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COP26 is underway. Positive messages, with lots of fanfare, have been abundant. Doubt and mistrust, however, are also in plentiful supply. We’ve compiled a few interesting developments from the past week’s activities, along with some criticisms. Over the coming weeks, we’ll be watching what unfolds on each of the items below, as well as other activities arising from COP26. Consolidation of Standards and Frameworks The IFRS Foundation announced the creation of the International Sustainability Standards Board (ISSB), which will consolidate the Climate Disclosure Standards Board (CDSB) and the Value Reporting Foundation (which has already consolidated the Sustainability Accounting Standards Board (SASB) and the Integrated Reporting Framework). This drive towards global standards and principles, and away from fragmentation and confusion, has been a key theme for a while, but it is unclear to what level the U.S., which doesn’t use IFRS accounting standards, will participate. Clarity on optimal disclosures is important, but BlackRock’s Larry Fink pointed out that the pressure exerted on public companies and financial institutions also needs to be put on private companies. He called the inconsistency, “the biggest capital markets arbitrage in my lifetime.”[1] Declaration on Forests and Land Use On Tuesday, 131 countries, including the U.S., signed a pledge that commits them to “working collectively to halt and reverse forest loss and land degradation by 2030 while delivering sustainable development and promoting an inclusive rural transformation.”[2] In addition, “CEOs from more than 30 financial institutions with over $8.7 trillion of global assets – including Aviva, Schroders and Axa – committing to eliminate investment in activities linked to deforestation.”[3] National Geographic reports that “skepticism is warranted” given a history of prior unmet international pledges and that within two days, “Indonesia—one of the most heavily forested countries—seemed to walk back its commitment.”[4] The overarching statements are lofty, but clarity on how specific targets and objectives will be met is currently missing. Global Methane Pledge As we reported in our recent blog, “Climate Policy Matters (and Methane Policy Matters a Lot!),” multiple countries have signed up for collective goal of cutting methane emissions by 30%, based upon 2020 levels. Fulfilling this may be “the biggest single thing governments can do to keep alive the goal of limiting global warming to 1.5 degrees Celsius above pre-industrial levels.”[5] However, China, Russia, India, which are presently the top three emitters, have not signed up. “1.5 is what we need to survive” The Prime Minister of Barbados, Mia Mottley, called on world leaders to “try harder,” stating that “national solutions to global problems do not work.” She noted that current Nationally Determined Contributions (NDCs) put the world on a pathway to a warming of 2.7°C, with some pledges relying on technology that is not currently operationalized. She called out the gaps in financing for mitigation and adaptation, noting that the central banks of the world’s richest countries had implemented $25 trillion of QE over last 13 years, $9 trillion of which was related to the pandemic. Had that $25 trillion been allocated to financing the energy transition and improving food systems, we could be on the way to keeping warming within the 1.5°C limit. “Simply put,” she asks, “when will leaders lead?” Similarly, the chair of the Least Developed Countries group, Sonam Phuntsho Wangdi, called the progress at COP26, “disappointing and in a way also frightening,”[6] and also urged for more financing. What has most resonated with you, or disappointed you, from COP26? – we’d love to hear your viewpoints and weave them into our future updates.

