Bond Investors Can Help Hold Companies Accountable Post COP26

In addition, COP26 launched several key initiatives to address greenhouse gas (GHG) emissions and accelerate the energy transition. This could translate in 2022 into stronger Nationally Determined Contributions (NDCs) that take the world a step closer to the 1.5°C target.

On the emissions front, more than 100 countries joined a coalition led by the US and the European Union (EU) to cut methane emissions by 30% by 2030. This initiative aligns with the recommendations of the IPCC published in its Sixth Assessment Report (AR6) as a path to effectively reducing GHG emissions in the near-term. According to the IPCC, methane accounts for about half of the 1.0°C rise in global average temperature since the pre-industrial age.

Additional highlights include:

• A new focus on reducing the use of coal, albeit weakened by emphasis on phasing down rather than phasing out coal power. Coal contributes 46% of global carbon dioxide emissions and accounts for nearly three-fourths of GHG emissions from electricity production.
• A deal to establish a new carbon market and trading scheme for offsets, comprising a bilateral system in which countries can trade credits to meet decarbonization targets, and a centralized system for offsets, with 5% of the proceeds going toward a climate adaptation fund for developing countries.
• A renewed pledge for developed countries to contribute at least US$100 billion annually to developing nations for transition financing. Notably, this goal has never been met since initially agreed to in 2009 at COP15.
• Launch of a Breakthrough Agenda, a 10-year plan to make clean technologies and solutions for power, road transport, steel, hydrogen and agriculture more affordable by 2030.
• Endorsement of the Glasgow Leaders’ Declaration on Forest and Land Use by 120 countries spanning more than 90% of the world’s forests. This declaration targets stopping and reversing forest loss and land degradation by 2030.
• A pledge by more than 100 governments, regional authorities and businesses to sell only zero-emissions cars in leading markets by 2035 and globally by 2040. The agreement lacks support from many of the largest car markets, however, including China, Germany, France and most of the US. Four of the largest carmakers did not sign.

Pledges Aren’t Enough

While the agreements and pledges arising from COP26 are laudable, they aren’t enough. For one, countries’ pledges for reducing carbon emissions by 2030 fall far short of the levels needed to reach the 1.5°C global warming target set by the 2015 Paris Agreement. Instead, these 2030 targets are equivalent to 2.3°C, leaving the global climate at risk, particularly for fast-rising sea levels and extreme weather events. According to the World Resources Institute, “global emissions must drop by half by 2030 to prevent the worst impacts of climate change.”

Further, huge gaps persist between countries’ more ambitious climate pledges and the tangible policy steps needed to achieve them. For instance, governments have provided little clarity about how they’ll reach their net-zero carbon targets, mostly set for 2050 to 2060, that promise to take global warming projections nearer to 1.8°C.

So how do governments plan to close the distance between their weak 2030 commitments and their net-zero ambitions? It’s hard to say. This unknown has created a significant credibility gap that requires radical collaboration among many actors to narrow.

Big Polluters Must Lead the Transition Away from Fossil Fuels

Much of the responsibility for closing this gap lies with some of the heaviest polluters: the transportation, utility and energy sectors. But the lines of responsibility are tangled. For example, the ability of the auto industry to help curb carbon emissions is contingent on the pace at which utilities shift to renewable energy. After all, the benefits of driving electric cars are limited if batteries are charged by coal-fired electricity.

At COP26, some world leaders pushed for phasing down unabated coal power. That transition is already under way, particularly among European utility companies. While unregulated, independent power producers are a bit further behind than regulated utilities, they are also working to transition away from coal to gas and battery storage facilities. In the EU, most utilities have either already exited coal or will by 2030, given the EU’s plan to be the first climate-neutral continent by 2050. This does not include Poland or the Czech Republic, two of the three European countries with the highest coal-fired installed capacity.

Most regulated utilities in the US already plan to reduce their (less economical) coal generation and to build capacity in renewables (where they expect a bigger rate base). In short, these companies are generally willing to shutter coal plants. The question is, how quickly? The timeline for transition is determined in partnership with state regulators, who must consider grid reliability, the grid’s ability to support electric-vehicle infrastructure and regional coal employment. Even so, 75% of US coal capacity is likely to be retired by 2050.

As with utilities, integrated exploration-and-production (E&P) companies in Europe are paving the way for E&P globally, by setting ambitious and science-based carbon reduction targets and by directing a material portion of their capital budgets toward lower-carbon and renewables projects. US E&Ps are maintaining production discipline for fossil fuels and have scaled back investment in new drilling. Budgets for capital expenditure increasingly include low-carbon investments, such as biofuels, hydrogen renewables and nature-based offsets.

Where Investors Can Make a Difference

With companies facing mounting pressure to invest in green capex, we expect the market for green bonds and bonds linked to key performance indicators (KPIs) to continue to surge in size and importance. But labels aren’t enough. In order to fairly assess KPI-linked bonds, for example, investors must understand how companies set and achieve sustainability targets that decarbonize their emissions along the full value chain. A forthcoming global standardization of environmental, social and governance (ESG) reporting under the International Sustainability Standards Board will aid in transparency.

In the meantime, responsible investors must determine whether a company’s climate strategies are specific and actionable; how its emissions pathway compares to its peer group; if its plans are sufficiently ambitious relative to its emissions starting point; whether its net-zero target is science-based and how it aligns with NDCs; and how its net-zero plan breakdown between near-term (2030) and long-term (2050) goals aligns with NDCs.

Lastly, active investors can—and should—play a critical role in climate action by tracking countries and companies to make sure they’re on course to deliver on their ambitious climate goals. This often entails taking a seat at the table with a company’s management team to understand the impact of ESG factors on investments, to advocate for changes in corporate behavior and practices, and to hold companies accountable as stewards of our environment.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.

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