COP26: Why the climate summit matters to financial institutions, regulators and risk managers

The United Nations Climate Change Conference of the Parties (COP26) in Glasgow is just around the corner. Kicking off at the end October, the mega conference will host representatives from nearly 200 countries for two weeks, with a focus on reviewing of the Paris Agreement and each country’s carbon reduction commitments.

The Paris Agreement: where it all started
In 2015, the Paris Agreement set a global framework for the world’s nations to mitigate the worst effects of a warming planet. Representatives of 196 governments agreed to actions aimed at limiting global warming to well below 2 degrees Celsius – preferably to 1.5°C – compared to pre-industrial levels. To put this lofty goal into perspective, consider this statement from Ibrahim Mohamed Solih, president of Maldives:

“The difference between 1.5°C and 2°C is a death sentence for the Maldives.” 

At the time of the treaty, reaching the Paris targets translated to slashing global carbon emissions to net zero – i.e., achieving carbon neutrality – by 2050 or sooner. By 2020, all signature parties were required to submit nationally determined contributions (NDCs) outlining their plans for meeting their reduction commitments.

Where are we now?
According to the UN's NDC Synthesis Report, published last month in preparation for the COP26 climate summit, nations must urgently redouble their climate efforts to prevent global temperature increases beyond the Paris Agreement’s stated goals. The NDCs of 191 countries combined still indicate a sizable 16% increase in global greenhouse gas (GHG) emissions in 2030 vs. 2010 levels.

According to the latest Intergovernmental Panel on Climate Change (IPCC) findings, such an increase in GHG, without immediate action, may lead to a 2.7°C temperature rise by the end of the century.

Further, the IPCC’s Summary for Policymakers, also published in September, includes more up-to-date Paris Agreement simulations that reflect recent observations of rising temperatures and the increased occurrence and severity of extreme weather events.

Using the latest data, the IPCC estimated that limiting global warming to 1.5°C would require a 45% reduction in CO2 emissions from 2010 levels by 2030. To limit warming to 2°C would require a 25% reduction. This is clearly beyond the global trajectory based on current NDCs.

Moving forward: Glasgow Summit
Discussions are moving from “by when should we become net zero” to “what should the decarbonization curve and path towards ‘Net Zero by 2050’ look like?” Setting clear carbon reduction targets for 2030 requires that much more immediate and tangible actions be taken now compared to more hypothetical “who knows when?“ or “I will no longer be around” timelines for 2050.

Finding a path to securing global net-zero emissions by mid-century, and keeping 1.5°C within reach, is the COP26 summit’s foremost goal. Considering the latest data, this would mean turning 2030’s projected 16% CO2 bump from 2010 levels into a 45% decrease.

Clearly, achieving such a turnaround would require significant retooling of countries’ proposed decarbonization plans and rewritten NDCs. COP26 negotiations are therefore expected to be intense, with the big countries playing a major role. The first big decisions could be made at the G20 Leaders’ Summit, preceding COP26 in late October.

Regardless, the COP26 discussions will be broader than merely pushing for stronger decarbonization plans. They will also center on securing climate financing for supporting of these plans, particularly in less developed countries.

As part of the Paris Agreement, developed countries committed to providing at least $100bn in climate finance per year by 2020. Unfortunately, similarly to the NDCs, the reality is falling short of these financial commitments. According to the OECD estimates, $78.9bn in climate finance was mobilized in 2018.

COP26: The impact on financial institutions, regulators and risk managers
As stated by the COP26 organizers:

“To achieve our climate goals, every company, every financial firm, every bank, insurer and investor will need to change.”

The outcome of COP26 could have significant impact on how seriously governments respond to climate change. Increasing decarbonization efforts will immediately impact certain industry sectors, particularly “brown” industries. In concrete terms, this could lead to governments strengthening some of the already aggressive carbon pricing policies they’ve planned in different parts of the world.

In addition, new policy initiatives will certainly magnify the transition risks faced by financial institutions in their loan and asset portfolios. The latest IPCC report provides much more clarity on the magnitude of physical risk expected in the 1.5°C-to-2°C increase world. Financial firms would be wise to begin incorporating this new information into their physical risk assessment processes.

The newly updated IPCC findings and agreed upon NDC scenarios will form the basis for climate risk stress testing and scenario analysis going forward. They will also play a crucial role in informing both climate risk management processes and the financial sector’s various net-zero decarbonization initiatives.

As outlined in the COP26’s stated goals:

“Financial institutions must play their part, and we need work towards unleashing the trillions in private and public sector finance required to secure global net zero.”

Looking ahead
It remains to be seen how COP26’s outcomes will impact financial firms’ day-to-day activities, but change is certain. For starters, a strong message from COP26, be it positive or negative, could spark considerable volatility in ESG (environmental, social and governance) investment markets.  ESG assets surpassed US$40 trillion globally in 2020 and may hit $53 trillion by 2025.

All in all, there are myriad reasons financial and risk management professionals should pay close attention to COP26. I personally have high hopes for this summit, because our window for charting a better course is closing quickly.

We, both as individuals and collectively as an industry of financial services professionals, must take significant action – and we must do it now. At the same time, we must also be aware of the consequences of the actions we take today and the risks that come with them – and we should be prepared to address them once they arrive. After all, that is what climate risk management is all about.