With so much focus on CO2, we often forget that there are several other greenhouse gases (GHGs) that are contributing to global warming! One particularly potent gas is methane (CH4). While it accounts for considerably fewer overall emissions, it is 25 times more efficient at trapping radiation over a 100-year period [1] compared to CO2, and more than 80 times more powerful over 20 years. [2] As a result, focusing emission reduction efforts on methane is a powerful means to mitigating global warming, especially over shorter time horizons. Source: EPA – https://www.epa.gov/ghgemissions/inventory-us-greenhouse-gas-emissions-and-sinks In fact, expediting methane abatement has been categorized as “the single most effective strategy to reduce near-term global warming to keep the goal of limiting warming to 1.5 degrees Celsius within reach.” [3] COP 26 will see the official launch of the Global Methane Pledge. Countries that commit to the pledge are signing up for “a collective goal of reducing global methane emissions by at least 30 percent from 2020 levels by 2030 and moving towards using the best available inventory methodologies to quantify methane emissions, with a particular focus on high emission sources.”[4] Countries and jurisdictions already committed include Argentina, the European Union, Ghana, Indonesia, Iraq, Italy, Japan, Mexico, Pakistan, the U.K., and the U.S. Methane is an output of various natural and human activities including agriculture, fossil fuels, land use, natural wetlands, and waste management. However, each participating country has a different methane emissions profile. For example, the majority of Pakistan’s methane emissions are derived from agriculture while most of Indonesia’s methane output comes from waste. As part of its commitment, the U.S., via the Environmental Protection Agency (EPA), will be working to reduce oil, gas, and landfill methane emissions. The U.S. Department of Agriculture (USDA) is also engaged and will work with farmers and ranchers to “expand the voluntary adoption of climate-smart agriculture practices that will reduce methane emissions from key agriculture sources by incentivizing the deployment of improved manure management systems, anaerobic digesters, new livestock feeds, composting, and other practices.” [5] In support of the Global Methane Pledge, several major philanthropic organizations will contribute over $220 million. These funds will provide “expertise, financial resources, technical support, and best-in-class data to ensure methane reduction progress and accurate monitoring, verification, and reporting, including in the resource extraction and agriculture sectors.” [6] Philanthropic backing was key to the implementation of the Kigali Amendment to the Montreal Protocol, which has accelerated the removal of hydrofluorocarbons (HFCs). HFCs are another short-lived, but potent GHG. “Although HFCs do not reduce stratospheric ozone, they threaten to accelerate climate change because their global warming potential (GWP) is large—thousands of times higher than that of carbon dioxide.” [7] We look forward to the formal launch of the Global Methane Pledge and the broader agenda of COP 26. The Montreal Protocol has shown that global cooperation can lead to significant change in a short time and we hope to see even greater success as a result of these pledges. In our recent event, The Great Repricing: Financial Advice in the Age of Climate Change, Monique Aiken of The Investment Integration Project (TIIP) and Stephan Nicoleau of FullCycle spoke about prioritizing methane reductions in their session, The Possibilities of Infrastructure Justice. Beyond critical emissions abatements themselves, rethinking energy infrastructure and other industrial processes from a social perspective can lead to better health outcomes for communities presently located near high pollution sites. Watch their fireside chat here, and also check out the other sessions from the virtual conference that are now available free on demand.

All eyes are on the UN Climate Change Conference (COP26) in Glasgow next month. Our team, alongside climate activists and policymakers worldwide are fixated on Nationally Determined Contributions (NDCs), or global emission reduction plans, under the Paris Agreement, and specifically how the signatories will decide to transparently measure progress on the NDCs. The atmosphere is a global common-pool resource, meaning that if one country does not pull their weight in terms of emission reductions, all countries will pay the costs in terms of physical effects. Today, climate transparency and data gaps at the national and corporate level are being most successfully addressed by technology rather than regulatory disclosure requirements. We are also watching innovators explore the application of blockchain to the transparency of ESG practices. Already, we’ve seen agriculture and trade companies, such as Brazilian meat processor and the world’s second largest food producer JBS SA, use blockchain to track the supply chain of their cattle suppliers in all the geographical regions in which they operate.[1] Other technologies offer scalable access to real-time, accurate climate data that allow us to hold organizations and companies accountable to their climate commitments. Planet Labs Inc., an Earth imaging company based in San Francisco, holds part of the answer of how to hold the feet of countries to the fire on the emissions reduction commitments. Andrew Zolli, VP for Sustainability and Global Impact at Planet, presented current research findings at our conference, The Great Repricing: Financial Advice in the Age of Climate Change. His session, “The Really Big Picture: How Satellite Data Can Help Mitigate Climate Change” brought hope of radical transparency around GHG as he introduces us to Planet and their hundreds of deployed satellites. Unlike traditional earth observing satellites, these are the size of pieces of toast, rather than school buses. Each contain cameras that together collect a picture of every location on earth, tracking experienced changes and most importantly, pre-indicators of change. By obtaining a real-time, accurate view of Earth’s forests, agricultural fields, and supply chains, Zolli explains that they “allow much greater transparency about human activities on the Earth in ways that can allow us to encourage some and discourage others once we link this observational capacity to the financial system.” The satellites allow for tracking the movement of goods around the planet, monitor the operations of coal-fired power plants, and provide live imagery of carbon sequestering forests. They also may act as the verification method for payment of performance mechanisms like the UN-REDD + Program, in which wealthy countries pay forest asset holding countries to refrain from deforestation. This set of satellite data is also our key to getting independently verifiable information on climate warming gases in the atmosphere. The applications for COP26 are immense, particularly using this data to build artificial intelligence models to estimated carbon emissions. They can help policy makers hold countries accountable when they fail to meet their NCDs. It’s expected that COP26 will finalize the technical details of the Paris Agreement’s enhanced transparency framework to hold countries accountable for their climate emissions. We anticipate that Planet’s data could play a positive role at CO26 by helping countries build more ambitious plans and holding them to account when they fail. Andrew Zolli’s full presentation is now available on demand, along with 20 additional climate focused sessions at The Great Repricing: Advice in the Age of Climate Change.

