Taking a step back – what does Net-Zero really mean?

“Net-zero” may be a concept you’re familiar with as this initiative has been featured in headlines as the discussion around climate change has heated up. With COP 26 in Glasgow now upon us, more investors have been drilling into what net-zero truly means, what actions have been taken, and what it means for their investments.

We are now at the point where extreme weather conditions and rising temperatures are recognised as being caused by human action (or inaction) and widely acknowledged as an existential risk for humankind. This link between rising temperatures and the level of greenhouse gas emissions was made explicit at COP 21, which notably resulted in the 2015 Paris Agreement. It was during the same negotiations that the concept of net-zero was invoked; for every unit of carbon dioxide emitted, at a minimum, the same volume should be removed from the atmosphere. The Paris Agreement’s goal was to limit global warming to below 2  compared to pre-industrial levels and preferably to 1.5. Drastic cuts to emissions are needed to achieve net-zero by 2050.

The link to asset management

Net-zero funding requirements are reaching all-time highs. Over the past few years, we have seen a surge in the issuance of “sustainable” or “green” products, including the UK government after the (heavily oversubscribed) release of UK green bonds in September 2021. The Sustainable Development Goals are also increasingly relevant to net-zero, having stated that there is a financing gap of $2.5trn annually needed to fulfil all 17 goals. Opportunities are appearing in this space and demand for net-zero finance is coming to the forefront.

A number of investment managers have implemented new policies in line with government guidelines on net-zero. They have been encouraged to improve the transparency of carbon emissions; push for greater engagement with companies on sustainability, and to plan ahead for expectations of a changing environment.

At PortfolioMetrix, it is no different. The team believes it is crucial to be open and transparent about sustainability objectives. Whilst this is a primary focus for our ESG portfolio range, PortfolioMetrix Sustainable World, these considerations run throughout all our approaches, as part of the investment process. PortfolioMetrix recognises the importance of being proactive in meeting with underlying fund managers to understand more on their interpretation of ESG and how they are working towards climate-focused goals and integrating these discussions into their framework.

Net-zero progress to date

Government uptake of net-zero has been stronger in developed countries, with the EU and UK emitting lower levels than witnessed in the 20th century. However, we’re yet to see sharp reductions in overall emissions, as further action is needed from the greatest emitters (per capita), such as North America, Canada and Australia.

Developing countries have not been as progressive. To an extent, there is a conflict between them pursuing net-zero targets and continuing to strengthen their economy – it is unlikely that these countries are willing to sacrifice growth in favour of reducing emissions. Recognising this, wealthier countries have set up frameworks to help fund the energy transition in developing economies and provide access to low carbon financing.

Realistically developing countries are most at risk of climate change. Without the capital to react, they will be hit harder by more frequent and extreme weather events. Therefore, the real target of net-zero must be to create a new sustainable path of living, removing the need to emit greenhouse gases without stunting economic growth globally.

The road ahead

The “ratchet mechanism” set in the 2015 Paris Agreement helps to establish short-term goals that will build towards the 2050 target. The mechanism requires each country to report on their National Determined Contribution (NDC) every 5 years – in line with COP meetings. NDCs are explicit statements describing how each country intends to reduce emissions over the next 5 years. The goal is for NDCs to become more ambitious as we approach the 2050 deadline, making the 1.5  temperature limit more attainable.

The expectation is that as technology improves, the private sector takes on more responsibility, and pressure builds on individual lifestyles, the government will be able to offer more within its NDC to meet the target.

With COP 26 focusing everyone’s attention, investors are preparing for the next steps of delivering net-zero to be unveiled. However, legislation changes alone are unlikely to deliver the impact required, instead industry-wide collaboration is needed. Governments and corporations are stepping up and more will follow as conversations surrounding net-zero continue. It is clear net-zero is here to stay, but it will require a systemic change across all markets – only then will we be able to create a sustainable and healthy future for all.