Opportunities in the net-zero transition
“Treasurer Josh Frydenberg has thrown his weight behind the adoption of net zero emissions by 2050, warning that unless Australia moves, sanctions by capital markets will increase borrowing costs, affecting everything from home and business loans to major infrastructure investments.”
This warning was in the Financial Review reporting on an address by the Treasurer to the Australian Industry Group in September, before Prime Minister Scott Morrison announced that Australia would adopt a target of net zero by 2050 and just over a month before COP26 commenced in Glasgow.
What the Treasurer made plain was that the world’s capital markets are closely following developments in climate science, mostly recently the release of the Sixth Assessment Report by the Intergovernmental Panel on Climate Change which concluded that climate change was “widespread, rapid, and intensifying”.
Climate risk is an investment risk
A changing climate poses physical risks, for example, damage to infrastructure or operational interruptions due to extreme weather events. At the same time, efforts are focused on reducing greenhouse gas (GHG) emissions and the transition to a low-carbon economy will present risks and opportunities for most sectors. Broadly, climate change may be a material financial risk and failure to adequately consider such risks may be a breach of directors’ duties of due care and diligence.
In 2017, the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures released recommendations for standardised disclosure on climate-related risks. Since then, investors and financial regulators have increasingly demanded detailed climate-related financial disclosures.
The Australian Securities and Investments Commission requires listed companies to provide climate-related disclosures to enable investor decision making. The Australian Prudential Regulation Authority has sought to ensure regulated entities are seeking to understand and manage the financial risks of a changing climate just as they would other economic and operational risks.
APRA, together with stakeholders including the Supervisors Network for Greening the Financial System, is undertaking a Climate Vulnerability Assessment that involves Australia’s largest authorised deposit-taking institutions estimating the potential physical impacts of a changing climate on their balance sheet, alongside understanding the possible risks from the global low-carbon transition.
Investors were taking positions on climate change before COP26
Investors and financial institutions are pushing companies to set GHG emissions reductions targets, with a particular focus on achieving net zero emissions. Net zero focuses on reducing emissions generated through human activities as far as possible and then balancing residual emissions with removals from the atmosphere.
Achieving net zero emissions by 2050 will be critical to limiting the global average temperature increase by the end of the century to 1.5°C from pre-industrial levels and preventing catastrophic climate outcomes.
The focus on net zero is reflected not only in investment funds and asset managers committing to net zero portfolios or publicly advocating for their assets to reduce emissions, but also by global and domestic climate initiatives or financial sector industry groups as a collective. Under the Net-Zero Asset Owner Alliance, 33 institutional investors representing USD$5.1 trillion in assets under management, committed to transition their investment portfolios to net zero emissions by 2050. Overall, net zero commitments “by or near mid-century” now covers 90% of global GDP.
COP26 ratchets up ambition
The Glasgow Pact makes historic reference to the "phasedown of unabated coal power”. While the language is weaker than the “phase out” in earlier revisions, the direct reference to coal, and fossil fuels more broadly, sends a clear market signal. Other notable pledges include the Global Methane Pledge, which aims to significantly reduce methane emissions by 2030 and a commitment to halt deforestation.
In a welcome surprise, China and the United States announced their intention to work together on decisive climate action this decade. COP26 set the rules for an international carbon market, landing agreement on many of the outstanding issues that had stalled private sector engagement. The new International Sustainability Standards Board will go some way in ensuring future sustainability reporting and climate targets are comparable, thereby supporting transparency, investor decision making and the allocation of capital in financial markets.
Following COP, the Investor Group on Climate Change Australia (IGCC) stated that the commitments made keep the goal of limiting global warming to 1.5°C within reach, accelerating investment towards net zero emissions. However, goals are one thing, action is another.
The IGCC said. “The net zero emissions transition is inevitable and already underway, and investors want to seize the enormous investment opportunities, worth trillions of dollars, that will be created. There is a huge opportunity to create new jobs and boost economic growth, but only for those countries that get ahead of the curve.”
Net zero and opportunities
Getting ahead of the curve could not be more important for Australian companies. COP26 has shown, more than ever, that international pressure on Canberra is high, and decarbonisation policy changes could come quickly. In the interim, with investors unable to rely on national policy frameworks, companies need to demonstrate how their activities align with climate objectives. Without this, companies could be exposed to decreased stakeholder confidence and investor appetite. Although the absence of policy undoubtedly creates uncertainty and additional risk for business, it could also provide opportunities for market leadership.
In the financial sector, the movement towards net zero is accelerating as institutional investors commit to climate alliances and wide-ranging decarbonisation initiatives. As COP26 highlighted, action to drastically reduce GHG emissions this decade is as important as a long-term net zero ambition. As a result, setting only aspirational targets or failing to disclose clear strategies for emissions reductions may expose companies to reputational and financial risk.
*Dr Peter Holt, General Manager, Strategy, Energetics. Dr Holt leads Energetics’ strategy team which works with Boards, executive teams, risk and governance professionals.
Primarily advising Australian and global investors, banks and fund managers, he provides insights into the impact of climate change and develops frameworks to achieve emissions reductions, manage risks and create market-based solutions. A published doctoral professional, he has delivered multiple decarbonisation projects to assist companies transition to a zero carbon 2050.