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MARKETS
15 December 2022

Reflecting on COP27, and Looking Ahead to 2023

By Bonnie M. Wongtrakool, CFA

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Looking back at COP27, one of the overarching goals of last month’s convention was to scale up scale up climate finance, given that the world is investing only about a third of the estimated needs of $3–$4 trillion per year.1 As we articulated last month in our COP27 preview, our longstanding view has been that climate finance flows can be meaningfully increased through strategic partnerships among policymakers, multilateral development banks and private investors. We were pleased to see this principle both embraced and exercised at COP27, during which Indonesia’s Just Energy Transition Partnership (JETP) was announced. This $20 billion plan will be funded equally by governments and private investors and leverage the support and expertise of multilateral development banks, while requiring Indonesia to achieve a series of decarbonization goals over the next three to five years.2 We consider it a promising blueprint for other countries seeking to achieve their climate goals.

Another topic of note at COP27 was climate adaptation, or efforts to address the challenges resulting from historical greenhouse gas emissions. While investors have traditionally focused on climate mitigation (i.e., preventing or reducing emissions), financing needs for adaptation projects such as infrastructure for flood protection, desalination and climate-resilient crops are expected to grow over time as weather patterns continue to shift.3 COP27 drew attention to climate adaptation by establishing a “Loss and Damage Fund” for developed market countries to finance initiatives in developing countries,4 and by outlining a five-year agenda to build global climate resilience in the areas of agriculture, water and natural systems, social and physical infrastructure, and coasts and oceans.5

We also note the discussions of carbon markets at COP27. Although green technologies have advanced quickly in recent years, solutions to address carbon emissions in “hard to abate” activities such as cement, steel, chemicals and building materials do not yet exist at scale. Markets for carbon credits and offsets have emerged to fill this gap, but remain fragmented and lack the transparency and standardization that investors need. Two projects with global ambitions—the African Carbon Market Initiative and the US Energy Transition Accelerator—were unveiled at COP27, but scant details were provided about their technical design or implementation. Meanwhile, the European Commission recently proposed a Carbon Removal Certification Framework6 that could serve as the basis for verification across these markets.

Looking ahead to 2023, we expect dialogue on these topics to continue, as well as on the following trends:

  • Biodiversity: Stakeholders have increasingly recognized that biodiversity and climate risks are interrelated, as demonstrated by the deliberation of debt-for-nature swaps at COP27. We expect adoption of the Taskforce on Financial Nature-related Disclosures (TFND) framework and integration of biodiversity into investment analysis to ramp up, especially in the food, metals, and paper and pulp sectors.
  • Renewable energy: We expect green investments to accelerate, particularly in the US as the Inflation Reduction Act, which allocates almost $390 billion to climate mitigation and adaptation, takes hold. 70% of this amount is structured as tax credits and incentives to encourage private investment in renewables and decarbonization technologies.7
  • Human rights in supply chains: Lawmakers, investors and regulators are already aligned on this issue. Bipartisan legislation in the US seeks to prevent the use of forced labor in supply chains, and European regulations require corporate issuers to disclose their risks in this area. We expect companies to improve their due diligence practices in response, enabling investors to dig deeper into this area.

We believe sustainable investors are well positioned to benefit from these dynamic trends. What’s more, fixed-income investors can play a unique role in financing climate mitigation and adaptation at the sovereign level. Some of these needs are likely to be financed through green and sustainability-linked bonds, where sovereign supply has been quite light.8 And in corporate credit, we view select issuers in the metals and mining sector as attractive vehicles to participate in the energy transition. Western Asset looks forward to helping its clients achieve their financial objectives while also supporting sustainability in the coming year.

ENDNOTES

1. https://ir.citi.com/gps/iVRWOG-trKHhTLnxg04aCfgkjMG8utNdqSs_fLoIx508DX-R116Jr7f8kugDTidA8mwBDZadxUAWPkNh5UjSrGEQqPhoUagr.

2. https://www.whitehouse.gov/briefing-room/statements-releases/2022/11/15/indonesia-and-international-partners-secure-groundbreaking-climate-targets-and-associated-financing/

3. https://www.unep.org/resources/adaptation-gap-report-2022.

4. https://unfccc.int/news/cop27-reaches-breakthrough-agreement-on-new-loss-and-damage-fund-for-vulnerable-countries.

5. https://climatechampions.unfccc.int/cop27-presidency-announces-ambitous-climate-resilience-agenda/.

6. https://www.catf.us/2022/12/european-proposal-carbon-removal-certification-framework-first-step-towards-verifiable-carbon-dioxide-removals/.

7. https://markets.jpmorgan.com/research/email/-rk3lrtv/i4-C-sFGjkh5PGISuTCmCw/GPS-4268966-0, Figure 9.

8. https://www.iif.com/portals/0/Files/content/SDM_November2022_vf.pdf, page 4, Chart C.

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