COP27 in Focus: Will Energy Security and Economic Uncertainty Impact the Climate Transition?

Doug Morrow: While I believe the world is currently not in line with a 1.5 degree pathway, I'm optimistic that it's still within reach and I do believe there are enormous thematic opportunities for investors as we rewire our economy for net zero.

Michael Torrance: Welcome to Sustainability Leaders. I'm Michael Torrance, Chief Sustainability Officer with BMO Financial Group. On this show, we will talk with leading sustainability practitioners from the corporate, investor, academic, and NGO communities to explore how this rapidly evolving field of sustainability is impacting global investment business practices and our world.

Speaker 4: The views expressed here are those of the participants and not those of Bank of Montreal, its affiliates or subsidiaries.

Susan McGeachie: Welcome to another episode of Sustainability Leaders. I'm Susan McGeachie, head of the BMO Climate Institute. Today I'm joined by Nalini Feuilloley, Head of Responsible Investment at BMO Global Asset Management and Doug Morrow, Director of ESG strategy on our equity research team in BMO Capital Markets with COP 27 now upon us, we're going to drill down on what we'd like to see coming out of the party's continued negotiations on commitments and rules for greenhouse gas mitigation and climate adaptation. COP 26 saw the launch of the Glasgow Financial Alliance for net zero, which today has 550 members spanning financial services from banks and insurers to asset owners and managers. All GFAN members, including BMO, have committed to achieving net zero GHG emissions by 2050 in our lending and investment portfolios and over this past year have released reports on our progress. These activities have created a rapid evolution in the strategic and competitive environment for all providers at Capital.

Just in the past year we saw Deutsche Bank rated in an investment fraud pro due to allegations of greenwashing in its provision of ESG products. On the other end of the spectrum, US Republicans are pulling BlackRock from their state pension funds due to CEO Larry Banks' focal commitment to ESG, particularly climate change. Banks long use to vociferous calls to end fossil fuel financing are now facing legal pressure on so-called woke bias with allegations that their leaders are putting political agendas ahead of the financial wellbeing of their clients. Most of the beleaguered CEOs, however, maintain that their focus on sustainability is tied to their fiduciary responsibility to their clients, viewing the global energy transition as one of the most significant events to affect the long term value of the companies they finance. Nalini, given the increasing complexity since COP 26 within the climate finance environment, what do you see as the key issues for the finance community to solve it this year's COP, and how do you see these issues impacting the future of GFANs?

Nalini Feuilloley: Thanks Susan for the question and I'm happy to be here today. In terms of the key issues for the finance community at this year's COP, I would say they're probably twofold. The first would undoubtedly be around energy security and how that balances some of the objectives that GFANs has set out. And then the second thing I think is the need for the finance community to really stand united behind GFANs and driving the transition forward to net zero future. So maybe I'll start with energy security.

Just given the ongoing conflict between Russia and Ukraine, a lot of what we've seen in the sensationalist headlines and media this year is that given energy security is such a big issue, that's really an excuse for the finance community to slow down our agendas that have been really focused on climate action. The reality in my view is that the energy security issue in some cases has actually accelerated plans for certain countries and regions who are looking to transition away from fossil fuels and in other situations it has required certain countries and regions to actually revert to the use of fossil fuels like coal.

Despite all of this happening in this year, in 2022 and maybe for the foreseeable few years, I don't see this impacting the long term trajectory of the climate action goals that the finance community has set in place. And I do think that we have to keep our head in the game around the commitments that we've made to get to a net zero future. I also think the finance community needs to continue to focus on the gap that has been identified in terms of funding the transition. The governments around the world can only do so much, and the capital that is actually required is so vast that only really our community can help with.

And so I think one barrier in the finance community and specifically the financial system is just how things are structured today, how asset classes are structured, how we view the risk return spectrum. And I think we need to continue to work with governments at COP 27 on how governments can provide mechanisms to help guarantee against sometimes the high risk nature of the type of climate technologies and solutions that we want to support because if we find a way to balance that out, then we can potentially unleash a flood of private capital towards that gap that is so needed to be plugged.

