COP Blog: Investing in a lower carbon economy - a year after Paris

World leaders and scientists are in Morocco at COP22 this week to follow up on the historic climate change agreement a year ago in Paris to reduce carbon emissions. Do environmental, social and governance (ESG) investors know enough now to position portfolios for a lower carbon global economy?

A year ago, 196 countries committed to a universal pledge to reduce their carbon footprint by reducing emissions of greenhouse gases. On 4 November, the Paris Agreement came into force after having been ratified by 100 parties including the US, China, India and the European Union. Together they exceeded the required threshold of 55% of the world's carbon emissions.

The Paris agreement required countries to communicate a plan of action by 2020 and provide five year updates beginning in 2018. The agreement focuses on a carbon reduction to keep the global temperature increase limited to 1.5°C to 2°C.

At the 22nd Conference of Parties (COP22) meeting this month, nations have an opportunity to follow up on last year's Paris agreement. We expect countries at COP22 to establish concrete action plans, set deadlines for agreeing on the rules of measuring and monitoring emissions, and discuss of key policies. The recent surprise US election result may impact the Paris agreement –all eyes will now be on the United States given President-elect Donald Trump's widely voiced scepticism toward climate change.

Climate change: a lack of consensus

We hope that the meeting takes a step toward providing ESG investors much needed clarity, through elaborating on the target setting and reporting framework.

Countries have submitted plans so far that only guarantee limiting the temperature rise to 2.9°C compared with 1990, according to the United Nations . Importantly, many nations lack regulations such as emissions caps, carbon pricing or carbon-related taxes. As a result, there is little consensus on what a lower-carbon world would look like in 2030 and beyond.

The lack of consensus is problematic for investors as they seek to identify appropriate investment opportunities that meet the most probable climate scenario. Amidst the confusion there are areas of opportunity for investors with tools like climate alignment portfolios and the development of low carbon indices – however, for these to work effectively, there are still improvements to be made to carbon footprinting.
Investors need to take steps toward a low-carbon economy

Investors need clarity on the implications of countries' commitments at the COP21 and the specific policies, regulations and other tools that would pave the pathways to a low-carbon economy. Typically, investors seek robust country and sector risk analysis when making investment decisions. For ESG investors, this analysis is particularly important for the most exposed industries, such as energy, utilities, car manufacturing, transport, steel, cement, and such.

For now investors can turn to experienced asset managers for a range of low carbon investment opportunities ranging from active to passive.

Many of these, like our own Emerging Markets Custom Low Carbon Optimized Equity Index Fund, utilise a combination of engagement and positive and negative screening to achieve their goals. As the landscape becomes clearer and the analysis more refined, the range of innovative investment solutions will continue to expand.

Conclusion: more decisive action needed

The Paris agreement set the tone for the COP22 where investors expect to receive more clarity on the plan of actions at country level and the translation of aspiration goals into laws and regulations. Over the past few months, we have seen the development of tools to help facilitate a transition to a low-carbon economy yet industry standards are still being defined. We are hopeful that this month's meeting will prove to be a significant step forward for investors.

Mamadou-Abou Sarr is global head of ESG investing at Northern Trust Asset Management