investors, progress here would be a crucial outcome from COP26.

    Close to 80% of the global economy is now covered by net-zero targets

    By our estimates, close to 80% of the global economy is now covered by net-zero targets, implying optimism on reaching the Paris Agreement goals to limit future global warming to 1.5°C (see chart). Yet we lack clarity on the strategy and action plans - including policy guidance and detailed industry strategies – to get there. The latest report2 published by the Intergovernmental Panel on Climate Change (IPCC) in August 2021 estimates we could reach already 1.5°C by 2030. By our calculations, the implied temperature rise of the companies comprising the MSCI World Index is 2.9°C. This makes it hard for investors to allocate capital at scale with a net-zero mind-set. 

    Much of the focus at COP26 will be on countries’ plans of action. Here, progress is uneven, dependent on the level of development, fossil fuel dependence, and exposure to the physical risks of climate change, among many other factors. Developing countries argue they should not face the same pressures and timelines as developed ones. In our view, key priorities at COP26 will be setting credible interim targets for emissions reductions and frontloading these, locking in green recovery packages and infrastructure plans (including public/private partnerships), better guidance on the policy direction chosen in the pursuit of net zero, and the regulatory backing to reinforce these ambitions. The journey to net zero encompasses a combination of emission reductions, and high-quality carbon offsets. We believe the focus should be on the former, with offsetting shifted towards long-term carbon removal. Sweden’s progress on the former has been impressive, with the country now committed by law to reaching net zero by 2045, having exceeded its 2020 renewable energy targets eight years early. Iceland has made good progress on the latter, including via the world’s largest facility to take CO2 out of the air and turn it into rock3.

    In our view, a planned adaptation and asset repricing – with public and private sectors working together – is vital to help avoid sudden shocks that would damage industries, governments and investors alike. With the vast commercial opportunities, and risks, of the climate transition in mind, many companies have now made net-zero pledges (see chart). Taking COP26 as a catalyst, we would urge more to set science-based targets, helping investors make informed decisions on corporate trajectories. Policy action can help ratchet up pressures, creating a virtuous circle, as they did for electric vehicles (EVs). Market forces are the driving factor behind EV adoption: costs could reach price parity with petrol or diesel alternatives in the next five years, Bloomberg research suggests, spurred by plunging battery costs. But future bans on petrol car sales, government R&D funding and EV subsidies are also an important driver. In the coal industry too, market forces are driving change (solar energy, for example, is now cheaper than coal), with the move accelerated by government-mandated curbs on emissions, the sale of coal, and the building of coal-fired power stations.


    Priority 2: The move away from oil and gas

    Gas and oil prices’ rollercoaster ride has shaken markets, underlining the challenges the global economy faces in weaning itself off fossil fuel dependence, and how potentially destabilising the transition could be. Addressing this issue is a top priority at COP26.

    Recent energy prices spikes have been sparked by supply bottlenecks and a sharp recovery in post-pandemic demand. But a structural shift is also at play, as countries move away from coal and oil, towards natural gas as a cleaner ‘bridging’ alternative in the shift to renewables. Yet a greater reliance on gas in the energy mix likely means accepting greater price volatility ahead. Unlike oil, there is no global cartel controlling supply and smoothing prices, and bringing fresh gas supplies online can take years. This conundrum is just one example of how managing the tectonic shift away from fossil fuel reliance – and doing so in a way that does not destabilise the global economy – is a profound challenge.

    Renewables should supply 90% of our energy needs by 2050

    By 2050, renewables should supply 90% of our energy needs, estimates the International Energy Agency4 (see chart). Today, fossil fuels supply almost that much. Removing fossil fuel subsidies is an urgent priority for policymakers worldwide. The IMF estimates no single country prices all its fuels to accurately reflect their full supply and environmental costs5. In many countries, removing subsidies may mean reordering the social safety net, perhaps by taxing fossil fuels and redistributing the profits to the most vulnerable. In Europe, proposals to broaden carbon taxes have faced opposition from parties concerned about widening fuel poverty6. Honesty at COP26 about the scale of the change needed is vital. We risk an environmental backlash if consumers feel they are being charged for the transition by the backdoor.




