Autumn Investment Monitor 2017  

Investors have crucial role in global shift to decarbonisation

This article is part of
Autumn Investment Monitor 2017

Investors have crucial role in global shift to decarbonisation
‘The Paris accord is done’: investors should expect increased innovation to help combat climate change

Since the Paris Agreement entered into force on November 4 2016, global decarbonisation – the process of reducing the carbon footprint of a portfolio – has continued making great strides.

To achieve the climate objectives set out by the agreement, there will need to be a further $90trn (£68trn) of infrastructure investment over the next 15 years, meaning annual global investment needs to increase from $3.4trn to $6trn. This is why the financial community’s involvement is key to enabling the real economy’s sustainable transformation.

The mobilisation of investors in making the transition to the low-carbon economy possible is the reason why the decision by the US to leave the Paris Agreement will not have as much of an impact on the fight against climate change. 

Investors have taken an unprecedented interest in the topic of climate change. Taking the CDP (formerly the Climate Disclosure Project) as a benchmark, investors with around $100trn in assets under management are looking into climate-related financial risk. So what does this mean for the investment community?

First, long-term investors have acknowledged the market failure of climate change-related risks being mispriced in short-term markets. This has encouraged the management and disclosure of asset exposure. 

Market initiatives for knowledge sharing and best standard setting are being launched and supported by promises from large renowned investors. Take the Portfolio Decarbonisation Coalition, for example. It has gathered 29 of the world’s most prominent investors, representing more than $3.6trn in assets under management, and committed to align in excess of $600bn worth of assets with a low-carbon economy.

Second, innovative climate finance products are becoming less scarce with the rise of responsible behaviour, which is encouraging the early adoption of solutions such as low-carbon indices and green bonds. Having doubled in 2016, the green bond market is expected to reach close to $60bn in value by the end of the year. 

Crucially, governments are realising the potential of using investors to meet their climate targets, after implemented a number of initiatives. The most noteworthy is France’s Article 173, which encourages both disclosure and contributions to investments that fund the low-carbon energy transition.

Looking ahead, investors should expect increased innovation to help combat climate change, and developments specific to each asset class. Although different investment models present their own challenges, there has been significant progress on the market in addressing these.

In equities, the difficulty comes from the time horizon, complexity and scalability. Low-carbon indices help reduce climate-change risks over the long term without impacting returns in the short term. They generate a free option on a mispriced asset, addressing the time horizon issue. 

For complexity, these products focus on corporates that could be impacted instead of trying to identify the next successful green technology. Finally, regarding scalability, the underlying market is $6trn.  

For infrastructure and real assets, obstacles stem from the lack of knowledge and long learning curve. One innovative solution to address these concerns has been to set up a strategic partnership with an energy infrastructure company in order to facilitate the financing of green real assets.