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The conclusion of COP26 last weekend left climate professionals with a familiar feeling: progress was made, but the final agreement is still far from what is needed to prevent the worst impacts from climate change. In the Glasgow climate pact, countries committed to “phase down” coal power and fossil fuel subsidies. While “keep 1.5 alive” was a motif of the summit, current commitments put the world on track for between 1.8°C and 2.4°C. Under just a 2°C scenario seas are projected to rise about .5m, with dire impacts on coastal cities, and over a billion people would be exposed to dangerous extreme heat. However, an important part of the agreement was the decision that countries will be expected to return next year to COP27 with further commitments to reduce emissions in line with the critical 1.5°C target.
There were also a series of new agreements, including a deforestation agreement in which over 100 countries committed to ending deforestation by 2030, a methane agreement in which over 100 counties committed to reducing methane emissions by 30% also by 2030 and an agreement between the US and China to reduce emissions this decade. These agreements range in terms of their significance, with the ground-breaking deforestation agreement including around $20 billion dollars from public and private sources, while the methane pledge lacks enforcement and interim targets, and the US-China agreement provides an optimistic signal but doesn’t include tangible milestones or expectations. Meanwhile, the International Financial Reporting Standards Foundation launched a new International Sustainability Standards Board (ISSB), which is tasked with developing global Sustainability Disclosure Standards including for climate risk. Existing initiatives like the Climate Disclosure Standards Board will join the ISSB, demonstrating important progress in the development of consistent reporting frameworks.
Together these new announcements show the world is slowly but surely starting to head towards the energy transition away from fossil fuel. Such a transition will have broad credit implications across sectors and the global economy, as noted in the Moody’s Investors Service report, Carbon Transition – Global: COP26 pledges point to accelerated energy transition; implementation is key hurdle. “Successfully implementing new pledges made before and during COP26 would cover 70% of the emissions reductions needed to reach the IEA’s Sustainable Development Scenario annual CO2 emissions by 2050. Pre-COP26, that figure was about 50%,” said Frank Medrisch, Assistant Vice President – Analyst at Moody’s Investors Service. While a more rapid energy transition would raise credit pressures for carbon-intensive sectors and countries, it could also unlock significant investment opportunities in new technologies. However, the credit implications will only crystallise if clear steps and measures to deliver on these pledges are implemented.
One of the most important developments at COP26 was the increase in financial sector commitments to address climate change as a systemic financial risk. The United Nations Glasgow Financial Alliance for Net Zero (GFANZ), a group of investors, banks and insurers controlling $130 trillion in assets, pledged to have their investments hit net zero emissions targets by 2050. In its report, Financial Institutions – Global: Financial firms' rising climate commitments will support accelerated carbon transition, Moody’s Investors Service concluded that if GFANZ members follow through on their commitments, it will increase pressure on carbon-intensive sectors and companies without credible carbon transition strategies because their access to capital will progressively tighten. This also raises asset and reputational risks for the financial institutions with high exposure to carbon-intensive industries and a lack of measurable carbon transition planning. G-20 financial institutions collectively have nearly $22 trillion in exposure to carbon-intensive sectors, which represents 20% of their total portfolios, on average, according to Moody’s Investors Service estimates. Nevertheless, green financing will also open vast new lending and investment opportunities for financial firms.
To ensure accountability on these commitments and avoid greenwashing, data and benchmarking will be key to enable shareholders to track companies’ progress, unpack the implications of their commitments and hold them accountable. “The net zero commitments represent serious acknowledgement by financial stakeholders which is essential, but commitments are just the start. There is an urgent need for increased transparency on how net zero will be implemented, while at the same time increasing ambition. The current pledges still aren’t enough,” said Emilie Mazzacurati, Global Head of Moody’s Climate Solutions.
Moody’s ESG Solutions’ initial review of 2,700 companies’ temperature targets found that only 13% have set quantifiable targets that can be scored in our temperature alignment framework and of those the average associated temperature increase is 2°C, which underscores the need for greater clarity on what net zero ambitions mean and how they translate into impacts. Likewise, the average disclosure rate across the 11 Task Force on Climate-related Financial Disclosures recommendations was only 22% in 2021, based on our review of over 3,800 companies. While this shows improvement from last year it highlights the significant room for continued growth in terms of comparable climate risk disclosure.
Climate adaptation was central in the opening pages of the Glasgow Agreement and the document “urges” developed nations to at least double their total adaptation financing for developing nations from 2019 levels by 2025, which would equate to $40bn in adaptation financing. There were also new pledges to the Adaptation Fund, which focuses on grant-funded adaptation projects for developing nations. However, these numbers are still a small fraction of the projected funds required for climate adaptation, and more dialogue and research is needed to further scale adaptation financing. This is essential because the differences in expected physical impacts under a 1.5C and 2C scenario are significant, and while emissions reductions are essential to avoid the worst impacts, we are already locked in to some increase in physical climate risks due to emissions already in the atmosphere.
Moody’s Investors Service report, Sovereigns – Global: COP26 highlights policy focus on climate resilience, with differences in effectiveness, finds that resilience will be a key determinant of credit trajectories, underscoring the opportunity for adaptation finance to combine varied sources, from official loans and grants, to MDB projects to private finance. “Sovereigns' ability to mobilise and invest in adaptation funding effectively will in part determine the credit impact of physical climate risk,” said Marie Diron, Managing Director – Sovereign Risk at Moody’s Investors Service.
Biodiversity loss, as well as the need to ensure a just transition also received more attention at this COP than previous forums. As climate risk and biodiversity loss are interconnected challenges, exacerbating one another and both presenting significant risks to communities and economies, the inclusion of natural capital and biodiversity at COP26 represents essential progress in better addressing these risks. Likewise, the need to factor in the multifaceted impacts of a transition to a low-carbon economy and the physical risks of climate change on workers, supply chains and communities continues to grow more urgent and must be an essential topic for further research and action.
Check out “Ready or Not? Sector Performance in a Zero-Carbon World”, a new report that assesses the outlook in a scenario of rapid emissions reduction for carbon-intensive sectors – the ones whose transformation will be vital to the world’s ability to halve emissions by 2030 and achieve a net zero economy by 2050. Incorporating insights from across Moody’s, it analyzes these sectors’ exposure to climate risk and their relative ‘transition readiness’, and models the likely impacts on their default risk.