As world leaders – some armed with passionate speeches about the impending climate crisis – descended on Sharm el-Sheikh in Egypt to attend COP27, Citywire Amplify invited several ESG experts to give us their thoughts about the climate summit. We asked them what progress, if any, has been made since COP26 last year in Glasgow, and what it means for the asset management industry.

What has changed for the asset management industry since COP26?

Lucian Peppelenbos, climate and biodiversity strategist at Robeco: At COP26 there was a wave of net-zero pledges from investors and corporates. Since then, the focus is on delivering on these pledges. Many have published a net-zero strategy and interim targets. But this has not taken all scepticism away from critical stakeholders who question whether net-zero pledges are leading to real action. At COP27, a UN expert committee will announce credibility criteria for net-zero pledges. This may be followed by third-party verification and/or mandatory requirements. Asset managers will need to ensure that their net-zero plans are robust, transparent and in line with science.

Markets changed significantly. 2021 saw record inflows into ESG funds. 2022 saw an energy crisis and a cost-of-living crisis. The main benchmarks are re-carbonising, most notably due to the increased weight of the energy sector. At the same time, there is evidence of accelerated investments in renewables and strengthened public policies supporting this. That is, the energy transition proves to be uncertain, uneven, and disruptive. Navigating this transition and generating returns in these markets, while keeping the course on net zero, is a key challenge for asset managers.

Eric Pedersen, head of responsible investments at Nordea Asset Management: The invasion of Ukraine and the resulting rally in oil and gas-related investments are currently helping to separate those who were serious about tackling climate risk from those who maybe saw it primarily as a marketing opportunity. We need to avoid being distracted by the tightness in energy markets just now – where the risk is, money will be locked into investments not viable over the long term, as countries start moving to meet national decarbonisation targets.

Jon Hale, global head of sustainability research at Morningstar: A year ago, many asset managers got on board with the concept of net-zero commitments but have since realised how difficult it is to figure out exactly what such commitments mean and how they can be achieved over a specific period. This has been made harder by this year’s difficult global environment marked by inflation, declining stock and bond markets, and energy shortages resulting from Putin’s invasion of Ukraine.

COP27 marks 30 years since the UN Framework Convention on Climate Change was adopted. What has it meant for your fund’s portfolios? And what will it mean for the future?

Lucian Peppelenbos: 30 years ago, climate change was an agenda for scientists, NGOs and ministers of environment. Nowadays it engages heads of state, corporates, investors, regulators, central banks, etc. It has mainstreamed. Though we are still not on track for 1.5C, the future is inevitably low-carbon. Because more and more, the cost of inaction is starting to outweigh the cost of action. Our portfolios contribute to that transition to a net-zero economy. We invest in transitioning high-carbon industries toward net zero: for example, car manufacturers and mining equipment suppliers. We also invest in climate solutions such as clean tech, EV and battery storage solutions, and nature-based assets. And we exercise our influence as a shareholder if companies do not transition well enough.

Eric Pedersen: For us, it has meant continuously increasing the sophistication of our risk analysis, our climate-related engagement with companies, and the application of our Paris-aligned fossil fuel policy to two-thirds of our assets, so far. I have no doubt this trend will continue as the deadlines to avoid catastrophic climate change continue to shorten.

Jon Hale: The meetings have helped the asset management industry focus on the investment risks posed by the climate crisis, and have driven home the fact that the asset management industry has an important role to play in mitigating it.

COP27 highlights the impact of the climate crisis on the developing world. The focus will be on whether wealthy nations, and those most responsible for global warming, will agree to assist poorer nations that are being disproportionately impacted.

There is an urgent need for a $100tn green investment if we are to reach 2050 net-zero goals, half of which must be allocated to the energy and utilities sectors. This is to help these sectors as they face scrapping polluted assets before they reach the end of their economically useful life. What would that mean for investors in terms of financial risk? Can it be mitigated?

Lucian Peppelenbos: Analysis shows that the more sudden and unplanned the transition is, the higher the financial risks. So, yes, risks can be mitigated, as long as we manage the transition. We are currently not on track – the UN Environment Programme’s latest report indicates we’re heading for 2.4C – but five years ago, we were still heading for 4C+ of global warming so there is an improvement. We have seen more and more governments and businesses stepping up, committing to net zero, and putting the necessary policies in place. We have seen the costs of clean technologies dropping exponentially, and we see shifts in consumer preferences. We are still at an early stage. The transition will be disruptive and it will create risks and losses. But overall we are positive that we can rise to the challenge.

Eric Pedersen: We have long said investors need to look beyond the ‘obviously green’ – such as hydrogen, battery technology and electric vehicles – and to the companies where actual, real-world decarbonisation is already happening. Here, utilities are central and often strongly committed, as are many industrials. It is a bit harder with the oil and gas sector – as the path is not as visible as in utilities. Logic dictates that over the next 20 years, the companies we know today will either have changed beyond recognition or be gone altogether.

Jon Hale: Investors make decisions based on the expectation of an appropriate risk-adjusted return. It’s good to see many investors today focusing on driving impact, but that has to be a secondary consideration for how they allocate their investments. That’s why, ultimately, governments are going to have to use their ability to drive capital to address net-zero goals, through direct public investments or market-based incentives.

A winding road ahead

In a year that has been marred with geopolitical tensions and an energy crisis that is set to engulf Europe as winter approaches, Sarah Peasey, the director of European ESG investing at Neuberger Berman has warned that the transition will not be easy or linear. She said the industry would have to rethink what qualifies as green investments – especially at a time when we are facing setbacks.

‘If 2022 has taught the investment community anything, it’s that pragmatism is a key ingredient in the transition,’ said Peasey (pictured above). ‘That might mean temporary compromises with economic and political reality [where] some transition technologies will be deprioritised until the energy shortage abates and markets have normalised again.

‘Meeting transition objectives requires much more investment in the extraction and production of the metals used to build renewable-energy infrastructure. And while we believe companies that are already on a path to net-zero emissions present generally attractive risk profiles, we also recognise the need to stay invested in high-emitting companies when they commit to engaging with capital providers on credible decarbonisation plans. [But] it’s when the setbacks pile up that opportunities to reset, like COP27, become more challenging – but also more critical.’

Your voice matters

Masja Zandbergen, the head of sustainability integration at Robeco, said she would like more shareholders to use their voice and shares to call out companies without meaningful climate policies. She also wants to see an end to the phrase ‘our shareholders want us to maximise profits’ – shorthand for doing nothing about sustainability.

‘More and more we are seeing big institutional shareholders, even passive investors with large stakes, raising their voices (or voting their shares) towards better plans on climate,’ she said. ‘Raising your voice can be more effective than exclusion – however, for companies that are not willing to change, exclusion should be on the table.’

Yet Zandbergen (pictured above) knows that exclusion doesn’t change anything. Likewise, changing consumer behaviour can help pressure companies to act, but she doesn’t see that as the main driving force.

‘Most powerful could be regulation. Raising minimum wages and labour standards laws, carbon taxes and restrictions on pollution are immediately felt by companies in their P&L. Unfortunately, I do not really see that happening in a meaningful way. Transitions are never led by regulation. So that leaves us with companies innovating towards more sustainable solutions, supported by long-term shareholders who believe this is the way to success.’