Susan McGeachie: How do you see the financial community leveraging GFANs to come together to solve for some of the opportunities you described?

Nalini Feuilloley: So I don't see any material adjustments to GFAN. I think it's just more level setting the expectations of GFANs, right? GFAN is really a forum for the finance community and all actors within it to speak the same language, work on the same plane because if we're all working towards the same goals using the same set of tools, then the wider economy, the wider private sector will be able to move towards net zero emissions collectively. So it's really just the influence part of GFANs that we need to re-endorse, but I don't actually see it being overly prescriptive or changing because of some of the backlash that we've heard of late.

Susan McGeachie: Great. Doug, in turning to you, immediately following COP 26, I recall that you wrote that climate change remains front and center in the minds of not just ESG investors, but increasingly all investors across capital markets. What do you think is going to be at the table at COP 27 this year?

Doug Morrow: Well, I think climate change remains a critical issue for a large number of investors, and I do believe that investors, particularly those with long-term investment horizons, remain intently aware of the financial impacts of climate, the ramifications of energy transition and the importance of net zero. But like Nalini alluded to, the world is just a fundamentally different place than it was in November 2021 when COP 26 concluded. And I do believe that investors probably like never before, are having to balance climate commitments with a deeply uncertain economic backdrop, disruption in energy markets resulting from Russia's invasion of Ukraine as well as stubbornly hot inflation. So I think that partly for these reasons, I believe the mood going into COP 27 is somewhat subdued. It's not just the geopolitical situation, but the logistics and emissions of getting to Egypt. And we have seen reports that some large investors are planning to skip the conference.

But having said that, I think it's important to remember a few things. First, in my opinion, there was always going to be less emphasis on the role of the private sector at this year's conference than there was at COP 26. This one is going to be focused much more on implementation. I think that we could potentially see some developments around food and farming. This is based on some proposals that we've seen floating around. But clearly the big issue at COP 27 is going to be climate finance. And the phrase that we're all going to hear a lot about is loss and damage. So this is UN speak for climate reparation payments. So just a bit of context here, back at COP 15 in 2009, developed countries pledge to deliver a hundred billion dollars per year in climate finance to developing countries by 2020. This is to help with climate adaptation, emissions mitigation, et cetera.

And we just haven't seen financing anywhere close to that figure. We have seen leadership over the last few weeks from Germany and Denmark and a few other countries, but we certainly have not seen any earth shattering statements heading into the conference on this file. And at the same time, impacts from climate, as we've all seen, have continued to escalate in almost accrual, but predictable kind of way because the developing countries are modeled to bear the brunt of climate change impacts, including the genuine prospect of climate change refugees at many island states in the South Pacific. So I think that climate finance is definitely going to be the top issue going into COP 27. I think there's palpable frustration in the developing world at the lack of climate finance flowing from developed countries, and I think it could prove to be a significantly divisive issue going forward.

Susan McGeachie: What do you see as the main challenges countries will face in reaching target agreements? And maybe you mentioned some of them just on the climate finance targets, and I know as you said, the countries have committed to certain levels of climate finance. So perhaps if you wanted to speak to some of the challenges they'll see in achieving those commitments as well as their GHG reduction commitments.

Doug Morrow: Sure. Well, this is it. I think a lot of Inc has been spilled on these questions. I think their front and center for in the international community and investor minds. I think the main challenge that countries face in reaching emission reduction targets is that it's simply difficult to balance economic growth with absolute emission reductions. Even though the world has made significant improvements in emissions intensity, i.e. the amount of emissions required to generate a unit of economic output, this is due largely to the incredible deployment of renewables that we've seen over the last few years. I think another factor is multilateral coordination. Climate change is a global problem, but it's being managed in a nation state model. So what that means is some countries are moving more aggressively than others, which can lead to things like finger pointing and weakened political resolve. And at the end of the day, in my opinion, the most important driver in all this is carbon pricing.

