At times, you wouldn’t have been blamed for questioning the sincerity of the event, given its occasional theatrics. Although UK prime minister Boris Johnson’s opening speech seemed genuine and heartfelt, jokes about still being in office in 2050 were tone deaf. Meanwhile, UK finance minister Rishi Sunak waving around his big green briefcase didn’t do much to distract from the lack of concrete government regulation in his plans for the 'world's first net-zero aligned financial centre'. Greta’s labelling of it as a ‘greenwash festival’ is undoubtedly in the back of the minds of all those following COP26, and this was the theme seen with most media coverage of the event; ‘yeah not bad, but isn’t the world still going to burn?’. 

In the second week, US Special Presidential Envoy for Climate John Kerry, showed the world that green doesn’t just mean money in the US. Kerry successfully steered two powerhouse economies towards the US-China joint declaration to cooperate on climate change. The impact of such a deal is yet to be seen but the initial details offered a brief moment of relief for those watching the event unfold.  

At the last moment, a huddle involving the US, China and India resulted in China and India rejecting the wording on coal, and diluting the final text from “phasing out” to “phasing down” of coal production, something that Boris Johnson assures us will have little impact on the pathway to the end of coal. However, the result brought the COP president, Alok Sharma, to the brink of tears as he apologised for the lack of transparency over this issue as well as the final outcome. Critics say that the countries’ pledges will not do enough to keep 1.5°C alive, while the official line is that the goal is not dead yet, with the UN Secretary-General, Antonio Guterres, stating that it's “on life support”. Regardless, COP26 has seen some successes, the effects of which will be far reaching, even if not yet enough to secure our planet’s future. 

Deal roundup:

• 46 countries signed the ‘Coal to clean power transition’ statement, however, major coal producers such as the US, India and China failed to sign up, leaving out 72% of global coal usage. The final text saw the 196 governments present at COP agree to “phase down” coal globally. 

• Four of the world's five largest car manufacturers failed to sign a deal to ban the sale and purchase of diesel and petrol cars by 2040 (but the UK, Uber and hundreds of city and regional authorities have). 

• More than 80 countries pledged to cut methane emissions by at least 30% by 2030 compared with 2020 levels. The pledge covers countries that emit nearly half of all methane, and make up 70% of global GDP.

• A deal to end deforestation by 2030 signed by 134 nations (critics point out that a similar pledge was made by 200 countries in 2014, with little progress since).

• 45 governments pledged urgent action and investment to protect nature and shift to more sustainable ways of farming

• 19 countries as well as other corporate signatories agreed to the zero-emission shipping lane pact, which commits them to developing technology, expertise and port infrastructure that will allow key international shipping routes to go zero-carbon, and decarbonise by 2050. 

Other stuff

• The US and China signed a joint statement addressing the climate crisis, including an annual meeting, but the statement contained little in terms of emissions reductions targets.

• The Glasgow Finance Alliance for Net Zero’s (GFANZ) brings together 450 signatories across the financial sector, signing up $130trn of AUM to “deliver the estimated $100trn of finance needed for Net Zero over the next three decades”. Signatories are expected to meet Net Zero by 2050 across the assets in their portfolios and “deliver their fair share of 50% emissions reductions this decade”, reviewing targets every five years, first reporting on progress within the next year. Critics have pointed out that the plans don’t actually require by law anything that will hold companies accountable for a Net Zero transition plan, with calls for more government intervention and regulation. 

• The UK leads the way on the finance sector Net Zero drive with plans to create “world’s first Net Zero financial services centre” by essentially doubling down on the methods already in place. That means increasing (comply-or-explain) Net Zero climate disclosures for asset managers, asset owners and listed companies. The UK also created a new anti-greenwashing taskforce, with the purpose of providing more guidance to investors around credible decarbonisation strategies. 

• Reporting consolidated: The creation of the International Sustainability Standards Board (ISSB) has been announced. The idea is to build the pathway to a streamlined, mandatory reporting framework. The ISSB will consolidate the Climate Disclosure Standards Board (CDSB), an initiative of the Climate Disclosure Project (CDP) and the Value Reporting Foundation (VRF), which houses the Integrated Reporting Framework and the Sustainability Accounting Standards Board (SASB) Standards by June 2022. Good news for investors currently drowning in the ESG reporting framework alphabet soup. The ISSB could also support financial flows between developed and developing markets, a key element of the COP talks this year, resulting in increased awareness. 

