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June 15, 2023

Climate credibility: 5 ways to close the gap

There are certain steps investors can take to help close the credibility gap between companies' climate ambition and credible action.

By Eva Cairns

climate credibility
Investors must close the gap between climate ambition and credible action. (Image by Shawn Hempel via Shutterstock)

The transition to low-carbon energy is happening across every sector around the world. However, climate action is not happening at the speed and scale required, or the credibility needed, to ensure net zero by 2050. 

To achieve this ambitious goal and limit warming to 1.5°C above pre-industrial levels, emissions need to halve by 2030 – a cut of around 7% a year. But emissions are still on the rise and the only year they fell was in 2020 (by 6 %) due to the pandemic.

It’s been more than seven years since the 2015 Paris climate agreement when the goal was set to limit warming to below 2°C, and ideally within 1.5°C. But even now, countries’ nationally determined contributions (NDCs) – their formal decarbonisation pledges – only put the world on a path to 2.4°C, according to Climate Action Tracker.

That means policies aren’t providing the certainty and financial incentives for decarbonisation to occur at the pace that’s needed. The latest Intergovernmental Panel on Climate Change Synthesis Report contains a dire warning – this really is our last chance to take urgent action.

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While governments, corporations and financial institutions are doing more than ever before, with more than 90% of economic activity covered by net-zero pledges, it’s become clear there’s still a big disparity between climate ambition and credible action – the climate credibility gap.

At abrdn, we suggest five ways in which investors can help to close this gap.

1. Understand the credibility of corporate climate targets

Investors need to take a forward-looking view of carbon emissions to understand how companies manage emissions and where they can expect the carbon footprint of their investments within their portfolios.

Our research showed that corporate emissions targets can’t just be taken at face value. Companies rely on the policy environment within which they operate and the maturity of the technologies they use. Third-party carbon target-tracking tools may only offer narrow coverage or fail to consider factors outside a firm’s control.

That’s why we developed a bespoke framework that uses six factors to derive a climate transition credibility score: robustness of the emissions-target design, historical emissions performance, technology readiness, policy supportiveness, green revenues and climate governance.

When we tested this framework on some 400 of the large-cap global stocks most exposed to the energy transition, we found a large dispersion in the delivery of emissions pledges, and none of them had a fully credible transition plan.

2. Exert influence through active ownership

Large investors have the ability to engage with a company’s management team to discuss those environmental, social and governance (ESG) issues affecting the firm that are financially material, and to understand the related risks and opportunities.

In doing so, we can set expectations on what ‘good’ looks like from an investor’s perspective. We can also influence the behaviour of a carbon-intensive company or challenge a firm when its actions to deliver on a carbon target seem insufficient.

As shareholders, we can also express approval or disapproval of corporate policies by casting our votes during shareholder meetings.

Investors can act individually or collectively. Discussions can be held behind closed doors or made public. Different approaches have their advantages and disadvantages.

However, we believe that divesting from a holding should only be done as a last resort – once all other avenues have been exhausted – as investors lose all influence once they walk away.

3. Allocate capital to credible transition leaders

Financing the energy transition is as much a responsibility for the private sector as it is for governments and the public sector.

Once investors have a clearer idea of which companies are energy-transition leaders, we’re in a better position to help channel investments to those firms that want to be part of the solution.

Credible transition leaders are companies that have set ambitious emissions reduction targets, want to innovate and transform their businesses, and lead by example within their sectors.

As such, they are more likely to avoid the risks associated with the energy transition and take advantage of the opportunities. Our climate credibility framework helps us identify those credible leaders across sectors.

Many investment opportunities will be in emerging markets. The International Energy Agency and World Bank estimate that some 70% of the capital needed for the clean energy transition must go to developing countries.

4. Take a forward-looking view through climate scenario analysis

Climate scenario analysis models the financial impact of different climate outcomes – based on different levels of climate policy ambition and alternative pathways of technology development.

For example, our bespoke climate scenario approach builds plausible climate pathways by reflecting different policies across sectors and regions – highlighting the extent of policy gaps.

Assigning probabilities to each scenario helps us assess how likely the world is to meet the Paris objectives, as well as identify which path we’re most likely following.

The climate credibility gap between national-level pledges and binding action is reflected in our ‘mean’ scenario – which points to temperature increases above 2°C. With global emissions still rising, we assign very small probabilities to net-zero scenarios.

Climate scenario analysis provides data that can be used to monitor net-zero progress at a micro and macro level, understand the financial impacts of longer-term climate risks and opportunities and identify priorities for further action.

This is important for investors because national policies need to provide the right signals and incentives to help promote capital allocation in line with net-zero goals, encourage corporate decarbonisation and incentivise investment.

5. Promote policy advocacy and engagement

As investors, we have a voice that we can use to advocate for positive change. We can do this at the company level, and we can do this at an industry or national level.

Our research, as well as our involvement in developing industry best practices, puts us in a good position to discuss with policymakers the incentives needed to attract capital and enable net zero at the pace required. Carbon pricing is an important example of one incentive.

At abrdn, we’re also in a position to monitor the progress made towards those goals; for example, through our climate policy index. Where there’s a shortfall, we can identify what more needs to be done.

We’re a signatory to the Global Investor Statement on stronger climate action, which is a powerful platform from which investors can urge governments to close the gap between climate ambition and credible action.

We attend the annual United Nations climate conferences, such as Cop27, which bring together organisations, policymakers and investors. It’s our ethical and fiduciary duty to speak up and be vocal about issues that need to be addressed

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