The Path from COP26 – Facilitating the Transition

Stella Cox CBE, Managing Director of DDCAP and Jennifer Schwalbenberg Chief Governance Officer provide some practical clarity on what needs to be considered and done when divesting from heavy emitting sectors

Stella Cox CBE Managing Director and Jennifer Schwalbenberg Chief Governance Officer

Introduction

ESG-focused capital market activities are often synonymous with portfolio divestment from heavy emitting sectors such as oil & gas, cement, steel, aviation and mining. However, by divesting, ESG-principled investors effectively abandon control to those who may not share the same concerns and who may not exert their influence in furtherance of a sustainable agenda. Equally, by refusing to provide financing to these sectors the capital markets leave these industries without the necessary resources to transition to more sustainable practices. Divestment does not result in lower emissions.

The capital markets need to focus on decarbonising the real economy, not their portfolios. Conscientious investors and financiers need to identify those companies making the ambitious commitments, setting strong goals and taking action. If concerned investors support these sectors to transition to new technologies and, where possible, retool to accommodate renewables, they enable these sectors to convert intent into action. The global finance community, and in particular the Islamic Capital Markets (ICMs), have the responsibility to help accelerate this change and become stewards of said change.

Recent examples of transition sukuk and other commitments

Many of these currently high-emission sectors will be sectors the real economy still needs in 2050 and viable low or no carbon alternatives do not yet exist at the scale required. Some sectors face significant hurdles to achieve decarbonisation whether they be economic, technological or rooted in other considerations. Other sectors may not be able to completely achieve decarbonisation but still need to be included in the global economic transition and need assistance to develop effective offset programmes for residual emissions. Estimates suggest that an annual USD6.9tn in infrastructure investment and between USD1.6tn and USD3.8tn for energy transition is required to meet the Paris Agreement targets.1 As there are not sufficient public funds to satisfy this, private capital is vital, and this presents a considerable opportunity for the ICMs to mobilise funding. To date, there have only been 18 transition bonds globally, and far fewer transition sukuk, but it seems momentum may be growing. In 2020, the Islamic Finance sector saw the first ever transition sukuk by Abu Dhabi’s Etihad Airways, which raised USD600m for investment in sustainable aviation and carbon reduction targets. In March 2021, the Islamic Development Bank (IsDB) raised $2.5 billion with its Sustainability Sukuk, the proceeds of which will be allocated to eligible projects under the IsDB’s Sustainable Finance Framework, which incorporates supporting the transition to

a green economy as one of the three main pillars of its climate change policy.

The market has also seen increased commitment to transition funding in the MENA region. For example, in September 2021, the Arab Petroleum Investments Corporation (APICORP) announced they are considering the issuance of transition sukuk as part of their green bond framework. Additionally, KSA’s Public Investment Fund (PIF) has stated that it would look to “’gradually’ move toward turning down investments that lack their own sustainability plans”.i In the meantime, the PIF has been investing in the transition, boosting its stake in ACWA Power International which focuses on renewable energy sources and investing in electrical vehicle manufacturer Lucid.ii

Standing alongside investors and corporates, financial institutions are also supporting clients in this work. Standard Chartered’s recently introduced Sustainable Trade Finance Proposition in the UAE helps industries transition and reduce carbon emissions by offering financing that recognises their efforts to lessen their carbon footprints. HSBC has made a similar commitment and in early 2021 announced the formation of a dedicated Sustainable and Transition Finance team in the Middle East, North Africa and Turkey which will help institutions, corporates and individuals to transition to a more sustainable future.iii

How to facilitate a meaningful transition

Stakeholder collaboration (including multilaterals, sovereigns, global financial institutions) across the ICMs is needed to ensure the industry mobilises the necessary capital as efficiently as possible to those companies with a legitimate dedication to the transition. Effective leadership from within the ICMs will be imperative to ensure effective standards are put in place, and compliance with those standards is monitored.

In its recent white paper, Climate Bonds Initiative (CBI) have posited what might constitute a “transition bond” or “transition sukuk”. Under this new label, companies would be held to account based on “five hallmarks of a credibly transitioning company, i.e. a company whose transition is rapid and robust enough to align with … the Paris Agreement.”iv These key elements would be the focus and requirement of the certification assessment to achieve the “transition” label. Specifically, the CBI’s hallmarks include: (1) Paris-aligned targets; (2) Robust plans to reduce emissions; (3) Implementation action; (4) Internal monitoring; and (5) External reporting. The proposal, whilst complementing existing ESG frameworks and methodologies, goes beyond them to “avoid transition labelling”. CBI acknowledges that “different industries will have greater or lesser potential to reduce emissions/ increase sequestration over time, meaning that the end goals and speed of transition will vary substantially by sector”, however, the requirement for all would be to reduce emissions to the greatest extent possible, as quickly as possible.

Whether the ICMs look to adopt this framework, or develop their own, the key governance elements must reflect a company’s “willingness and ability to deliver on its decarbonisation targets” as well as provide the necessary granularity “to ensure that those targets are ambitious and in line with climate goals”.v Governance and accountability will be key to ensuring a meaningful transition, requiring transparency not only of targets met, but

1 Climate Investment Opportunities: Climate aligned bonds &issuers 2020 at https://www.climatebonds.net/files/ reports/cbi_climatealigned_bonds_issuers_2020.pdf

i https://www.aljazeera.com/economy/2021/9/21/saudi-arabias-wealth-fund-plans-green-debt-issuance-soon ii https://www.aljazeera.com/economy/2021/9/21/saudi-arabias-wealth-fund-plans-green-debt-issuance-soon iii https://www.oerlive.com/oman/hsbc-fuels-omans-transition-to-a-low-carbon-economy/ iv https://www.climatebonds.net/files/files/Transition%20Finance/Transition%20Finance%20for%20

Transforming%20Companies%20ENG%20-%2010%20Sept%202021%20.pdf v https://www.climatebonds.net/files/files/Transition%20Finance/Transition%20Finance%20for%20

Transforming%20Companies%20ENG%20-%2010%20Sept%202021%20.pdf targets missed. Projects must be analysed not only from an investment perspective but also from an efficiency perspective, to avoid needlessly repeating structures that do not produce optimal results. Transition financing must address scope 1, 2, and 3 emissions and short, medium and longterm targets must be set. The ICMs need to work together to agree methodologies and governance structures to be able to get to work to address these considerations and enable the transition.

Call to Action to Facilitate the Transition

The Earth is what all of humanity has in common; it links people across cultures and continents. What impacts this planet will impact all, but not necessarily equally, and many of those least responsible for this crisis will, and in some cases already do, number amongst the communities most impacted. The world has already seen its first climate refugees and if the current trajectory is maintained, they certainly will not be the last.

The discussion in the final weeks of the run-up to COP26 in November 2021 has shifted from what to achieve at COP26 to where does one begin after COP26. Recent data shows that even with the drastic changes to the living and working patterns of much of the global population during the COVID-19 pandemic, there wasn’t a significant reduction to global emissions. Further, without efforts for protection and preservation of a habitable planet, the UN Sustainable Development Goals will not be achievable. Therefore, a strong argument exists for increased efforts to bolster action to reduce emissions and protect biodiversity. But as actions require resources, the financial community, and in particular the ICMs, must focus on mobilizing resources to meet these goals. The ICMs have a responsibility to meet this call to action, to continue to mobilise funding for green, blue and sustainability projects and begin to formalise their plans to dedicate resources to facilitating the transition required.