A disorderly transition

We already see signs of shifting supply and demand patterns creating volatility, not to mention protectionism, in markets. Evidence suggests we are at the start of a disorderly transition. Next to the actions of policy makers, how disorderly the transition becomes will be influenced by asset owners, investors, and companies’ own emission reduction plans.

The transition requires huge investment in new green infrastructure. But reaching net zero depends on more than this. High emitters in traditional ‘smoke-stack’ industries require funding to spur their transition to a low-carbon world. Just how much funding and the conditions upon which it is received becomes the crucial question. There are five economically important, high-emitting sectors where successful transitions will generate powerful change. These are power, buildings, mobility, industry and agriculture which together generate more than 90% of global emissions. Each of these sectors is capital intensive with substantial fixed assets and long-standing business models. Change will not be quick or easy.

Transition investments or transition finance is the burgeoning investment category that will support high-emitters in their efforts to reduce emissions. This is distinct from climate solution providers which offer the products and services that drive decarbonisation.

This is not a free pass for investors to own high-emitting sectors. Instead, responsible investors must distinguish between companies that have a credible transition plan and those that can’t or will not change sufficiently. Investors need the assurance that these ‘transition investments’ have the capacity to reduce emissions in the long run. To do this, the most appropriate course of action is to adopt a categorisation framework that consistently identifies which assets qualify as transition investments.

The Sustainable Markets Initiative have launched an approach to do this. Its framework places transition assets into one of five categories which allows investors to identify companies that may qualify as Paris-aligned transition candidates. Such a framework can underpin the required growth in transition finance.

The low-carbon transition will have marked macroeconomic effects – notably the potential for higher inflation. One of the benefits to asset owners therefore is that investment in the transition leaders across high-emitting sectors could provide some inflation protection and solid returns as the leading names attract capital at the cost of the laggards.

For transition investing to work, both carbon impact and commercial returns are essential. Rather than disinvesting from heavy emitters we can mitigate carbon emissions by supporting those companies with robust transition plans.

This paper argues that growth in transition investments and transition-related targets will help mitigate disorder, in the process improving our chances of a lasting transition to net zero.