• 1.5°C is slipping through our fingers; Nationally Determined Contributions (NDCs) will be revisited in 2022. Usually there is a five year cycle (also known as the ratchet) for countries to revisit and establish more ambitious NDCs, the UK position is that this is no longer frequent enough. Countries have agreed to revisit NDCs in 2022. However, Christiana Figueres, the UN climate chief who oversaw the 2015 Paris summit, called for annual updates.

• Denmark and Costa Rica launched the Beyond Oil and Gas Alliance (BOGA) in an effort to kill off fossil fuels in a phased approach. Only eight countries have signed the pact, with a further three members signed up as associates, while the alliance was friend-zoned by Italy as it joined with limited requirements. Notably the UK declined the offer to join BOGA, not wanting to fall off an energy ‘cliff-edge’ and spike prices any higher than the current surge. 

Policy implications

Although it looks as though COP26 has missed out on its fairytale ending – where planet earth is reunited with its long lost atmospheric CO2 levels and we all live happily ever after in a sub 1.5°C world – this doesn’t mean business as usual for companies or investors. Some pretty stringent policy implications are in the pipeline. The PRI’s Inevitable Policy Response (IPR) has predicted  the following ambitious measures following indicators seen at COP26:

Carbon pricing and the Article 6 hurdle

Article 6 of the Paris Agreement deals with how countries can use carbon offsets to meet the requirements of the Paris Agreement and trade carbon credits in a global market. After six years of negotiations, rules have finally been put in place for the global carbon market. The market is expected to pave the way for a boom in the trading of emissions credits. The results will have implications on companies across the board, as most are relying on carbon offsets for their Net Zero targets. More details available here.  A little further down the line, implications of the EU Carbon Border Adjustment Mechanisms (CBAMs) may lead to the US announcing a 2025 carbon pricing system, which the IPR report could result in a pathway to $65/tCO2e by 2030. The EU’s Emissions Trading System (ETS) commitments are also evolving, which may lead to a $75/tCO2e by the same date. 

Coal and clean power

Within the context of global temperature rise, this year’s coal deal fell short. Nevertheless, countries responsible for 28% of the world’s coal production are now in agreement to phase out use between 2030-2040, and the remainder of the 196 governments present at COP have agreed to begin “phasing down” coal, which although vague, will help to set the wheels in motion for the end of coal. Countries agreeing to the more concrete phase out approach include major European countries such as the UK, Germany, France and Spain (full list available here). This agreement will put pressure on many European HY companies to shift away from coal immediately, hitting fossil fuel intensive industries hardest. Although the US failed to sign the coal deal, Biden’s objective is to end all coal-fired power generation by 2035. By 2040 the US will likely implement a binding and credible 100% clean power standard for 2040, which will end unabated fossil fuel electricity generation, although the recent auction of a vast amount of oil and gas drilling leases in the Gulf of Mexico makes this feel like a distant future. On the other hand, a ‘Statement on International Public Support for the Clean Energy Transition’ put a stop to overseas oil and gas financing, along with the current exclusions on coal finance. The statement was signed by over 20 countries, including the US, Italy, and Canada – historically big funders of overseas fuel projects.

Zero emission vehicles

China, France, Germany, Italy and Korea will end the sale of petrol and diesel cars and vans by 2035, five years after the UK plans to. This will in turn drive the industry’s transition to Electric vehicles. Investors should watch out for HY companies that are reliant on car fleets, such as rental companies and supermarkets, and see if they have credible and timely EV vehicle transition plans in place.

Industry 

The IPR expects that all major economies including the US, Germany, Japan and China will require new industrial plants to be ‘low carbon’ by 2040, starting with steel and cement. This will be driven through a combination of carbon pricing and emissions performance standards. In the shorter term, the EU Carbon Border Adjustment Mechanisms (CBAMs) and increasingly stringent Emissions Trading System (ETS) commitments are also likely to drive up carbon prices and force any companies within the EU, or importing to the EU, to turn to greener industry energy sources over the next five years. Investors should analyse issuer’s energy transition plans and assess the risk faced by any laggards in this space.

