Before the 26th UN conference on climate change (COP26), there were pockets of cynicism in some quarters about how much would be achieved.¹ With China’s President Xi Jinping not even travelling to Glasgow, the world’s largest emitter of CO2 emissions was missing leadership representation at the summit. However, despite the misgivings, the conference has brought encouraging progress.

First, the US and the EU have announced a global partnership to cut emissions of the greenhouse gas methane by 2030.² More than 100 countries have signed up to the initiative, which was first proposed September and aims to limit methane emissions by 30% compared with 2020 levels.

Even though Russia and China have not joined, the International Energy Agency (IEA) welcomes this pledge as “the most impactful way to limit near-term climate change”.³ “We estimate that if the world achieves a 30% cut in methane emissions from human activity by 2030, it would have a similar impact on global warming as switching all the world’s cars, trucks, ships and planes – the entire global transport sector – over to net zero emissions technologies,” said IEA Executive Director Fatih Birol. If this pledge is fully implemented – along with all other commitments made prior and during COP 26 – this could keep the world’s rising temperatures to within 1.8C by the end of the century, according to IEA.⁴

Second, 23 countries have made new commitments today to phase out coal power, including five of the world’s top 20 coal power-using countries (South Korea, Indonesia, Vietnam, Poland and Ukraine).⁵ Dozens of organisations also signed up to the pledge, with major lenders like HSBC and Fidelity International agreeing to stop financing the coal industry. This follows recent announcements from China, Japan and South Korea to end public overseas coal financing, as the UK’s presidency stressed.

Third, hundreds of the world’s biggest banks and pension funds have committed themselves to limit greenhouse gas emissions. The Glasgow Financial Alliance for Net Zero (GFANZ), representing more than 450 financial institutions across 45 countries, could deliver the estimated US$100tn of finance needed for net zero over the next three decades, the initiative claims.⁶ Deutsche Bank was one of the founding members when the group was launched in April 2021.

“Corporates with the greatest carbon intensity (even within each sector) have lower cash reserves and lower profit margins”
After COP 26 – the burden shifting to corporates? (Deutsche Bank Research)

Finance is key to the massive economic transformation required to move away from fossil fuels and reach net zero, as flow reported in the article “How banks contribute to COP26”. While governments are making announcements to reduce emissions, it will have to be corporates fulfilling these promises, a new report by dbResearch “After COP 26 – the burden shifting to corporates?” points out.

Examining several datasets, analysts Luke Templeman, Olga Cotaga and Karthik Nagalingam provide some revealing insights on four major questions:

1. How much progress have companies made on decreasing the carbon intensity of their operations?
2. Can companies afford the cost of climate change?
3. Is economic growth and reducing emissions possible at the same time?
4. How can investments in reducing emissions be financed and incentivised?

The analysis shows the cost of change is a key worry for managers. “That is particularly the case as corporates with the greatest carbon intensity (even within each sector) have lower cash reserves and lower profit margins. This makes it harder for them to bear the cost of reducing their carbon profile,” the Deutsche Bank Research team states.

European corporates that have the lowest levels of cash are 70% more carbon intensive (emissions per US$1m of sales) compared with companies that have higher levels of cash, the report finds (see Figure 1, left). Furthermore, companies that have below-median profit margins have more than twice the intensity of carbon in their operations as companies with high profit margins (see Figure 1 right).

So how can finance contribute to the transition towards a net zero business model? According to Templeman et al there are two key methods in which finance can create positive change.

• First, through Sustainability-linked bonds, which have become particularly popular as the amount issued exceeded US$50bn per month twice in 2021. If the companies fail to adhere to its ESG targets, the interest payable on the bond increases and vice versa.
• Second, finance can facilitate asset-light business models, which reduce corporate emissions, via assets-as-a-service. In short, when using AaaS, someone else owns the assets a company uses to run its business thereby lessening waste. “Minimalism has been rewarded by investors for some time. In general, the share prices of companies that are asset-light outperform those that are asset-heavy,” the report states.⁸

Looking at the US specifically, the more asset light a company, the better its ESG score tends to be (see Figure 2).

There are many legitimate reasons, concludes the report, why corporates should be the focus of public attention for combatting climate change. It adds, “There are also some political reasons why companies will increasingly have this responsibility delegated to them.”

The upside and downside of this responsibility, predict the authors, “will only become more pronounced in the short term”. Already, they note, “Those companies that are proactive are increasingly benefiting from increased customer loyalty. Conversely, customers are growing used to boycotting products they believe do not live up to environmental expectations.”

Their research makes a powerful case for ensuring corporates have proper targets that drive real change, as these “provide companies with a measurable goal to which its employees, customers and investors can align”.

After COP 26 – the burden shifting to corporates? by Luke Templeman, Olga Cotaga and Karthik Nagalingam

Sources

¹ See https://bit.ly/3mYnQ0Q at theguardian.com
² See https://bbc.in/3D19YZk at bbc.com
³ See https://bit.ly/3bWLlB2 at iea.org
⁴ See https://bit.ly/3qiVh0h at iea.org
⁵ See https://bit.ly/31F3gKB at ukcop26.org
⁶ See https://bit.ly/3EUAeF6 at gfanzero.com
⁷ See https://bit.ly/3qmrGCZ at blog.google
⁸ See also the Deutsche Bank white paper Asset as a Service