COP27: Treating the Symptoms, Not the Disease

In many respects, COP27 was neither feat nor flop.

Introduction

“The world is on a highway to climate hell with our foot still on the accelerator.”

That rather grave admonition from UN Secretary General Antonio Guterres kicked off COP27 in Sharm El-Sheik, Egypt, billed as the COP for Africa, where many hoped for progress on climate financing for historically marginalized communities and emerging markets.

On this, COP27 delivered. The creation of a “loss and damage” fund was undoubtedly a crucial step in building global resilience against the physical impacts of increasingly frequent and severe weather events. Yet as innocuous as the phrase “loss and damage” may sound, it’s also freighted with blame and possibility of unlimited liability. Amidst the heated debate, Prime Minister Mian Muhammad Shehbaz Sharif of Pakistan reminded the global community that it’s not just about apportioning blame, but also helping vulnerable countries prepare to withstand further catastrophe.

Alas, as the two-week event wore on, COP27 often proved an exercise in triaging the symptoms of climate change rather than treating the underlying disease. By the close of the conference, the goal of curbing global temperature rise to 1.5º C—which will demand reducing global emissions by 5 – 8% per year between now and 2030—appeared to be slipping out of reach.

Here is a closer look at what COP27 managed to achieve (including progress on methane emissions and gender impacts); where we believe it fell short (particularly on biodiversity and the low-carbon energy transition); and what it might mean for investors in the years ahead—along with a summary guide of key initiatives announced at the conference.

What Was Achieved

Loss and Damage

Much discussion focused on compensating the developing world for the havoc wrought by climate-related disasters, such as the Pakistan floods earlier in the year. Developing countries have long argued that industrialized nations have benefited from exploiting fossil fuels while leaving the rest of the world to bear the brunt of rising temperatures.

For now, climate finance tends to favor mitigation projects with greater potential to generate attractive returns, while adaptation initiatives can be longer term, tricky to quantify, and even harder to monetize. Still, funding appears well shy of what’s needed: In developing countries, the annual gap for climate-defense measures—such as early-warning detection systems—is estimated at $160 billion to $340 billion by the United Nations Environment Programme.

Delegates eventually came to a high-level agreement—and some jurisdictions immediately contributed toward a loss-and-damage fund. While the arrangement is light on specifics, a new transitional committee representing 24 countries plans to present their recommendations for how the fund will work and where the money will come from at COP28.

Methane Emissions

Methane emissions from farming—nearly half of total global methane emissions, according to a Princeton University report—remains another massive challenge. During COP26, 120 countries signed the Global Methane Pledge to cut emissions 30% by 2030. COP27 added 30 more countries to the roster, though accurate emissions-measurement remains elusive. To that end, this year the UN launched the Methane Alert and Response System (MARS), a global database of methane leaks spotted by satellite. We think the UN is on the right track—in fact one of our funds has exposure to a company that plans to launch satellites that can detect methane leaks.

Young Voices

COP27 hosted a first-of-its-kind pavilion dedicated to the impacts of climate change on future generations. At one event, presenters unveiled a “Global Youth Statement”—with contributions from young people in 149 of 193 nations—calling for climate resilience, international cooperation and a fair energy transition. Several youth-led protests broke out as well, with many dissenters echoing Greta Thunberg’s critique that COP27 was an exercise in “greenwashing.”

We believe young voices are increasingly critical to the climate conversation: A recent Stanford University survey found that 70% of young investors are very concerned about climate change—and that 80% think it’s very or extremely important for asset managers to try to influence the environmental policies of companies in which they invest.

Gender Impacts

Pakistan’s unprecedented monsoon exposed the vulnerability of millions of women struggling to cope with the vicissitudes of climate change. Lack of medical access and unhygienic conditions particularly threaten reproductive health and labor-participation rates.

To promote resilience in the face of climate challenges, the Egyptian Presidency launched the African Women’s Climate Adaptive Priorities (AWCAP). Concrete objectives include ensuring women share in the resources earmarked for green-economy training programs, as well as boosting the percentage (now 36%) of African women working in science, technology, engineering and mathematics.

Where We Fell Short

Mitigation and Adaptation

Reaching some semblance of agreement on loss and damage is only part of the climate challenge; averting future catastrophe through mitigation is also mission-critical.

