From COP21 to COP23: What are the signals that investors should be looking for from the COP in Bonn?

And so the circus returns. The climate COP in December 2015 was such a landmark, but it’s not easy to dismiss the reflex thought that these big international gatherings on the climate change negotiations (or, to give the annual meeting its proper designation, the Conference of the Parties (COP) UN Framework Convention on Climate Change (UNFCCC)) have invariably failed to deliver. But the Paris Agreement– where, crucially, every country agreed that they are obliged (though not legally bound) to make their own individual contribution towards tackling climate change – really did change the game.

Two years on from that historic meeting, delegates meet from 6 November at COP 23 in Bonn in a somewhat ambivalent mood. On the one hand, the momentum continues, driven by policy makers, investors, corporations, cities and municipalities. There is a prevailing consensus that: not only is the transition to the low-carbon economy underway; but that a combination of domestic policy measures around the world and the spiralling fall in the costs of wind and solar technologies means that this transition is accelerating.

On the other, the worst fears of 12 months ago, when COP 22 in Marrakesh was greeted by the surprise election of Donald Trump to the US Presidency, have been realized. In May, Trump announced that he will withdraw America from the Paris Agreement because “it’s a bad deal for the US”. In procedural terms this withdrawal will take four years to complete, but one of the sub-plots in Bonn will be how the US delegation behaves: passive bystander or disruptive participant?

Bonn will make no major decisions. But it still matters for investors who want to better understand the scale, pace and implications of the low-carbon transition. At the high level, the most important takeaway will be whether this international climate show stays on the road. 2018 will be a more significant year: it will be the first occasion for the parties to come together to assess their progress against the national emissions reductions goals they submitted to the Paris Agreement. So COP 23 will be about finalizing the rulebook for this 2018 stocktake (known as the “Facilitative Dialogue”), and making sure the building blocks are in place.

On the geo-politics, the investment community should be reassured that no other industrialized country is following the US through the Paris exit door. On the contrary, although there remain tensions between developed and developing countries about how ambitious their national climate polices should be, the indications are that Trump’s climate stance has if anything stiffened the resolution of the rest of the international community to stick firmly with Paris.

Critically, this includes China; and all stakeholders will want to be reassured that China’s behaviour on the international stage is in line with the stream of domestic policy announcements and measures on decarbonization to have emerged in recent months.

Signals from financial policymakers and regulators are also key for investors. COP 23 may not have much to deliver on that front – although it’s worth recalling that the Taskforce on Climate-Related Financial Disclosures (TCFD) was launched by Mark Carney and Michael Bloomberg at the Paris COP two years ago – but it will be followed hotfoot by the international climate summit that President Macron is convening in Paris in December, to mark the two-year anniversary of the Paris Agreement. The French have determined to make climate finance the focus of this summit, and they are pushing for a number of announcements. It will be interesting therefore to hear what that summit says about the TCFD, perhaps the European Commission’s High-Level Expert Group on Sustainable Finance – and on bringing the Sustainable Development Goals into investor and finance planning, where there is something of a push. The summit will also help showcase the policy framework, symbolized by the Energy Transition Law, the French are adopting on climate and transition risk disclosure.

COP 23 isn’t all about policymakers, of course. A developing theme in recent years has been how investor coalitions have used the COP to launch initiatives. We may for example hear from the PRI and UNFCCC and their work and engagement on ESG in credit ratings; from the UN, World Bank and investors on developing blended finance vehicles and tools to contribute towards the sustainable development Agenda 2030; and from the Sustainable Stock Exchanges (SSE) Initiative on their new “Guidance on Green Finance”. Green and sustainability bonds will remain high on the COP agenda; as well as the financing of sustainable infrastructure, including at cities and municipality level. Individual corporates may wish to use the meeting in Bonn to highlight the progress they are making with TCFD and SDG commitments in relation to strategy, disclosure, governance, targets and metrics.

Which is a long way of saying there’s a lot going on. Investors should stay firmly tuned over the next few weeks. See you in Bonn – or Paris.

 

(This article was also published in RI news on the 6th of October 2017)

 

How policymakers can drive the TCFD agenda, with Europe in the driving seat

As published on Responsible Investor.com on the 12th of September 2017

The EU’s HLEG recommendations can dovetail with other regulatory changes to back up the climate reporting shift.

There has been extensive commentary on the work of the Taskforce on Climate-Related Financial Disclosures (TCFD), first on its formation and then on its recommendations, which were presented in final form to the G20 in Hamburg in July 2017.

