By Sara Rosner Director, Environmental Research and Engagement—Responsible Investing, Adriaan du Toit Director—Emerging Market Economic Research; Senior Economist—Africa, Markus Schneider Senior Economist—EEMEA

COP27, the latest United Nations Conference of the Parties, concluded recently with mixed results on some of the key agenda items. In our view, though, the event will be remembered more for the way it shifted the global climate-change debate.

For the first time in recent years, emerging nations were front and center at the conference, shaping the agenda and receiving clear recognition of their importance in the world’s response to climate change. As one speaker put it, “The battle for climate change will be won or lost in Asia, the Middle East and Latin America.”

The biggest impact may have been from forcing two key topics onto the agenda. The first is adaptation—the need for countries, industries and consumers to prepare for further physical impacts from climate change, adjusting their behaviors accordingly. The second topic is loss and damage, which touches on accountability for adverse climate impacts. In fact, emerging nations successfully fought to include a roadmap to a loss-and-damage fund in the COP27 agreement.

A Small Win for Adaptation, a Bigger One for Loss and Damage

The adaptation and loss-and-damage topics cut straight to the scale and on-the-ground reality of climate-change impacts and the expense of addressing them. Just 7.5% of all climate financing is channeled to adaptation; the rest is used for reducing carbon emissions. Of the estimated US$2.4 trillion a year needed to fund emerging countries’ 2030 transition efforts, more than half will come from external sources, according to a report from the London School of Economics and Political Science released at the conference.

In a modest win for adaptation, countries agreed to commit a total of US$3.18 billion over five years to fund early warning systems. Though the amount is relatively small, the deal was encouraging, given that adaptation was on the agenda for the first time. A bigger win was an agreement to work toward establishing a fund for loss and damage—another agenda first-timer—to help poorer countries recover from climate-related damage.

Progress on the fund may not be smooth or immediate, but language in the agreement seeks to spread capital sourcing beyond developed countries to financial institutions and other organizations. The first step: establishing a transitional committee to explore ways to make the fund operational, which will be reviewed at COP28 next year.

More Urgent Action Needed to Tackle Emissions

Data published during the conference highlighted the urgency of the climate challenge. A draft of the US government’s Fifth Annual Climate Assessment found that the US, historically the biggest polluter, has warmed 68% faster than the planet as a whole over the past half century.

In its Provisional State of the Global Climate in 2022 report, the World Meteorological Organization noted unprecedented rates of rising sea levels, record ocean heat waves and severe weather events. The world has warmed by 1.15 degrees Celsius, leaving little wiggle room to achieve the 1.5-degree goal under the Paris Agreement.

Given the urgency of the backdrop, there was general disappointment in the actions taken to tackle emissions. The final COP27 agreement called on countries to accelerate “efforts towards the phasedown of unabated coal power and phase-out of inefficient fossil fuel subsidies,” instead of phasing down all fossil fuels. This language also left the door open for more use of natural gas—though cleaner than coal, it still releases significant amounts of CO2 and methane. Also, the agreement called for countries to renew targets every five years instead of yearly. In a departure from discussions at previous COPs, this year’s agreement did not call for emissions to peak by 2025.

Partnership: A Key to Effective Financing Solutions

The financing challenge focused attention on ways to better channel capital to emerging markets, particularly in support of adaptation efforts and low-carbon projects. A key issue at hand is investors’ ability to feel confident about governments’ commitments to the energy transition and a steady flow of investable projects.

To that end, a new level of partnership between public agencies and private sectors is critical—one that transcends traditional interactions between development-finance institutions and governments. There must be more innovative structures involving a wider range of stakeholders to help ensure a predictable supply of projects at suitable scale.

Partnerships should also promote and facilitate innovative public-private finance approaches, with instruments backed, where relevant, by concessional, philanthropic and blended finance—the use of development finance to attract other forms of funding. Connecting with partners on the ground and using local as well as international banks and finance services is essential.

South Africa, for example, has mapped out the use of an $8.5 billion financing package from wealthier nations to decommission coal-fired generation and develop renewables, among other efforts. Meanwhile, the US and Japan are among a group of countries offering Indonesia as much as $20 billion to transition its power-generation mix away from coal.

Adaptation and related physical risks brought the role of insurers into sharp relief at COP27. The most advanced firms in this area are partnering with governments to develop networks focused on repairing assets to prioritize resistance to climate-change and future-proofing. These networks are also thinking through commercial opportunities from de-risking transition-critical assets; insurers recognize that adapted assets are lower-risk. Better data for early warning, monitoring and other uses is also an imperative.

Carbon Offsets and the Role of Biodiversity

Carbon offsets and markets, initially expected to dominate COP27, were upstaged by adaptation and loss and damage. However, a statement from the International Monetary Fund that carbon would need to be priced at $75/ton in order to meet a 1.5-degree trajectory created headlines.

The US announced an Energy Transition Accelerator, an initiative to create a new class of carbon offsets based on investments that help accelerate renewable energy projects or resilience in emerging countries, though there are concerns that it might reduce the impetus for governments and companies to remove or lower their own real-world emissions.

Much of the discussion about carbon offsets focused on nature-based solutions such as planting trees, agricultural projects or protecting forests from destruction—and the potential opportunity for emerging countries in this arena. There was also significant emphasis on the role of nature and biodiversity in addressing the physical risks of climate change.

Evolving Opportunities and the Need for a Just Transition

Conversations about possible transition-related commercial opportunities could usher in what was referred to as a “second era” of climate finance.

The first era focused on setting standards, making commitments and scaling up renewables in developed markets. The second would target implementation and action: sustainable consumption patterns, decarbonizing food systems and buildings, scaling emerging technologies and materials, and growing the role of nature and renewables in emerging markets. Businesses recognized the consumer demand for nature-based and climate-positive processes, systems, products and services. But they also called on governments to do more to incentivize consumer spending and help businesses that deliver environmentally safe goods and services.

Another key issue is ensuring a just transition that doesn’t leave some groups behind, yet there’s a shortage of human talent with sustainability and climate skills. Investing in education and training must be a priority for the public sector, along with cultivating entrepreneurs and startups. This imperative applies to companies, developed markets and financial-services firms.

Investors Will Need to Go Beyond Their Comfort Zones

Several speakers pointed to the need for investors to understand and manage the risks of adaptation for issuers, arguing that investors should research these risks with the same level of commitment they give to emissions reductions—their main focus to date.

Discussions about the structure and financing mechanisms of the proposed loss-and-damage fund will be of particular interest to credit investors: it’s likely to become one of the main intersections of climate-change and country risks, especially for lower-income countries initially.

Institutional investors admitted that enhanced partnership-finance or blended-finance arrangements would require them to go outside their comfort zones to embrace a number of firsts, such as investing directly in infrastructure or in private rather than public companies, as well as engaging in new markets and with new counterparties that have different shades of political risk.

To sum things up, the formal part of COP27 is over, but the real work for investors has just started—implementing its lessons into their research and strategies.

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 change over time.

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AllianceBernstein

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