Investors are warming to opportunities stemming from climate change, and other takeaways from COP28.
COP28, the latest United Nations Conference of the Parties on climate change, delivered mixed results on some key agenda items but provided new insights into climate-related opportunities and the initiatives needed to implement them. For investors, some of the most interesting discussions concerned opportunities in the form of transition finance, adaptation, blended finance, carbon markets and nature-based solutions.
Funding challenges—especially against a difficult global backdrop of looming elections in the US, Russia and elsewhere, high debt burdens and interest rates, and rising geopolitical tensions—were readily apparent. But so were potential opportunities for climate-related investment.
Investors Warm to Opportunities and Solutions
The need for mitigation and adaptation—particularly in hard-to-abate industries such as steel, cement, transportation and energy—appeared to resonate strongly with investors. Opportunities included scaling up technologies such as clean hydrogen, energy storage, carbon capture and storage, and direct air capture and storage, using government support (through policies such as the US Inflation Reduction Act) and blended finance.
To that end, the COP28 Presidency unveiled the Global Decarbonization Accelerator, a set of initiatives focused on scaling up new energy systems, targeting noncarbon greenhouse gas emissions and decarbonizing energy systems today.
Among market-led developments, the Institutional Investors Group on Climate Change finalized its guidance on climate solutions, while several firms predicted the emergence of financial products, including exchange-traded funds, that claim to address the physical risks of climate change.
According to global consulting firm McKinsey, helping higher-emission industries and economies pivot to a lower-carbon economy would involve spending US$275 trillion on physical assets for energy and land-use systems between 2021 and 2050.1 The average annual spend of US$9.2 trillion would be US$3.5 trillion more than the current outlay. The transition would be universal, significant and front-loaded, with uneven effects on sectors, geographies and communities, even as it creates growth opportunities.
Renewable energy and nuclear power featured in high-level announcements, with heads of state and governments pledging to triple renewables capacity to at least 11,000 gigawatts by 2030, and to double the global rate of improvement in energy efficiency from 2% to 4% annually in the same time frame.
More than 20 countries led by the US launched a declaration aimed at tripling global nuclear energy capacity by 2050, urging other countries to join and inviting shareholders of international financial institutions to push for nuclear power to be included in lending policies. Many decision-makers aired concerns about a potential dearth of appropriately skilled human capital for the scale and depth of such economic transformation.
Overall, the transition could result in a loss of about 185 million direct and indirect jobs and a gain of about 200 millon globally by 2050.
Loss and Damage Fund—A Win for Adaptation
One of the most decisive measures announced at COP28 was the establishment of the Loss and Damage Fund to compensate developing countries for the physical effects of climate change. After years of negotiation, the faund, which will launch in 2024, received pledges of more than US$700 million from countries at the event.
This is well below the US$387 billion a year that developing countries need, according to the United Nations Environment Programme (UNEP)’s Adaptation Gap Report. To complicate matters, public multilateral and bilateral adaptation flows to developing countries were down 15% to US$21 billion in 2021.
One of the ways to increase funding, according to UNEP, is for the Loss and Damage Fund to move toward more innovative financing mechanisms.
Blended Finance Needs a Fresh Approach
Despite criticism of multilateral development banks (MDBs) and development funding institutions defering excessively to the interests of the advanced economies that fund them, there is little appetite to change these organizations’ charters, given the elections underway or on the horizon in many large donor countries. Some institutions are stepping up their involvement in climate finance. The World Bank, for example, has committed to allocating 45% of its capital to climate-related transactions.
MDBs provided about US$5.5 billion in climate-related blended finance between 2015 and 2022, but more is needed. To this end, according to the Climate Policy Initiative, public financial institutions need to move from project-based approaches to more coordinated country platforms with local financial insitutions or national development banks.
Observers were cautious to point to blended finance as a panacea for enabling climate-related finance to developing countries. However, many investors noted that public financial institutions will have an increasingly critical role to play in derisking transactions at scale to enable private sector capital flows.
VCMs Lose, but Nature Gains Ground
In a setback for voluntary carbon markets (VCMs), which have been plagued by allegations of greenwashing, the conference failed to agree on new rules that would create a central accounting system for countries and companies to offset and trade their carbon emissions.
But nature-related solutions—which intersect strongly with emerging markets, blended finance and VCMs—won a share of the spotlight, underlined by the launch of a financial roadmap for restoring and preserving mangroves, which sequester carbon at three to four times the rate of terrestrial forests.
Many leaders also pointed to Ecuador’s debt-for-nature swap that was executed in May as an example of how developing countries could potentially capitalize on natural assets and address biodiversity risks.
The Global Sovereign Debt Roundtable initiative announced at COP will see the International Monetary Fund, the World Bank and India facilitate discussions on the management of sustainability issues, sovereign debt restructuring and relief to emerrging-market countries.
Opportunities Grow, but the Right Approach Is Critical
As countries and governments struggle to reach consensus on curbing emissions in core areas such as fossil fuels, the focus on climate solutions is likely to grow. For investors, this suggests an increasing array of opportunities in mitigation, adaptation, blended finance and nature-based solutions.
It also underscores the importance of specialist climate knowledge, robust fundamental analytics and an active management style as the key to unlocking those opportunities.
1 McKinsey said its analysis was not a projection or prediction and did not claim it to be exhaustive but rather was a simulation of one “hypothetical, relatively orderly path” toward 1.5⁰C using the Net Zero 2050 scenario from the Network for Greening the Financial System.
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 revision over time.
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