That was a killer start to the Climate Change 2021: The Physical Science Basis, the Sixth Assessment Report (AR6). The Intergovernmental Panel on Climate Change (IPPC) scientists analysed evidence looking back thousands of years and found the scale of the impact is unprecedented.2 No country or region is exempt. This article is not just about what we believe will happen, but what climate scientists demonstrate has already happened and how climate change is already impacting our environment. It speaks of urgency and the need for scale but also gives hope – we can stabilise the climate if we respond. We summarise the key predictions and discuss what these mean for capital markets, companies, assets and investor portfolios. And importantly, the key actions investors can take to move towards net zero.
AR63 is the result of more than 200 scientists collating more than 14,000 peer-reviewed scientific studies from 66 countries. Its presents its findings in an eye-popping Interactive Atlas.
The AR6 Summary for Policymakers (a more digestible version of the 4,000-page report) was unanimously approved by the governments of the 195 country members of the UN Convention on Climate Change and will form the basis of decision-making at the upcoming COP26 meetings in November. Two further studies prepared by other Intergovernmental Panel on Climate Change (IPCC) working groups will be released in 2022.
This AR6 report does not tell us how to act, only that we must. It makes it clear that immediate greenhouse gas (GHG) emissions reductions are vital for us to help achieve the target of net-zero emissions by 2050, and thereby preserve both climate and financial stability. Key takeaways are:
Global Surface temperature increase since 1850 – 1900 (oC) as a function of cumulative CO2 emissions (GtCO2)
Source: SMP 37
There is good news. The IPCC authors tell us that net zero is achievable – but only if we act now. Rapid emissions reductions matter greatly, and we can, through climate action, seek to achieve a low level of warming and therefore a more stable economic outcome. The report’s very low emissions scenario involves only a temporary overshoot to 1.6°C.12 The strengthening quest for climate stability gives hope for the Paris Agreement goal of limiting the rise in global average temperatures to 1.5°C. This scenario is clearly in the best interest of long-term investors.
The 1.5°C scenario means assets are less exposed to the risk of physical damage from climate change related events, compared to scenarios with greater warming. Risks in the short term are concentrated in sectors disrupted by climate transition; high-carbon utilities and energy companies lose out if assets become ‘stranded’, particularly in the low warming scenario where emissions have already peaked. Companies focused on achieving the 1.5°C scenario will also present investment opportunities over the next 10 years.
Global momentum to achieve the 1.5°C scenario is also growing via government policy and regulation. Over 1,600 pieces of legislation support the Paris Agreement. This momentum is captured by the UN’s ‘Race to Zero’ campaign, which tracks commitments across government, industry and investors. It states that 70% of the world’s economies have made net-zero commitments, over varying timescales.13
Technological tipping points and pricing shifts – such as the costs of renewable energy and storage, the development and uptake in energy efficiency, greener grids, and electrifying new sectors – are changing whole supply chains. While not all countries are on the same trajectory, with China and the US14 still dominating global emissions, capital markets are moving to support the low-carbon economy.
Advice and Analysis
We have been providing our clients with advice and analysis to address climate change for over a decade. We published our seminal Climate Change and Strategic Asset Allocation report in 2011 and subsequently Investing in a Time of Climate Change reports (2015 and 2019) based on climate scenario analysis. Scenario analysis, as demonstrated in the AR6 and supported by the Task Force on Climate-related Financial Disclosures (TCFD), is a key tool for investors to anticipate the range of potential portfolio implications that may transpire. We continue to evolve our climate modelling and will present an update later this year.
Tools
Our scenario analysis confirms that a 1.5°C scenario is an imperative for long-term investors. It is therefore in investors’ best interests to support this outcome, not simply hope it happens. This is where Mercer’s Analytics for Climate Transition (ACT) advice and portfolio analysis comes in. ACT is a step-by-step process that helps investors set their pathway to support the lowest IPCC climate scenario and help achieve a net-zero portfolio outcome. It allows investors to rank companies and portfolios by their capacity to support annual emissions reductions (transition capacity), prioritise active ownership of companies, and allocate to transition solutions.
Integration with Investment Solutions
For clients that invest with Mercer’s Investment Solutions portfolios – all assets in the Pacific and for all discretionary assets in Europe, Asia, Middle East and Africa – we have set a target of net zero by 2050 and are aiming for at least a 45% reduction by 2030 on absolute portfolio carbon emissions, scope 1 & 2. This covers more than $80 billion of global assets under management to-date.15 Our CIOs and portfolio managers are actively working with appointed investment managers and implementing changes on the behalf of clients.
Teams in other regions are in the process of undertaking their own analysis and setting governance processes.
- Alexis Cheang, Partner of Sustainable Investment
The following summarises four areas where investors can act. Note that reporting should not just cover emission reduction figures, but also for active ownership and solution allocations:
When setting targets, establish and report on the baseline starting point date. Define the scope of emissions captured – whether only CO2 emissions or also methane/other GHGs – and prioritise absolute emissions, not just carbon intensity.
Integrate climate metrics within portfolio asset allocation, asset class construction, and sector and company exposures to help achieve annual and rolling progress on short- and long-term milestones.
Measure against climate transition benchmarks by setting a year-over-year carbon reduction target, with tolerance ranges to facilitate dynamic portfolio management, and utilise a climate transition/Paris aligned index where possible.
Demonstrate how voting and engagement has resulted in investee companies making appropriate strategic business changes to build transition capacity and progress against science-based targets. Consult the Climate Action 100+ Net Zero Company Benchmark16 for more information on expectations for the world’s highest emitting companies.
Escalate active ownership measures with companies that do not reduce emissions by real-world measures and build appropriate transition capacity within three years e.g. escalate via voting decisions on director appointment or remuneration resolutions and/or consider screening out the company (see below).
Engage with policymakers, directly or collaboratively, as well as other market participants as this will remain key to setting the context that all investors and companies work within.
Invest in transition solutions that provide opportunities for investment returns. Certain companies and asset classes will also positively impact the transition capacity of other companies in the portfolio. Ideally set significant green revenue targets that are increased year-on-year.
Provide evidence for any ‘net’ counting, stating how emissions removal works in the portfolio, e.g. nature-based solutions. Note that AR6 does not consider carbon emissions removal technology to be ‘the answer’ in the foreseeable future.
Identify all high carbon and low transition capacity companies or assets, especially those with fossil fuel reserves. Particularly when active ownership strategies have failed, set policies for thresholds on expansion, new investments, and timeframes for when certain companies or sectors should be sold.
AR6 reinforces the urgency for action and the scale at which change needs to occur. The scientific evidence is unequivocal. To address climate damage, already done and to come, there are clear methodologies for capital markets, companies and investors to play a role in creating a net-zero economy and achieving climate stability. A wide range of public and private sector actors are responding to the science and this is moving money; when money talks, markets listen. Investors have risks that need to be managed and opportunities to pursue. Investors have many levers to pull and potential actions to take in addressing short- and long-term risk-return questions while pursuing a net-zero portfolio. The future holds many uncertainties, but one thing is certain, there are zero places to hide.
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