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Investment Insight Series – Paris Agreement Context

Investment Insight Series

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The US officially withdrew from the Paris Agreement on November 4th, making it one of only two nations in the world (Syria being the other) to not be a part of the climate accord. But with news that Joe Biden will re-join on his first day in office in January 2021 (all being well) bringing the agreement back into the spotlight it seemed a good time to explore it in our Investment Insight series.  

As with ESG and the SDGs, the Paris Agreement goals are widely recognised and used by companies, investors and governments. They provide an overarching set of aims for dealing with the impacts of climate change and act as a driving force in mobilising finance flows consistent with low greenhouse gas emissions and a climate-resilient pathway. The Paris Agreement is yet another framework applied to our responsibly managed portfolios.    

Intended to mobilise a global response to the threat of climate change, it was a landmark accord, signed at COP21 in Paris in 2015. (To give it its full title, the event is otherwise known as the Conference of the Parties to the United Nations Framework Convention on Climate Change. Catchy!) COP26, delayed from earlier this year, is due to be held in Glasgow in 2021.  

The key long-term goal of the agreement is to restrict the increase in global average temperature to well below 2°C (3.6°F) above pre-Industrial levels. The aspiration is to limit the temperature rise to 1.5°C as this achievement would substantially reduce the risks and effects of climate change. The Paris Agreement is not legally binding under international law, but it serves as a significant landmark in tackling climate change on a global scale.  

Notionally determined contributions (NDCs) are at the heart of the treaty. These voluntary pledges represent each country’s efforts to reduce emissions and adapt to the impacts of climate change. Irrespective of size everyone agreed to set, implement and report on its NDCs, with updates to commitments due every five years, starting in 2020.  

Initial commitments vary by country but they tend to fall within the range of 25–30% of 2005 levels of greenhouse gas emissions by 2030. Unfortunately, according to Climate Action Tracker, many nations are not currently on course to achieve their targets and the progress made to date is not enough to keep global warming under the 2°C (3.6°F) threshold. 

From an investment perspective, policy action on climate change at both a national and international level is a potential source of risk and opportunity. A transition to a low-carbon economy may affect company cash flows and profitability, resulting in ‘stranded assets’. This means that the value of certain assets is significantly reduced because they are rendered obsolete or non-performing from a financial perspective.  

A prime example of this would be the major oil companies. If we stop using oil, their reserves under the ground will no longer be worth anything like what they have previously been valued at for their accounts. (Awareness or anticipation of this kind of global change is part of the process of thematic investing we looked at last time.)