In short, the TCFD is a big deal; and the reaction has served to emphasise that following the watershed Paris Climate Agreement in December 2015 change is underway in the financial community, as it is for other parts of the economy affected by the climate and energy transition. Less considered is how policymakers and regulators can help drive this key agenda relating to disclosure and climate risk.

The first point to make is that the TCFD’s genesis is policy-based. It was the G20 who first pulled the trigger in 2014 when its finance ministers met. Following their initiative, Mark Carney, as FSB Chairman, and fresh from his own high-level interventions on climate change and the “tragedy of the horizon”, approached Michael Bloomberg about establishing the Taskforce.

It has therefore come full circle for the TCFD to present their report to the G20. But there’s a problem. Although taskforce members themselves have indicated that their recommendations are aimed as much at policymakers and regulators as they are at the business and finance community, the G20 now doesn’t know exactly what to do with the report.

The G20’s July communique carried only a reference to the TCFD report, and made no attempt beyond that to take it forward, either directly or indirectly. The primary reason for this is quite simple: the depressing reality of US federal climate policy in 2017, and how that has spun on its axis since 2014 when a rather different US administration was in office.

To be clear, even if Obama (or Hillary Clinton) had been in office, there would have been limitations on the G20’s mandate to direct action on the TCFD report. But with US international climate policy under Trump playing unwilling participant or blocker, the G20’s political will in this area is fractured. Those who advocate making the taskforce recommendations bite therefore need to look elsewhere if policymakers and regulators are going to act.

The EU – or European countries – have for some time looked the most likely candidates to carry the TCFD torch. This is not only because of the leadership shown by senior figures such as Carney. The last 12 months have demonstrated that even if they were initially late to the game on the implications of climate risk for finance and investment, the European Commission now really seems to have grasped it. The catalyst was Financial Services Commissioner, Valdis Dombrovkis, the former Prime Minister of Latvia, fresh from his appointment in the summer of 2016, and his decision to add substance to the deliberations about climate finance in the Capital Markets Union (the Commission’s flagship finance initiative under President Juncker) by appointing a “High-Level Expert Group” (HLEG) on sustainable finance.

The HLEG has just published its interim report, prior to a final report that will go to the Commission at the end of 2017. The signs, in the report’s ambition and scope, are promising. The interim report carries unqualified endorsement for “clear, comprehensive and comparable” disclosure of information, and it cites the need for forward-looking analysis on how portfolios are aligned with the transition. On the latter point, proponents of a stronger disclosure regime are highly supportive of scenario analysis, where corporates (and possibly financial institutions) run publicly available assessments about how they will tackle the climate and energy transition under different policy and technology scenarios. This constituency will therefore welcome the report’s positive reference to scenario analysis (specifically giving climate-related disclosures in the energy or extractives sectors as an example).

A key point about the HLEG is that it will be reporting into a regulatory environment that offers opportunities for incorporation into existing or promised initiatives. Two such possibilities are the EU’s Prospectus Regulation and the Non-Financial Reporting Directive (NFRD), both of which deal with aspects of corporate reporting. The updated Prospectus Regulation, having entered into force very recently, has now been passed on to the relevant EU-wide body ESMA (the European Securities and Markets Authority) which will draft guidance, including possibly on what factors should be publicly disclosed as material factors in company prospectuses. The NFRD does what it says on the tin, laying down the rules on the disclosure of non-financial information by large companies. It has been criticized for its lack of specificity and that it risks placing ESG information in a silo. But it is being reviewed in 2018, and there will be pressure on the Commission to take account of HLEG proposals in the review.

That said, there will inevitably be challenges to what the HLEG recommends, and investors (corporates and financial institutions) will need to be alert to signs of push-back from opposing interests: e.g. business coalitions or national regulators who are unenthusiastic. The IHS Markit report in May which questioned the TCFD recommendations on scenario analysis – on the grounds that it could undermine efficient capital allocation – demonstrates how progress may not be straightforward.

It is also worth noting the potential for other international bodies to push forward policy and regulation on climate-related financial disclosure. IOSCO (the International Organisation of Securities Commissions) is essentially the international equivalent of ESMA and, although it may not have the regulatory mandate that ESMA has inside the EU, IOSCO wields considerable influence in setting standards for capital markets. It would therefore be surprising if this organization has not been prompted by the TCFD report to examine the climate disclosure agenda.