Yet only 23% of global emissions right now are covered. And at a price that is well below what is generally believed to be a sustained change driver, i.e. between 80 and a 100 dollars a ton. I think it's also important to remember that the Paris Agreement, which contains the global reduction goals that the world is striving for, i.e. 1.5 degrees above pre-industrial levels by 2100 are not legally binding. Countries do face obligations around things like reporting and increasing the ambition level of their targets over time, but the NDCs themselves are not legally binding. And in my view, this flexibility is actually one of the reasons that allow the Paris Agreement to be agreed and passed in the first place. As some listeners may have seen the UN released analysis last week heading into COP 27 that painted a pretty challenging picture based on UN modeling, taking all current NDCs into account, the world is heading for around 2.5 degrees of warming by the end of the century, which is obviously well above the two degree targets and the stretch goal of 1.5 in the Paris Agreement.

So it's not just about operationalizing existing pledges. Climate science would say countries need to significantly increase the ambition of their pledges as well. But while the task is obviously daunting, I think there's a tremendous amount going on that we can all be excited about. For example, Inflation Reduction Act in the US is clearly a historical piece of legislation. The EU is proposing to boost, not downgrade by the way, it's renewables targets building efficiency standards among many other measures with its Fit for 55 package.

We've also seen new clean energy targets from China, India, Australia, Indonesia, among other countries. So there are definitely signs of policy momentum. And as for investors, right, we've all seen the figures. Trillions of dollars in capital spending will be required in transition technologies to really bend that emissions curve closer to 1.5. Things like grid modernization, battery storage, CCUS, renewables, hydrogen, EV infrastructure, zero emission buildings. I mean, the list goes on and on. So while I believe the world is currently not in line with the 1.5 degree pathway, I'm optimistic that it's still within reach and I do believe there are enormous thematic opportunities for investors as we rewire our economy for net zero.

Susan McGeachie: Thanks, Doug, for the reminder that we have reasons to be optimistic and there are opportunities in the energy and low carbon transition. Nalini, how do you think these challenges, as well as the opportunities that Doug has mentioned, affect investment strategies?

Nalini Feuilloley: I think that they affect investment strategies in a few different ways. So I think generally speaking, from a responsible investor lens, we always welcome policy and regulation that is top down in nature across the globe because it really reinforces our message around the long term impact of climate change. So even though it can be disruptive and disorderly, I think with all these countries falling behind, as Doug has mentioned, if we can see policies coming to fruition that actually accelerate the work of the private sectors, specific sectors in particular, then that just allows investors to come in and reinforce those same requirements over the long term. So I think we want to see more regulation come to the fore. I think we've seen a whole host of new regulation come out just in this last year, just since COP 26, that is actually change the way our community is looking at the work that we do in this space.

We're trying to rid of greenwashing, we're trying to encourage more disclosure on the climate front. You saw this huge consultation that the SEC put out earlier this year around climate disclosures. These are the things that are actually going to move the needle and move the industry forward. In terms of opportunities, I don't think Doug could have said it any better. I think there are so many great opportunities, especially in the private markets. I think with public issuers, what GFANs has been able to do for us being part of the net zero asset manager initiative, is really focus on how we engage with our public issuer companies, how we vote our proxies.

But there are some contrarian arguments out there that it's actually not moving the needle in any substantial way, right, in the public markets. So I think a lot of the opportunities in terms of climate solutions, the ones that Doug walked through, they're really going to come to fruition in the private markets. So rethinking private market asset classes, which I alluded to before, is where I see the investment community moving towards. How are we going to be able to support and scale up these technologies and still generate the returns that beneficiaries of pension plans need to retire.

Susan McGeachie: In terms of capitalizing on what you've just been talking about, what would be one outcome you'd want to see out of COP this year to enable some of the opportunity?