Agriculture

An overlooked area of policy implication in this COP is within agriculture.  Notably, Brazil plans to scale its low carbon farming programme, saving 1bn tonnes of CO2 equivalent emissions by 2030. Germany’s plans to lower emissions from land use by 25m tonnes of CO2 equivalent emissions by 2030. The UK’s aim is to engage 75% of farmers in low carbon practices by 2030. IPR predicts that other major agricultural producers such as the US, Canada and Australia will have comprehensive mitigation policies in place by 2025 to reduce emissions from crops and livestock.

Land use

The deforestation deal marked one of the more successful pledges at COP26. 134 countries, including those that contain major tropical forests (Brazil), pledged to end deforestation by 2030. This will have implications for European high-yield issuers that produce wood and paper products such as paper packaging and biomass fuel, as well as those reliant on woody biomass for industry operations. Investors should keep a keen eye on these companies’ growth plans, as well as the number that have credible forestry certifications in place. 

Likely pathways to Net Zero emissions

Based on the predicted policy implications of COP26, the IPR and the International Energy Agency (IEA) predict the following global decarbonisation pathways. 

Energy and industry-related CO2 emissions

In short: the pink line is more ambitious than we currently have policies for, but realistic if we are to stay below 2°C.

Source: PRI COP26 Investor Event with IPR: Live from GlasgowSource: PRI COP26 Investor Event with IPR: Live from Glasgow

• IEA STEPS - Stated Policies Scenario (if countries adhere to policies currently firmly in place) - 2.7°C warming

• IEA APC - Announced Pledges Case (if countries meet their Net Zero targets on time and in full) - 2.1°C warming

• IEA SDS - Sustainable Development Scenario (what is needed to stay well below 2°C) - <2°C warming 

• IPR FPS 2021 - Forecast Policy Scenario (what IPR forecast as likely if ambitious policies are implemented)  - <2°C warming 

Energy-related CO2 emissions

In short: the pink line is a whole lot more ambitious than what we already have, will require new and stringent NDCs from countries in the next few years, but is required for a 1.5°C scenario.

• IEA NZE - Net Zero Emissions (what is needed to stay below 1.5°C of warming) - <1.5°C warming
  

• IPR 1.5°C RPS - Required Policy Scenario (what IPR forecast as likely if policies are implemented to keep below 1.5°C

2050 is far away, but decarbonisation is near

What investors should expect is emissions likely to continue rising over the very short term. However, if one was to be optimistic, or even in keeping with predictions for a 1.8 - 2.4°C of warming pathway, we may begin to see countries’ pledges take effect in the next two to five years, meaning companies across all industries will have to decarbonise in line with the projected pathway or face becoming the first climate victims of the corporate world. This means that even bonds and loans issued in 2021 may be affected by expected policy before maturity. Additionally, more stringent ‘comply or explain’ reporting requirements will hit a variety of financial institutions and public companies, while carbon trading is set to boom as Net Zero strategies start to take shape. 

How does HY stack up?

Notoriously lagging behind companies financed by IG investors or with listed equities, private HY issuers will have to pull their socks up over the next few decades as decarbonisation (and other climate related policy) accelerates. The below graphs give an indication of how many HY issuers are exposed to, and are engaging with, the key themes of COP26: ‘Net Zero’ transition, deforestation, methane, electric vehicles, and coal power. 

As can be seen from the graphs, mentions of Net Zero, electric vehicles and deforestation have seen a sharp rise in recent years, indicating increased engagement on those factors in line with policy changes and public awareness. Mentions of methane have seen a steady climb with a sharp rise in the last two years, which aligns with an increased awareness around methane and expected policy changes (which have been realised at COP26). The number of documents referencing coal has seen a more steady climb, which is indicative of the long term awareness around coal; targeted early on as the worst emitting energy type. References to coal are expected to rise over the next few years as companies respond to the accelerated policy changes laid out at COP26.