Climate change – what the Paris Agreement means

29/07/2016
Provided by Mercer.
 
The UN Climate Change Conference, held in Paris in late 2015, resulted in the Paris Agreement.  For the first time, countries committed to lowering their greenhouse gas emissions sufficiently to keep a global temperature rise well below 2°C this century. Given every other attempt to reach a meaningful agreement failed, this commitment is a big deal.

The Paris Agreement will come into force once it has been signed by at least 55 countries accounting for 55% of global emissions.

Climate change and laws to address climate change, create risks for investors. However, they also create investment opportunities in areas such as low-carbon technologies and infrastructure, which are likely to grow significantly.

Key elements of the Paris Agreement
 
Temperature goal: to limit overall global warming to less than 2°C and possibly down to 1.5°C above pre-industrial levels.

Net zero emissions goal: it was agreed that ‘net zero’ emissions would be reached in the second half of the century (by balancing carbon released with an equivalent amount split out or offset) with emissions peaking ‘as soon as possible’.

Five year review cycle: pledges will need to increase over time, with countries resubmitting every five years. Submissions can only be strengthened (i.e. no backtracking on prior pledges) and long-term targets are encouraged.

Climate financing: the agreement has a goal to support the costs of the transition for poor countries. It has set a floor of US$100bn per year by 2020 for this purpose, and it is anticipated that this will increase over time. 

Legal status: emission reduction plans are not legally binding, but the yet-to-be-determined reporting mechanisms and the five year review process is.
 
How is the Paris Agreement expected to affect investment markets?
 
Investment portfolios can expect to be impacted by evolving investment risks and opportunities, together with growing scrutiny as to how managers respond to climate change (for example, whether portfolios are aligned with a 2°C outcome).

The risks and opportunities for investors created by the transition to a decarbonized economy are potentially significant. A study, published by Mercer in 2015, established a framework for considering the impact of four different climate change scenarios on investment risk and return across asset classes and sectors.

The study drew some important conclusions – including that climate change will have an impact on returns, regardless of which scenario unfolds. It also highlighted that investment managers can take specific actions to make their investment portfolios more resilient.

Given the uncertainty associated with climate change, the Paris Agreement allows investors to focus on the transformation scenario, which sees warming limited to 2°C this century. The good news is that this is now considered more likely than it was just a few months ago. The expected impact on investment returns over 10 years under this 2° scenario are shown in the chart below.

The chart shows that returns from some asset classes, like emerging market equities and infrastructure, could benefit from climate change, whereas returns from others, like global equities and private equity, could suffer.

What is Mercer doing?
 
Mercer is actively involved in research and discussions on integrating climate considerations within investment practices. We participated in the Paris Conference, at which we made the following commitment.

Mercer’s commitment – The Paris Pledge
Mercer believes that climate change poses an investment risk that requires management by investors today. By signing the 2015 Paris Pledge for Action and the 2014/2015 Global Investor Statement on Climate Change, Mercer has supported two initiatives that signal the investment community’s support for strong domestic and international climate policies.
 
We’re using our research to help us build investment portfolios for our investors. We’re also measuring the carbon footprint of our share portfolios to understand how our investments are impacting the climate. We’re also working with the specialist investment managers we appoint to increase their focus on sustainability when selecting companies. More detail can be found in our Responsible Investment Policy.
 
Summary

 
  • The Paris Agreement is a commitment to lower greenhouse gas emissions sufficiently to keep a global temperature rise well below 2°C this century.
  • It gives investors more certainty about the extent to which climate change might impact investment outcomes and allows them to anticipate the sort of policy changes that will be required to keep warming to 2°C.
  • Mercer has developed a framework to assess the potential investment impacts of a 2°C scenario. We are incorporating this into the way we build investment solutions; measuring the carbon footprint of our share portfolios; and working with the investment managers we use to improve their approach to sustainability.

     


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