Summer 2018 was a powerful reminder that Germany is not immune to climate change. 2018 was the hottest year since meteorological records began in 1881 and the farming industry felt the economic impact directly, with crops failing in many parts of north-east Germany. Experts warn that this is a mere precursor of things to come. Eight of the nine hottest years since 1881 have been in the 21st century.
Global greenhouse gas emissions were higher in 2018 than ever before. The data is deeply concerning and shows how important it is to redouble our efforts to prevent climate change. This was underlined recently in the IPCC special report ‘Global Warming of 1.5°C’ presented at the UN Climate Conference in Katowice. The IPCC report stressed that every 0.1 of a degree on the temperature scale counts, particularly in respect of the so-called tipping elements in the Earth System.
Tipping elements are supra-regional components of the Earth system that experience a qualitative change in function as soon a certain temperature threshold is crossed. These include, for example, the Greenland ice sheet, the permafrost areas in Siberia, the tropical coral reefs, and the Amazon rain forest. Once such tipping elements are activated, self-reinforcing processes are set in motion that are difficult or impossible to halt. The rainforest, which locks in CO2, could gradually turn into savannah, the coral reefs could die off and the ice sheet melt. The consequences would be catastrophic as both the speed and the consequences of the tipping process are unforeseeable.
The threshold for many tipping elements lies between two and four degrees of global warming. This partly explains why the Paris climate agreement set a target of keeping global warming to below two degrees Celsius compared with pre-industrial levels. We only have a few years left to achieve this target. By 2050 at the latest, net emissions of greenhouse gases must be brought down to zero.
Failure to act may be costly
But even the former self-proclaimed poster child of climate protection, Germany, risks missing its reduction targets by a wide margin. The underwhelming performance to date could have painful consequences for the economy. The costs could run into the billions because certificates will have to be purchased for all greenhouse gas emissions that exceed the targets. Unchecked climate change could have even more far-reaching effects, however, which is why the World Economic Forum in Davos believes climate change constitutes one of the greatest risks to the functioning of global supply chains. Virtually all sectors would be affected, be it through supply shortages, crop failures, storm damage, increased investment risk or exchange rate losses.
Some business sectors have already recognised this risk. A growing number of companies are taking action to reduce their susceptibility to the effects of climate change and are pursuing ambitious targets to become carbon-neutral before 2050. “These pioneers are not being opportunistic, but proactive. That earns the c ompanies respect and offers the prospect of better long-term upside potential for investors,” says Jennifer Paffen, an ESG analyst at Union Investment.
The most important tipping elements in the Earth System
Initiatives for transformation
The transformation of the global economic system into a carbon-neutral world demands immense investment. However, it also affords huge opportunities for companies and investors, such as through new patents a nd innovative business models. While fossil fuels are becoming less important, renewable energies are now a vital aspect of climate protection measures. This also has implications for the financing of the Paris climate targets, a matter that has been addressed by the action plan for funding sustainable growth put forward by the European Commission in March 2018. The plan is part of the EU’s efforts to create a low-emission, resourceefficient circular economy. Capital flows – which are increasingly shaped by investment decisions and explicitly take account of sustainability criteria – are one of the levers that will help achieve this.
“The EU action plan should now also bring additional pressure to bear on financial players who had been waiting to see what the EU would do,” predicts Dr Henrik Pontzen, head of ESG in portfolio management at Union Investment. “So far, they have tended to regard global warming and the necessary switch to climate neutrality as more of an abstract risk.”A lack of transparency and comparable standards means it has always been difficult to accurately quantify and assess these risks. It was difficult for the markets to put a precise figure on how great the climate risks and transformation opportunities really are, both with regard to individual companies and entire sectors. There are now new, clearly defined guidelines for investors and companies that should make it easier to drill down on whether the information being disclosed is complete and material. In May 2018, the Task Force on Climaterelated Financial Disclosures (TCFD) developed a framework that provides a valuable tool for use in climate reporting. The TCFD recommendations are a lever that will help investors and companies to take a holis- tic view of the risks and opportunities of climate change and of a low-emission economy in the core areas of each company.
The recommendations point the way forward. In its action plan, the European Commission announced that it would include the TCFD system in a revised Version Jennifer Paffen ESG Analyst in Portfolio Management at Union Investment of the CSR Directive. Union Investment also supports the findings of the Task Force to date and uses them, for example, in its dialogue with companies to call for climate risk analyses to become a deeper and more established element of business and financial reporting. The benefits of greater transparency with regard to how individual issuers of securities deal with the challenges of climate change are very clear to the cooperative-sector asset management company: “We use the identified opportunities in our investment decisions, and we try to minimise identified risks or manage them as effectively as possible against the background of climate change,” explains Jennifer Paffen, an ESG analyst in portfolio management at Union Investment.
Professor Ottmar Edenhofer, Director and Chief Economist of the Potsdam Institute for Climate Impact Research
Professor Edenhofer, the EU action plan for funding sustainable growth will be a major step forward in the fight against climate change. What more do you think needs to be done?
There is no doubt that the reform of the financial system and reorientation of capital flows towards a greener and more sustainable economy is an importing supporting measure. But new regulations won’t have any effect if the oversupply of fossil fuels is allowed to continue holding sway over the market. The most effective means of controlling this is to have a minimum price for carbon emissions that rises over time.
Carbon trading has long been an effective tool for reducing greenhouse gas emissions. Will that continue to be the case in future or are there better alternatives?
The trade in CO2 certificates should be a marketplace enabling the best and most efficient technologies for avoiding emissions to be identified. But it is not yet fulfilling this role. Policymakers must introduce a minimum price for the certificates, and sectors such as transport and building management, that have so far not been included in the emissions trading system, will have to sensibly price their carbon emissions. And of course global coordination is important, particularly with the Chinese who are also planning to introduce an emissions trading system.
What makes you optimistic about the fight against climate change?
I am not optimistic, but I haven’t given up hope. It’s easy to become frightened and anxious. The extreme weather events associated with climate change will increase. But after a lost decade it is clear that politicians are now beginning to take action. The last global climate summit strengthened multilateralism, the German government is showing serious interest in carbon pricing, and lots of people are taking to the streets on Fridays.
#Potsdam Institute for Climate Impact Research (PIK)
Opportunities for added value
Union Investment sees meeting the target agreed in Paris – to limit global warming to a rise of less than 2°C over pre-industrial levels – as part of its fiduciary responsibility. Our engagement plays an important role in this regard: we raised the issue of climate protection at virtually every AGM we attended in 2018. In our dialogue with the companies, we frequently call for more ambitious reduction targets and a more coherent two-degree strategy, and for CO2 prices to be factored into strategy decisions. The TCFD recommendations provide a guideline for many companies.
We believe it is important for climate protection to be integrated into the investment process. Combating climate change is a key concern, but it has to be placed in the wider context of the individual company. That requires close inspection of each individual company’s activities through the prism of ESG.
We believe investors will have a very special role to play in climate protection in future. Although there is still a lot of work to be done in terms of getting information out there and overcoming strong resistance to change, sustainability and climate protection are becoming important investment criteria for more and more investors. By including climate risks in our risk management strategy and in the engagement process, we are protecting our investors against the financial effects of climate change. And at the same time, our investors will be able to exploit the opportunities of the transformation to an economy that is as close to CO2-neutral as possible. This added value needs to be highlighted, because ultimately it is customers who decide how sustainably their money should be invested.
ESG Analyst in Portfolio Management at Union Investment
Unless otherwise noted, all Information and illustrations are as at 8 May 2019.