    Another priority is to provide price incentives for new technologies, to spur private sector solutions. COP26 is a huge opportunity to share best practice and strike new deals on public/private partnerships (PPPs) to help de-risk investments and finance the shift. PPPs can mobilise resources for large infrastructure investments including clean hydrogen and energy storage. PPPs are already at work to good effect. In southeast Europe, the Green for Growth Fund7 provides loans and refinancing for energy efficient improvements to businesses and domestic buildings. Risk-sharing between banks, international donors and private investors allows the latter to provide relatively low-risk financing, leading to an estimated one million tonnes of CO2 reduction to date. By building green criteria into public sector procurement, governments can also act as ‘first customers’ to support innovation, including for smaller firms bringing clean energy solutions to market. Canada’s Green Procurement8 policy now covers spending equivalent to around 13% of the country’s GDP9.

    Crucially, investors must also fund energy companies in transition, as well as the green providers – another key message that we would welcome from COP26. At Lombard Odier, we divide the investment universe into four ‘green’ solution providers; companies comparatively insulated from the net-zero transition; ‘burning logs’ with no plans to address their high emissions; and ‘ice cubes’, or high emitters with a credible path to decarbonise (see chart). We believe in investing in the green providers. We also believe that the ‘ice cubes’ will play an important role in achieving the goals of the Paris Agreement, and in cooling our clients’ portfolios. In our view, these firms will be crucial in transforming the global energy sector, and in generating future investment returns.


    Priority 3: The carbon conundrum

    Carbon is firmly back in the black. Soaring carbon prices10 are finally beginning to reflect the damage done by global emissions. Yet even as prices take baby steps towards levels needed to spur the energy transition, pressure mounts to bring them down. COP26 is a unique opportunity to advance a fair, global carbon price, as part of a market-friendly solution to a complex problem. Policymakers should grasp the thistle.

    Carbon pricing has both expanded, and risen, in 2021. The price to emit one tonne of CO2 in Europe rose to a record high of EUR64 in September, double January’s level, spurred by soaring gas prices. China, the world’s biggest sovereign emitter, started carbon trading this summer11, when the G20 nations also tentatively endorsed the use of carbon pricing mechanisms for the first time12. The European Central Bank is starting to include assumptions about carbon pricing in its macro forecasts. The head of Enel, Europe’s largest utility firm has called for more countries to put a price on emissions: 46 now do so worldwide13.

    The carbon price in Europe rose to a record high of EUR 64

    But this is just the tip of the iceberg. Eighty percent of global emissions remain unpriced and the average global emissions price is only USD3 per tonne, estimates the IMF14. The price must be nearer EUR100 to meet the Paris Agreement goals, notes the World Bank15. Even in countries that price emissions, many industries benefit from generous exemptions: from aviation in Europe, to agriculture in New Zealand. Governments can intervene in carbon markets to lower prices if they are deemed to rise too high: the UK is on track to do so in December16. Perhaps the toughest hurdle to overcome is opposition from the fossil fuel lobby, and from consumers worried about rising bills. Australia repealed a carbon tax in 2014 following protests; France’s gilets jaunes movement illustrated how divisive fuel taxes can be.

    This is because imposing prices high enough to spur the net-zero transition, without pushing high emitters to less regulated countries (so-called ‘carbon leakage’) or sparking further social inequality, is a tough challenge. Policymakers at COP26 are under pressure to make progress. This means using carbon pricing in tandem with investment in low-carbon alternatives (from energy to electric vehicles), that would help make the ‘green’ option the default, cheap option. Where this is not possible, it also means redistributing profits from carbon taxes to help shield the most vulnerable.