The other field that investors must monitor is national regulators. Again, we probably come back to Europe – and especially the French and German financial regulators (the AMF and BaFin respectively) – as those most likely to move. Still feeding off the post-Paris momentum and energized by their new President’s ambitions to do more on climate, the French have their Energy Transition Law – which inter alia strengthened carbon disclosure requirements for listed companies – to build on. The German Government would like to have done more with the TCFD report at the recent G20 summit; the question is whether they and their regulators will want to push on with the agenda once the German election is out of the way.

Franco-German interest also poses the question about how active UK policymakers and regulators will be. The UK Treasury and the Corporation of London would like the City of London to be the global green finance hub – witness the Corporation’s Green Finance Initiative. But there must be a concern that, with Brexit demanding so much time and attention, UK regulators are too preoccupied to be in the vanguard. It can’t help that the British Government is losing influence in Brussels, which is most disappointing when taking into account all that the Brits have done to drive forward the EU climate and energy agenda. Against this background in Europe, it would be no surprise to see a dynamic develop between EU-wide action and the priority accorded by the most progressive regulators. This brings us back to a core question: can government make a difference on this agenda through a pro-active approach; and do investors actually care about the policy and regulatory implications and developments?

In Conclusion

TCFD members, based on the track record of taskforces of this kind, are confident that business and finance will act on their recommendations. That seems reasonable. Peer pressure can be powerful, and a combination of action from the most forward-thinking companies and shareholder initiatives (e.g. on AGM resolutions) can help push things forward.

The HLEG’s emphasis towards a sustainable financial system through integrating ESG factors fully into financial decision making is also highly encouraging. In line with this, HLEG’s advocacy for harmonization of acceptable definitions and frameworks around ESG and sustainable finance at EU level addresses something that has plagued and hindered the scaling of the sustainable and responsible finance industry globally.

However, although there is undoubtedly rising interest in climate risk among the investor community, caution and a view that climate change is tomorrow’s problem rather than today’s (in effect, reinforcing Carney’s fears about the tragedy of the horizon) can still be strong restraining factors. Likewise, regulators can be cautious beasts. There are therefore risks that investors and regulators will hold each other back, which could undermine an orderly climate and energy transition. In short, more national regulators will probably need to stick their necks out and show some leadership; and investors – who are advised to stay fully on top of the policy agenda, above all in the EU (think for example about responding to the HLEG consultation in train) – would be advised to engage with governments: it’s always more productive to try to influence change than be a passive bystander.

Post-Election Enlightment: Where Does The Minority Conservative Government Go On Climate And Energy?

Despite some attention on the Conservatives’ so-called “price cap”, and Corbyn’s Labour proposing a form of energy sector industrialization, energy policy was a dog that mostly failed to bark during the recent election campaign. That was even more the case where climate change was concerned, notwithstanding President Trump’s attempt to put the issue on the political agenda by his decision to withdraw the US from the Paris Agreement.

Since the election on 8 June, the state of British politics and the position of the British Government has been in a state of flux, to put it mildly. Now that Theresa May has reached an agreement with the Northern Ireland Democratic Unionist Party (DUP) that will provide some stability at least for the short-term and has allowed the Queen’s Speech to pass, it seems a good time – for all those in the business, civil society and policy world who take an interest in such things – to examine the prospects for climate and energy policy under this new government (assuming it lasts at least into 2018, which is not guaranteed).

Even if debate did not really catch fire, the manifestos did reveal some stark differences between the main protagonists. Conservatives and Labour may have been in agreement on a variant of the price cap. Otherwise, they projected competing policy approaches. The governing party – even if they are now pursuing a more interventionist line than Margaret Thatcher would ever have contemplated – took a business-as-usual approach, supporting fracking, more nuclear and maximizing North Sea resources. The Tories also made clear their opposition to onshore wind farms, although there was a clear endorsement of the offshore sector.

Labour, by contrast, were more forward-leaning on a low-carbon approach, demonstrating an intent that it should be in the mainstream. As part of their “sustainable energy policy” (based on the energy trilemma), Labour were more full-throated on the benefits of the low-carbon economy and renewables projects. They also said that they would ban fracking because of the risk of lock-in to high-carbon projects, and made a more overt connection between investment and an industrial strategy.

This is all worth factoring into the new post-electoral landscape of uncertainty and volatility, in that the Government’s “supply and confidence” agreement with the DUP may not necessarily extend to energy policy, and that the views of Labour and the small parties might have a disproportionately stonger influence on the direction of policy. They have arguably already had an impact, in the light of the Government’s decision to exclude fracking from its Queen’s Speech programme.