In our final edition of the Summer Series, we turn to emerging markets. For the RBC Emerging Markets Equity team, ESG is a critical component of their investment philosophy and process. This includes a detailed assessment of climate-related risks and opportunities as part of the stock selection process, company engagement activities, and top-down thematic research. Because emerging markets are disproportionately affected by both the physical risks and financial consequences of climate change, and the substantial deficits in social infrastructure and investment have been exacerbated by the COVID-19 pandemic, RBC believes Green Infrastructure is a multi-decade growth story. In their most recent thought leadership piece, Green Infrastructure, RBC identifies three key drivers shaping the trend: global warming, health implications exacerbated by climate change, and the responsiveness of governments seeking economic solutions in pursuit of global supremacy in effectively addressing adaptation and physical climate risks. To that last point, public concern has forced climate change onto governments’ political agendas. As a result, Green Infrastructure is likely to provide a source of economic growth for many countries around the world as countries consider and announce climate-related spending packages. President Biden announced that the intended $2.5tn infrastructure plan is likely to focus on Green Infrastructure and decarbonization. China committed to a net zero carbon target by 2060 and has invested heavily in electric vehicles and renewable sources of energy. Similar announcements from other governments globally are anticipated. Exhibit 1 shows the differences in policy between the U.S., Europe and China that underpin the Green Infrastructure theme. RBC suggests that the best way to play the Green Infrastructure theme is to begin with the sources of energy consumption most responsible for man-made greenhouse gases. According to the International Energy Agency, 73% of CO2 emissions are attributed to energy consumption, specifically electricity, heating, and transportation, as noted in Exhibit 2. Within these sectors, renewable energy is set to be the fastest growing energy source over the next two decades, driven primarily by solar and wind power. Transport accounts for 25% of global CO2 emissions, mainly because the sector relies so heavily on oil. New modes of transport – such as electric passenger vehicles, buses, and trains – should make the transport sector cleaner, assuming renewables are used to generate the underlying electricity. As the cost of batteries falls there will be increasing price parity between EV and internal combustion engine (ICE) vehicles, which RBC believes could mark the inflection point for EV sales. One of the most attractive parts of the EV value chain is the component manufacturers segment. These high return businesses have strong pricing power and are not exposed to the heavy capex cycle and competitive environment that are found in other parts of the value chain (Exhibit 3). Exhibit 3: ICE versus EV Manufacturer’s Suggested Retail Price by components Delving deeper into the EV value chain of battery manufacturers, there are multiple parts of the value chain required to produce battery packs that offer economic opportunities. (Exhibit 4) Exhibit 4: Battery pack components Source: Macquarie Research. Data as of December 2020. In terms of the cost breakdown, currently the cell accounts for about 76% of the total cost of the battery pack with the module cost estimated to be around 10%.1 Significant economies of scale in battery cell production mean that the sector is largely dominated by several large players. In 2014, the top three battery manufacturers represented 56% of the total and that increased to 70% in 2020. According to RBC, “South Korean battery manufacturers have the highest market share with the scope to increase that share and are the most technologically advanced with good OEM diversification.” This explains their slight preference towards South Korean cell producers. These are but a few of the Green Infrastructure themes and opportunities presented by RBC thought leadership. You can read the full report here.