    The EU’s approach here is encouraging, with plans to expand the European Trading System17 to include industries such as shipping and building, and to use money from auctions of allowances to fund low-carbon technologies, energy efficient buildings, and support lower-income households. The EU is also proposing a ‘carbon border adjustment mechanism’ or an effective levy on imports from countries that do not price carbon: a measure criticised by the US, but logical in a globally decarbonising world. While a fair, global carbon price is the ultimate goal, this type of mechanism may be necessary in a transition phase.

    With the broader goal in mind, the IMF’s recent proposal for a global minimum carbon price also merits further debate. This would set a price floor for a select number of large emitters, with variable rates for ‘advanced,’ ‘high’ and ‘low’ income countries – the full proposal can be read here. This year, countries worldwide have made impressive progress towards setting a global minimum corporate tax rate. We hope this achievement can spurs similar, carbon pricing ambition at COP26. 


    Priority 4: Measuring sustainability, addressing greenwashing

    What gets measured gets managed: a truism that has particular resonance in sustainable investing. More than 3,500 financial institutions, representing USD120 trillion in capital globally, have signed the UN Principles for Responsible Investment. Yet there is no single agreed definition of how to invest sustainably, nor of what a sustainable financial product is. COP26 could make big steps forward in this area.

    Traditional sustainable investment approaches, such as environmental, social and governance (ESG) criteria, tend to be based on historical data, and are backward looking in nature. They focus on companies’ business practices, rather than their business models. At Lombard Odier, we seek to go further: to assess the future alignment of companies’ business models to the net-zero transition, and the climate-related exposure in our clients’ portfolios. This includes the physical risks their investments may face from more frequent extreme weather events, liability risks they may face from fossil fuel litigation, and transition risks they face as consumers switch to more sustainable products. To do so, we use metrics such as investments’ future implied temperature rise, benchmarked against industry standards and global goals such as those of the Paris Agreement. Our clients can use this to assess their portfolios’ climate risk, and mitigate their exposure.

    Our approach builds on recommendations from the Taskforce on Climate-Related Financial Disclosures18 (TCFD’s) Portfolio Alignment Team19. These recommendations emphasise metrics of portfolio alignment including implied temperature rises. Reporting on these measures is now mandatory for large UK-based pension schemes. We would welcome moves at COP26 to hasten their adoption globally. Spurred by the TCFD’s recommendations, over 50% of companies now disclose their climate-related risks and opportunities, with a marked acceleration in uptake this year20. The announcement of national reporting standards and moves by central banks have accelerated this trend. The European Central Bank has discussed how to revise its collateral frameworks and monetary policy operations to be consistent with climate objectives. The Banque de France led climate stress tests on banks and insurers in early 2021, and has strengthened its sustainable investment charter, including via measures to exclude fossil fuels.

    Over 50% of companies now disclose their climate-related risks and opportunities

    Once companies disclose clear and consistent information on their climate risks, investors can make more informed decisions. Perhaps counterintuitively, we see attractive opportunities in today’s heavily carbon-dependent sectors such as energy steel, cement and agriculture, where the transition need is critical, yet solutions are harder to find. In August, Swedish firm SSAB produced the world’s first fossil-free steel21 using hydrogen technology, years before many thought this would be possible. 

    The adoption of standardised measures would also help address charges of “greenwashing” against investment firms. A company may have excellent business practices but still be on track for 3°C of global warming – a point many ESG metrics miss. For some investment managers, ESG criteria require them to categorise, or exclude, investments, without offering solutions. With 50% of all first-half 2021 flows into European exchange-traded funds going into ESG products22, a lack of transparency and common standards leaves the door wide open to critique. COP26 is an opportunity for the investment industry to start making a real impact.


    Priority 5: Harnessing nature – our net-zero ally

    Bees don’t send invoices. Perhaps they should. Nature represents the world’s most valuable industry, with natural processes underpinning more than 50% of global GDP, from agriculture and heavy industry to healthcare and tourism, according to the World Economic Forum23. Yet the exhaustion of nature is currently free, and the role of nature in capturing carbon emissions is far less developed than the moves being made to reduce them. COP26 could make important progress on both fronts.