Before going on to consider what might be the policy priorities over the next few months, we should note that just last week, the portfolios of BEIS Ministers were finally confirmed. The positive news, which we already knew, is that Greg Clark will provide some continuity – and hopefully complete some unfinished business – by remaining in place as Secretary of State. Less reassuring is that Nick Hurd and Jesse Norman, having made favourable impressions as Climate Change and Energy Minister respectively, have moved on to other departments, to be replaced by Claire Perry and Richard Harrington. Perry at least has some ministerial experience, from the Department of Transport, and it of course not Harrington’s fault that he is the 19th Energy Minister in as many years. But this will inevitably mean further delays on departmental business as the new ministers get familiar with their portfolios.

The other dominating factor is, of course, Brexit, which casts a shadow over climate and energy policy as it does over the whole of Whitehall. This piece will return to Brexit later on.

Investors would claim that BEIS and related departments can have no bigger energy-related priorities than the twin subjects of the Government’s Industrial Strategy and BEIS’s Clean Growth Plan (if this is in due course what its emissions reduction plan will be called). However, politically, there may be no urgent or daunting challenge than air pollution in British cities. Theresa May’s majority administration was, exceptionally, compelled by Court order to publish its Air Quality Plan in early May during the election campaign. The plan was met with widespread criticism for its basic approach: passing responsibility for action to local authorities with little in the way of concrete proposals or guidance, and no additional funding. As Client Earth and other indefatigable campaigners have made clear, the pollution in our cities is a public health emergency. Given the lack of anything substantial to say on this in the Queen’s Speech, the Government is likely to come under major pressure from parliamentary and non-parliamentary sources to take firmer action.

The way that the air quality and climate change debates have come together (most conspicuously in China, but also increasingly in the UK) has been striking over the last 12 months. If pollution is the most urgent challenge, then the investment community and all sorts of other stakeholders are becoming restive with what they perceive to be the Government’s “dithering” over its plans to back up its commitment to Fifth Carbon Budget targets under the Climate Change Act. The Clean Growth Plan had been Nick Hurd’s baby pre-election, and seemingly not long from publication then. The change of Ministers will cause a further delay – Q3, probably September, is now the latest time being suggested – but this plan will be vital when it does finally issue, for the following reasons:

it is meant to provide the evidence that – despite signals to the contrary, notably the thrust of the manifesto itself – the Government does want to make good its oft-repeated commitment to the Climate Change Act by looking beyond what has already been achieved on decarbonisation, notably in the power sector, to addressing some of the “tougher nuts” on carbon reduction;

one of those tougher nuts, as an excellent report from Policy Exchange has just reminded us, is the transport sector. The Government up to this point has shown mediocre leadership in this area, failing to devise a coherent, joined-up strategy which can support the development of the electric vehicles sector, bring down emissions and clean up the air pollution caused by conventional vehicles – a reminder again of how climate and air quality are now coming together;

it might finally plug the glaring gap in government energy policy since the collapse of the Green Deal, the vaunted flagship energy efficiency scheme under the coalition government. The Government desperately needs a new policy direction in this area, taking advantage of technology developments and the consultation on a smart flexible energy system that it ran before the election. Over the last two years, announcing the abolition of the Carbon Reduction Commitment (CRC) energy and emissions savings scheme and scrapping the commitment to zero-carbon homes, it has been heading in the opposite direction.

Other uncertainties prevail where the Plan is concerned. One of the policy areas that Nick Hurd was deliberately over was: whether the UK should remain part of the EU Emissions Trading System (ETS) when it leaves the EU; and, if it does leave, whether the Government should create a UK-only ETS or develop the carbon floor price mechanism to go the whole hog with a carbon tax. The March Budget put the whole area of carbon pricing on hold until the next Budget, which will probably be in November. A further complicating factor relating to the ETS is that Brexit D-Day in March 2019 is out of sync with the end of Phase III at the end of 2020: an example of where judicious transitional arrangements might come into play, perhaps.

We are also still awaiting the results of the consultation that the Government ran pre-election on its proposal to phase out coal power on the grid by 2025. By all accounts, they remain committed to doing this; but confirmation of that decision would provide some much-needed certainty for the power sector. It would also surely confirm the transformation now taking place in real time, exemplified by the hot summer day of 19 June when low-carbon sources (wind, solar, nuclear) were responsible for an unprecedented 70% of UK power generation that day.