Not a week goes by without more evidence of climate change wreaking havoc across the world. From wildfires in Greece and Turkey, to Hurricane Henri hitting the East Coast of the U.S., and this week’s announcement of the climate change-exacerbated water shortages in the Colorado River,1 there’s no escaping the deleterious impacts of continued warming. The proximate impacts on communities are acute and the indirect effects on businesses and consumers are extensive: wildfires are limiting the availability of lumber and drought is hindering agricultural production of commodities like coffee, chocolate, and rice. Global supply chains and entire industries are increasingly vulnerable to severe climate-generated disruptions.2 “It’s as if the planet is putting an exclamation point on a pivot away from business as usual, as we now acknowledge the physical and economic risks of climate change accruing to all sectors of the global economy.”3 From a public sector perspective, municipalities hard hit by physical climate impacts may find it increasingly difficult to borrow for climate-related projects and other expenditures. The drought conditions in the Western U.S., for example, may lead to reduced “income from their water systems because there’s less to sell or they may have higher costs to provide adequate supplies.”4 Conversely, “cities need to limit development in areas prone to flooding, for example, but also need the property tax revenue from building on valuable land.”4 The situation is so serious that, climate data company, risQ, calls climate risk “an existential threat to the municipal debt ecosystem.”5 So, look out for the credit downgrades. As the Sustainability Accounting Standards Board (SASB) explains, “[i]nvestors can’t simply diversify away from climate risk; instead, they must focus on managing it….”6 Managing such far-reaching and complex risks requires a level of collaboration across the financial services industry, governments, and other stakeholders that we’ve never before attempted. As stated in a piece co-authored by Michelle Dunstan of AllianceBernstein, “[f]inding solutions to any global challenge to humanity is a marathon, not a sprint. More precisely, it’s a collective marathon, run by governments and social, cultural, and economic constituencies, sometimes in competition, but often in collaboration.”7 An important (rhetorical) question is: are we adequately prepared for this marathon? Generally speaking, people don’t just show up and run 26 miles without having first completed intensive training and planned their nutrition and hydration. AllianceBernstein is looking to help prepare the financial services industry in its collaboration with Columbia University in launching the Columbia Climate School. Gitterman Asset Management is also working to create an immersive and educational experience through our conference, The Great Repricing: Financial Advice in the Age of Climate Change. We’re partnering with an impressive lineup of expert speakers and organizations to bring you four days of climate-focused content that you can access for 12 months after the event. Join us now and be part of humanity’s most important marathon.

We are in an inflationary environment as the world adjusts to a post-lockdown world. Investors are therefore interested in knowing how their portfolios might perform in an inflationary world. Quality stocks tend to fare well versus the broad market during inflationary times and paying attention to valuation alongside quality has delivered even better results. According to recent research from GMO, “in historic bouts of inflation… cheaper high-quality stocks beat the S&P 500 in 7 of the 8 inflationary periods.”¹ Quality companies are generally lower risk from an environmental impact perspective, owing to the asset-light nature of their businesses. As shown below, greenhouse gas (GHG) emissions, energy consumption, water use, and waste discarded are all significantly lower than the S&P 500 and MSCI World indices. As a constituent in our SMART Fossil Fuel Free Models, the GMO Quality Strategy has a history of providing strong returns with less risk and meaningful downside protection relative to broad market equity indices. GMO integrates ESG (environmental, social, and governance) factors in both Quality assessment and valuation modelling. As of 12/31/20 – Source: Bloomberg What is the Definition of a Quality Company? A Quality company generates high and sustainable return on capital. Key attributes include: Identifiable, high returning assets Long-term durability of the business model Management that invests prudently with a long horizon The GMO ESG Dashboard: Quality Strategy The Quality Strategy has an overall ESG score that is better than the benchmark, particularly with respect to environmental criteria. GMO’s final ESG score for the Quality Strategy is derived from MSCI’s ESG ratings data. It considers the industry-adjusted weighted-average key indicator scores, along with a set of portfolio adjustments that account for ratings momentum (the percent of companies trending positive/negative) and the overall ratings quality (the percent of laggards in the portfolio). The above charts are based on a representative account in the Strategy that was selected because it has the fewest restrictions and best represents the implementation of the Strategy.