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The talks at the COP21 in Paris were pure soap opera, but what else could this congregation of global leaders representing 195 countries with vastly differing economies and political outlooks ever be? Simmering superpower relationships were revealed, global billionaires flexed their investment muscle to a fanfare of press coverage, and the inevitable final-hour drama was delivered courtesy of China and the U.S. Notwithstanding, the deal reached calls for a collective effort to restrict global warming to “well below” 2C or 3.6F (calculated as the difference between 35.6F and 32F), with an “endeavour” to keep it to 1.5C or 2.7F and commits 195 countries to regular reporting to ensure accountability. The accord also calls for the world to reach net-zero emissions after 2050.
The fact that current climate pledges put the world on track for around 3C (5.4F) of warming highlights the significance of the deal. Deeper emissions cuts will have to be made later to stay below 2C, and each subsequent pledge must be more ambitious. Then there will be a legal obligation for developed countries to continue to provide climate financing to developing countries. Developed countries have promised to provide $100bn a year by the end of the decade, and this level of funding should be considered as a floor level for beyond 2020.
The consequence of Paris could, as a result, be far reaching. Tougher emissions targets look to be inevitable across the developed world. Companies will need to position themselves so that they can continue to progress even as environmental restrictions are increased. Growing investor wariness around unsustainable investments is well documented: in the last six months the Church of England, Norway’s sovereign wealth fund and California’s state pension funds (CalPERS and CalSTRS) have, amongst others, banned investments in coal. The Norwegians said at the time that “investing in coal companies poses both a climate risk and a future economic risk.” The Financial Times recently noted the rise of ‘active ownership,’ which seeks to challenge and change environmental, social and governance issues at companies, and joins a growing investor march towards sustainable investment – if not for the planet’s health, then for long-term returns.
We believe this is the time for smart management teams to recognise these moves and the COP21 accord as a clear signa
l to “go green” in order to thrive in the 21st century economy. Companies will need to add more detail on their environmental efforts, starting with clearly tracking emissions, and then showing their stakeholders how, and by how much, they are cutting emissions. Companies have many ways in which to communicate their efforts to the market: sustainability reports, presentations and press releases updating the delivery of key milestones in emissions reductions, Facebook and Twitter feeds, and so forth. We believe companies can garner benefit from the market if they consistently communicate their progress and future ambitions over climate change prevention. Thus, as the financial rewards and penalties become clearer, companies should look to display their "green" credentials centre stage.
Why? And what is next?
At the broadest level, we expect to see more government-led, legally-binding targets for emissions reductions in both the near-term (2020), mid-term (2025 - 2030) and long-term (2050). Remember that last October EU leaders agreed to targets of at least a 40% reduction in greenhouse gases and for companies to return to 1990 levels by 2030, as well as a 27% increase in renewables and energy efficiency. These could be revisited in the next decade now that COP21 has delivered. This is also the first time the U.S. has signed a global agreement – they were not signatories of the legally-binding Kyoto Protocol. However, eco-legislation remains far more difficult to introduce at a federal level. President Obama has made use of the Environment Agency for emissions control legislation, side-stepping the back-and-forth stalemate that appears to predominate with the U.S. bi-partisan system. The key to understanding U.S. sustainable investment therefore lies at the state level. Many states, such as California, already face climate issues, and this is creating “bottom-up” legislation to cut emissions and become more resource efficient.
The positive side is that businesses may benefit from greater continuity in government planning and construct clearer, more decisive strategies. However, the failure of the EU’s flagship carbon trading scheme suggests that unilateral and direct taxation measures may come to the forefront. Business laggards and “refuseniks” could face harsh penalties for non-compliance.
Investors know where this trade-off is going – simply witness the rising number mandated to avoid investment in “dirty” companies, and the increasing attention paid to environmental, social and governance issues by all investors.
A research report by Morgan Stanley published March 2015 put sustainable investments at $1 out of every $6 in 2014, with assets under management of $6.57 trillion. This study concluded that “investing in sustainability has usually met, and often exceeded, the performance of comparable traditional investments. This is on both an absolute and risk-adjusted basis, across asset classes and over time.”
A 2011 Harvard Business School study that reviewed the stock performance of 180 large U.S. firms found high sustainability firms significantly outperformed their counterparts: a $1 investment in 1993 became $22.6 by 2020 in the high sustainability portfolio, while the low sustainability portfolio reached $15.4, a 46% performance gap.
Finally, as another example, a 2014 meta-study by Oxford University of 200 studies, reports and articles on sustainability found that 90% of analyses on the cost of capital show sound sustainability standards lower the cost of capital of companies.
“Good” companies win long-term
In short, the market rewards “good” companies with cheaper funding costs, better stock price performance and lower stock price volatility.
Not too surprisingly, chief executives from blue chip companies like Coca-Cola, Dupont, General Mills, HP, Unilever and BP amongst others were all quick to express support for the deal. Some companies are expressing their plans through business groups. For example, a further 114 companies, including Enel, Sony, China Steel Corporation, National Grid, GlaxoSmithKline, IKEA, Proctor & Gamble, Kellogg, Unilever, Danon and NRG Energy announced they would cut their carbon footprint in line with science-based advice. The group, called the Science Based Targets Initiative (a joint effort of the World Resources Institute, WWF, the Carbon Disclosure Project and the United Nations), has combined carbon emissions of at least 476 million mt/year, equivalent to the annual emissions of South Africa.
Encouraging solar PV developments and energy storage, continuing efforts to improve insulation in buildings and use of LEDs, installing smart meters and planting (and keeping!) trees to offset emissions – these are all viable options for the near-term. Companies will now need to look at ways to reach beyond these near-term ideas to meet the ambitious goals that governments agreed to in the Paris accord. COP21 provides fresh impetus to eco and sustainable investing trends, making those companies who capitalise (and communicate) on them the true winners of the accord.
By Benita Barretto, Associate Partner in Finsbury’s London office
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