It’s conceivable, linked to the coal phase-out, that the Clean Growth Plan will also have some news about carbon capture and storage – Greg Clark is reportedly supportive. Despite the carrot of potential government support stretching back to the last Labour government, no CCS project has got off the ground in the UK, while progress is being made in countries such as Norway, the US and China. There is indigenous engineering expertise; but time is moving on if CCS is to have the impact at scale on carbon reductions that its advocates claim it can make.

Underpinning so much of this agenda is the financial support that the Government, ie HM Treasury, is prepared to give to low-carbon technologies through its mechanism of the Levy Control Framework (LCF). At the last Budget, Treasure announced that the LCF would “be replaced by another set of controls later in the year”. No announcement has yet been forthcoming, but this will be extremely important, in particular for the direction of travel it would imply for investors.

Apart from the Clean Growth Plan, the other two big indicators on the direction of policy – at least up until the autumn, when Budget considerations will start to loom large – will be the Industrial Strategy and of course the Brexit negotiations.

The Industrial Strategy is another initiative that was put on hold by the Election. For a political party that had for nearly four decades followed the mantra of “the market knows best”, the establishment of a strategy to set direction for British industrial policy was a big deal. But its scattergun approach did not feature energy as prominently as might have been expected, let alone propose that the low-carbon economy be at the heart. Attention to these two fundamental points would provide some welcome clarity and definition to the Government’s approach, and set some policy direction for investors: isolated support for electric vehicles is not enough, it needs to be part of a coherent, long-term approach. But all this will depend on what the Government heard in the consultation and whether they are able and willing – bearing in mind their weak political situation – to be clearer about their priorities.

The final version of the Industrial Strategy will also prove whether this government still has an appetite for large infrastructure projects. Heathrow 2.0 and HS2 garner much media attention, but what the strategy says about the Hinkley Point C nuclear reactor should be of major interest, in the light of reports that it will be years late and over budget, and the fact that it was not mentioned in the Tory Party manifesto.

It has become a truism, but that is the case because it’s true: Brexit will dominate governmental and parliamentary business over the next two years. It will have an impact on energy policy as over other sectors of the economy and, even if the Brexit pre-negotiations have given no sign that energy will be high up the agenda, there will be at least two problematic issues.

First, discussions about the future trading relationship between the UK and the EU have particular resonance for British access to the Internal Energy Market. The Government’s increasing dependence on cross-border interconnectors (which might become even more important if Hinkley Point C fails to deliver on time or somehow collapses altogether) to supply electricity and gas might conceivably be imperiled if there is an unsatisfactory post-Brexit deal (or, worst of all possible worlds, no deal).

Second, the May administration will surely be mindful of how the Irish dimension could trip them up in the Brexit talks, especially now they are reliant on the DUP for parliamentary support. An important part of this dimension is the all-Ireland electricity market. The Single Electricity Market (SEM) has been an important part of the peace legacy, and people in Northern Ireland the government in the Republic will be anxious to ensure that its multiple benefits are preserved.

In conclusion, setting aside its shaky political predicament, the Government has much on its side to drive a refreshed energy policy vision that could please investors and consumers. It has a positive story to tell on emissions reduction: as coal has come off the grid, the UK is leading the way in Europe, recording the largest decrease in emissions among the EU-28 in 2015. Despite lukewarm governmental support and concerns about enough investable projects, low-carbon energy production and consumption is on a positive trajectory, bolstered by a public opinion which consistently shows considerably higher levels of support for wind and solar than for shale gas (and, incidentally, a minimum two-thirds public support for the Climate Change Act and UK alignment with the Paris Agreement). Although the Government and the media niggle away about energy prices, a new Climate Change Committee report – with a reminder amongst other things about the value of (EU-driven) energy savings polices – has shown that bills have actually come down in real terms since 2008. There also signs that the City of London is waking up to the opportunities in green finance, and the need for institutional investors to address climate risk: as evidenced by the City’s Green Finance Initiative.

Despite these favourable conditions, this Conservative administration still seems stuck in a half-way house: between the modernising wing of Ruth Davidson, acknowledging the impact of clean energy and new technologies; but constrained by a right-wing that is instinctively suspicious of wind farms and still harbouring some old-fashioned climate deniers in their ranks (a perception which the appointment of Michael Gove at DEFRA will not have assuaged). Hence the mixed messages which in turn have a negative impact, especially on finance and investment which is looking for policies that are clear, predictable and for the longer-term. A Prime Minister without much interest in the energy and climate agenda, and who lacks authority, is unlikely to be much help. The Government needs to project a joined-up energy policy vision for both domestic and European reasons; whether it is willing – and in the current political environment, able – is another matter.