    Climate change is just one of nine “planetary boundaries”24 that scientists use to define humanity’s “safe operating environment” or the thresholds our species can tolerate (see chart). Climate is the area where we have the most comprehensive data to analyse. The others – including forest degradation, freshwater overuse and ocean acidification – are equally important, yet we lack ‘Paris Agreement’ type targets to address them. Deforestation alone is responsible for 11% of global emissions, similar to the proportion generated by all passenger vehicles on the planet25. COP26 is a unique opportunity to define clearer roadmaps and investment pathways to address the other eight, and to move towards putting a fair price on the use of natural resources. The benefits of doing so far outweigh the costs. Protecting mangrove forests alone could bring an estimated USD1 trillion in net benefits globally26] – providing flood defences, carbon sequestration and habitats for fish – 10 times the cost, notes the World Wildlife Fund. Advancing the WWF’s goal to grow global mangrove habitat by 20% by 2030 would be a start. COP26 discussions should also build on progress made at the COP15 meeting27, taking place with less fanfare from 11-15 October, where the focus is on biodiversity.

    As support for eco-friendly policies builds, and technology costs fall, investment opportunities are rising. Investors should focus on identifying companies that harness the power of nature, e.g. by using bio- and nature-based materials, and through regenerative farming and forestry, as well as those helping to preserve it, through a more circular, less wasteful economy. The EU’s Green Deal is taking important steps to address environmental degradation, as well as climate change. COP26 is an excellent forum for investors and climate scientists to learn from each other and for companies to highlight recent advances at side events.

    Managing natural resources sustainably could contribute more than 30% of the global climate mitigation effort

    COP26 could also take important steps to advance the role of nature in the net-zero transition. Nature-based solutions are currently the most impactful way of capturing CO2: a vital part of the transition, since even the most optimistic climate models do not forecast emissions being cut to zero by 2050. Natural Climate Solutions are about investing and monetising ways for nature to absorb CO2. They will be vital if we are to meet the steep decarbonisation objectives of the Paris Agreement. Today, large, scalable solutions are a work in progress, and COP26 brings together the necessary players – including governments, conservation organisations and the finance industry – to make this happen. Promising smaller-scale projects involve rebuilding coral reefs, preserving forests and peatbogs, farming kelp and improving soil-based carbon capture in farming by planting perennial crops, or ‘cover’ crops like clover, beans and peas after the main harvest. As well as largescale carbon removal, natural climate solutions can also avoid emissions linked to land use changes, and safeguard biodiversity.

    As companies increasingly pay to offset their emissions in voluntary carbon markets, these markets can deploy capital towards natural climate solutions. As they grow and deepen, oversight will be needed, to ensure they remain science-based, and subject to credible and transparent standards and regulation. COP26 could build momentum in this area, including via organisations such as the Taskforce on Scaling Voluntary Carbon Markets28. Managing natural resources sustainably could contribute more than 30% of the global climate mitigation effort, estimates the Center for International Forestry Research29. Nature is our most productive asset; in a net-zero future, it can also be our strongest ally.


    4 Net Zero by 2050, IEA report May 2021
    5 Still Not Getting Energy Prices Right: A Global Country Update of Fossil Fuel Subsidies, IMF, September 2021
    The Power of Procurement, Cutting the federal government’s carbon emissions, Clean Energy Canada, 2018
    12 G20 Third Finance Ministers and Central Bank Governors Meeting, 9-10 July 2021
    14 Launch of IMF Staff Climate Note: A Proposal for an International Carbon Price Floor Among Large Emitters
    15 Carbon Pricing Dashboard, World Bank
    18 TCFD: Measuring Portfolio Alignment: Assessing the position of companies and portfolios on the path to Net Zero
    20 Financial Stability Board, 2021 Status Report, TCFD
    23 Nature Risk Rising: Why the Crisis Engulfing Nature Matters for Business and the Economy, WEF, January 2020
    25 Source:
    29 The Circular Bioeconomy, Knowledge Guide, Center for International Forestry Research, 2020

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