Decarbonisation and protection of natural capital are closely interrelated themes, and both represent immense global challenges.
It is because of challenges like these that impact investing exists.
Large-scale challenges often create opportunities for investment, and the combined fight for emissions reduction and preservation of natural capital are no exception. Recent estimates suggest the net zero opportunity requires US$9.2 trillion of annual investment across the energy, mobility, industry, building, and agriculture and forestry sectors in every year to 2050. And while current estimates of the funding task for preservation of natural capital vary widely, the World Economic Forum and PWC calculate that over 50 per cent of global economic value generation is moderate or highly dependent on nature and nature-related services.
Our shared economic success is derived from nature.
These global fronts represent one of the largest capital investment waves in history. Successfully catching that wave requires careful navigation of complex sectors, risks, and opportunities. All against a backdrop of rapidly increasing urgency. As synthesised in the Sixth Assessment Report — recently released by the Intergovernmental Panel on Climate Change (IPCC) — the actions taken this decade will be essential to a liveable planet for current and future generations.
A structured approach is essential for any new investor navigating this rapidly evolving landscape.
Understand and engage with demand signals when making climate investments
The mental leap from engaging with data on global temperature increases and climate collapse to actually making a climate investment can be difficult for new climate investors. Understandably so — it has taken decades for countries and corporates to understand, define, and implement their own climate-transition strategies.
Though recent rapid adoption of transition strategies is itself a demand signal, there are many other signals that demand for climate change solutions and subsequent investment is accelerating.
In Australia, of the 187 companies in the ASX 200 with Australian operations, 45 per cent have now set scope 1 and scope 2 net zero emissions targets. More large businesses are making comprehensive commitments with science-based targets and initiatives to reduce greenhouse gas emissions.
Renewables energy uptake has also been rapid — over 35 per cent of Australia’s electricity in 2022 was supplied by wind and solar, up from 17 per cent in 2017. Moreover, financial support for the renewable energy sector continued to grow with AU$6.2 billion of commitments made in 2022 for renewables and storage projects (a 17 per cent increase on 2021).
Australian investment in climate change solutions will likely accelerate further with recent government action. At a federal level, Australia recently increased its target for emissions reduction by 2050 — a target that requires a doubling of current investment levels every year solely in the large-scale renewable energy sector. More broadly the Labor government recently refreshed Australian carbon markets via a comprehensive integrity review and announcing a plan to launch a nature repair market to improve national biodiversity outcomes.
Importantly, these examples are only several of the many demand signals for climate investors to engage with. Identifying and tracking relevant climate sector demand signals help investors assess how the risk profile of the climate sector is changing and provide support for investment and the timing of that investment.
Focus on additionality and integrity to reduce investment risk
Demand signals provide important thresholds for making investment, though the pace of change is very rapid and can be hard to navigate. Climate sector investment evolves constantly with regulatory change and new innovations and modes of implementation becoming available. It is difficult to accurately predict each (and especially all) of these drivers, even over short horizons.
A useful approach to mitigate uncertainty is through specific focus on positive additionality, and by extension — high integrity. Additionality, a core concept in impact investing, is the creation of new or additional outcomes relative to what would have happened in this absence of the investment or activity. Articulated another way, against a counterfactual of continued atmospheric pollution and destruction of ecosystems, is a specific climate change investment contributing to solutions?
Deeply assessing and quantifying whether an investment area makes a measurable contribution to combating climate change assists investors in forming a practical view on its likely long-term success.
Take for example recent changes in regulation for Australian carbon credit units (ACCUs). Investors over the past two years faced uncertainty around which of the many environmental credit schemes — which drive generation of ACCUs — would survive regulatory scrutiny following sustained pressure from market advocates and the subsequent federal integrity review. Specific carbon credit schemes that suffered were those deemed to have low additionality. Investors in projects under high integrity schemes were protected from these changes.
Beyond helping navigate complexity, a sharp focus on additionality and high integrity better aligns investors with the underlying themes of climate change and can help them avoid greenwashing.
Alex Debney, partner, Conscious Investment Management