Pakistan, for example, is particularly threatened by glacial runoff accelerated by rising temperatures: According to the Notre Dame Global Adaptation Initiative, Pakistan ranks 146 out of 182 countries in its ability to withstand the effects of climate change—data we integrate into our Emerging Market Debt assessment of Sovereign Sustainability.

Thus far, financing for mitigation-and-adaptation initiatives has been expected to come from two main sources: In 2009, a group of industrialized nations pledged $100 billion a year in support, while Article 6 of the Paris Agreement may provide for trading in carbon offsets to enable wealth transfers to finance adaptation projects such as afforestation and soil regeneration in key biodiversity areas. Frustratingly, developed countries have yet to fully deliver on their $100 billion in annual transfers—and even if these pledges are eventually met, significant additional capital would still be needed.

Two new initiatives—the Sharm El Sheikh “Adaptation Agenda" and the African Carbon Markets Initiative—offered fresh hope. The Adaptation Agenda—a checklist of actions to strengthen the resilience of approximately half of the world's population against climate-related risks—calls for $140 billion to $300 billion of public and private financing to achieve its objectives, which are split into five sectors: food & agriculture, water & nature, coastal & oceans, human settlements and infrastructure. The African Carbon Markets Initiative (ACMI) aims to improve the traceability and transparency of voluntary carbon markets—and ultimately attract $6 billion in new funding for the continent by 2030 while further boosting the credibility of nature-based offsets.

There was also much speculation about a U.S. proposal to accelerate funding for mitigation projects through a dedicated carbon offset program. Under this scheme, spearheaded by former Secretary of State John Kerry, U.S. companies would offset their emissions by buying credits in clean-energy projects in emerging markets—though details about ensuring the economic viability, completion and governance of such projects remain thin.

Biodiversity

Climate change erodes the very ecosystems that naturally absorb greenhouse gases. As a reminder of this insidious cycle, the World Wildlife Fund issued a new report warning that the Amazon could “cease to function” as a carbon cache within the next decade if no action is taken.

It was somewhat reassuring, then, to hear Brazil’s President-elect Luiz Inacio Lula da Silva take a crowd-stirring stand against illegal deforestation in the Amazon. COP27 yielded a few other biodiversity commitments, too—including the U.K. government’s $30 billion Big Nature Impact Fund, a public-private initiative to support activities such as tree planting and peatland restoration.

We hope for more meaningful target-setting at the COP15 Biodiversity Conference in Montreal in December. Specifically, we expect increased scrutiny on how companies and asset managers navigate biodiversity risks and opportunities in their value chains—as well as deepening acceptance of the Taskforce on Nature-related Financial Disclosures (TNFD) as the industry standard.

Clean Technology

All eyes were on President Joe Biden as he touched down on Decarbonization Day. After apologizing for the previous administration’s decision to pull out of the Paris Agreement, the President offered a number of new measures to help the U.S. shrink greenhouse-gas (GHG) emissions—including plans to strengthen methane restrictions, support early-warning systems to detect extreme weather events in Africa, and fund 10GW of solar and wind projects in Egypt.

Unfortunately, the Biden buzz overshadowed the announcement of additional details on a potentially more ambitious 12-month action plan called the “Breakthrough Agenda”. Put forth by nations accounting for over half of global GDP (including the U.S., U.K. and China), the Agenda aims to advance decarbonization solutions in five essential areas: steel-making, power-generation, ground transportation, hydrogen fuel and agriculture. Key actions include the deployment of essential infrastructure projects—including 50 large-scale net-zero-emissions industrial plants, 100 “hydrogen valleys” and a package of cross-border electrical-grid projects.

The Energy Transition

Maintaining energy security while making a global low-carbon transition was a tough balancing act before the pandemic-rebound spike in energy-related CO2 emissions and the protracted conflict in Ukraine.

In the run-up to COP27, a number of leading scientific bodies reiterated the urgent need for progress on clean energy. In its 2022 World Energy Outlook, the IEA's Net Zero Emissions (NZE) 2050 scenario suggests that annual investment worldwide would have to triple by 2030 to roughly $4 trillion, with half to three-quarters deployed in developing countries; the Independent High-Level Expert Group on Climate Finance (IHLEG) similarly estimates that the developing world needs $2.4 trillion, half supplied by international capital markets.