Nalini Feuilloley: So similar to what Doug mentioned before, I've never looked at COP 27 as a momentous opportunity specifically for the finance community just because of what the focus objectives are this year around implementation over commitments, really having countries strengthening their emissions reduction targets as per the Glasgow Climate Pact. There's also, we're looking for greater certainty in action around the delivery of the $100 billion annual financing that has not come to the fore, even though it was extended to 2023 just last year.

And obviously an agreement on an official mechanism around funding arrangements to address loss and damage in the global south. So I think a lot of what's top of the agenda for COP 27 is really at the national level and thinking about how the global north can really stand up and take responsibility for supporting the global south, who's really in the front line of these horrific weather related events that we continue to hear in the headlines day after day. So particularly for the finance community, I just want to see us unite and stand behind GFANs and say that we're not going to slow down because of energy security. We are going to continue to use our influence to keep on the trajectory towards net zero and not let the noise of sensationalist media headlines and politicized right winged politicians in the US try to take us off our course.

Susan McGeachie: That can maybe bring me, Doug, to the final question I'd like to ask you. You mentioned already the mood going into COP 27, both of you mentioned the divisive nature of the discussions around climate change in the finance community. Any other comments that you'd say about the mood going into COP 27, how Russia's invasion have Ukraine has affected it and or any of the other events over this past year?

Doug Morrow: Well, I think yeah, as you said I mentioned earlier, I think it's definitely contributed to a somewhat subdued mood, I would say, heading into the conference because it's obviously led to enormous uncertainty, disruption in energy markets, and as we've seen a short term scramble for quick energy solutions in Europe as western governments seek to reduce their dependence on Russian oil and gas exports. And as Nalini said, this has included, for example, restarting coal fired power plants and other fossil generation sources. So on the one hand, I think the conflict has really underscored how essential fossil fuels are to our energy and economic system as currently designed. But I also agree with Nalini that I think this scramble that we've seen is more of a short term phenomenon. My view, and this is something that we put out as a department through our notes, is that the invasion is actually going to accelerate energy transition over the mid to long term.

And the reason is that a growing number of investors are increasingly seeing that renewables and to some extent nuclear as well, contribute to energy security. So we've known for quite some time that renewables were becoming increasingly price competitive with fossil based generation. But I don't think the market properly accounted for the energy independence benefits as well, i.e. nobody can stop the sun from shining or the wind from blowing. So as I mentioned before, the backdrop heading into COP 27 is definitely more complex and challenging than it was moving into COP 26. But countries do not appear, or many countries at least, do not appear to be backing down on their climate commitments. And since the invasion, many countries have in fact pushed forward more ambitious policies such as we said the IRA in the US, Australia, the Fit for 55 proposal in Europe. So I do believe it is a more complex picture, but I also think there's a lot to be excited about.

Susan McGeachie: Great note to end on Doug. Thank you very much for your time. Nalini, thank you very much for your time and sharing your insights with us here today.

Michael Torrance: Thanks for listening to Sustainability Leaders. This podcast is presented by BMO Financial Group. To access all the resources we discussed in today's episode and to see our other podcasts, visit us at bmo.com/sustainabilityleaders. You can listen and subscribe free to our show on Apple Podcasts or your favorite podcast provider and we'll greatly appreciate a rating and review and any feedback that you might have. Our show and resources are produced with support from BMO's Marketing team and Puddle Creative. Until next time, I'm Michael Torrance. Have a great week.

Speaker 4: The views expressed here are those of the participants and not those at Bank of Montreal, its affiliates or subsidiaries. This is not intended to serve as a complete analysis of every material fact regarding any company, industry, strategy or security. This presentation may contain forward looking statements. Investors are cautioned not the place undue reliance on such statements as actual results could vary. This presentation is for general information purposes only and does not constitute investment, legal or tax advice and is not intended as an endorsement of any specific investment product or service. Individual investors should consult with an investment tax and or legal professional about their personal situation. Past performance is not indicative of future results.