Despite the ratcheting tension, there were some rays of progress. Indonesia’s new Just Energy Transition Partnership (JET-P) aims to marshal $20 billion of public and private investment to help the world’s fifth-largest carbon emitter wean itself off of coal power. This follows the successful launch of the first JET-P, for South Africa, at COP26.

Meanwhile, the EU committed to a 57% cut in carbon emissions by 2030 (versus 1990 levels). However, that slight improvement over its previous 55% target didn’t exactly impress the COP27 crowd, who noted that EU member states have been forced to backfill essential Russian gas supplies, likely leading to higher near-term emissions from increased coal generation. The tension, in our view, won’t ease anytime soon.

What It All Means for Investors

We believe—as COP27 made clear—the role of private finance in decarbonizing the global economy has never been more important.

At last year’s COP, the focus was on the Glasgow Finance Alliance for Net Zero (GFANZ), which established a network of 450 institutions that pledged to reach net-zero emissions by 2050. This year, talk turned to mobilizing the industrialized world to pay its fair share in slowing the pace of global climate change—and as echoed in the COP27 cover decision (known at the Sharm el-Sheikh Implementation Plan), institutional investors must do their part to hit net-zero targets and help close significant funding gaps.

To put that challenge in context, a recent report commissioned by the current and previous COP hosts, Egypt and the U.K., estimates that developing countries will need to secure $1 trillion a year in external financing by 2030 to avert climate catastrophe; meanwhile, a 2021 tally by the world’s leading development banks found that they collectively lent just $51 billion to developing countries last year, with private investors contributing only $13 billion.

In an effort to convince the private sector that risk doesn’t always outweigh reward when it comes to investing in emerging markets, a group of UN-appointed experts—called the UN Climate Change High-Level Champions—published a list of projects in need of $120 billion in funding to help developing countries cut emissions and adapt to global warming. Initiatives included a $3 billion water-transfer project between Lesotho and Botswana, and a $10 million plan to upgrade the public water system in Mauritius.

Debt markets, in particular, will be unequivocally crucial to success. ESG-labeled bonds now make up 11% ($170.5 billion) of emerging-market corporate issuance, and sovereigns are increasingly joining in: this year Chile and Uruguay issued $2 billion and $1.5 billion, respectively, of sustainability-linked bonds tied to specific emissions-reduction targets. Overall, the Green Bond Market—including a rising crop of sustainable bond labels (social, sustainability, sustainability-linked and transition)—had swelled to $3.5 trillion by end of the third quarter.

Last but not least, we believe that unlocking the transformative power of the capital markets will require further standardization of climate-related disclosure. On that front, the Carbon Disclosure Project (CDP), now with 18,700 voluntary users, announced it will incorporate the “IFRS S2” environmental-disclosure standard set by the International Sustainability Standards Body (ISSB) in the 2024 disclosure cycle—a potentially significant milestone toward the ISSB becoming a global baseline.

Summary

In many respects, COP27 was neither feat nor flop.

The good news, in our view, is that it highlighted the crucial role of dedicated, long-term capital in tackling large-scale projects in both industrialized and developing markets. It also reaffirmed a fundamental truth: Economic development among emerging markets must incorporate climate mitigation from the start in order to avert the far costlier approach of compensating for loss and damage in the future.

Unfortunately, the conference closed with many doubting whether a pathway to 1.5°C was still achievable. For all the promise of the GFANZ network, now with $150 trillion in committed capital, hearty proclamations don’t always lead to tangible action. Some banks, for example, have already threatened to pull out over being legally constrained from investing in carbon-intensive industries.

While we understand the need for pragmatism in the wake of geopolitical unrest, we maintain that decarbonization is critical to the future of the planet—and that actively engaging with companies has never been more important to helping them hit net-zero targets and drive overall progress on climate change.

In the meantime, here are a few trends to watch on the road to COP28:

• More details on the loss-and-damage fund, which we believe must accelerate investment into energy infrastructure and climate-resilience projects
• Rising issuance of voluntary carbon offsets for projects in emerging markets
• Further expansion of the ESG bond market driven by the EU, China and the U.S.
• Increased renewable-energy development, despite the current energy crunch and limited progress from governments to increase their NDCs