Emerging market transition finance will be critical to successful climate action. It has been estimated that there is a US$94.8 trillion gap – an amount higher than global GDP – between existing commitments and the investment required for emerging markets to make a transition to net zero by 2060. (This model requires the developed world to reach net zero by 2050, and to then be net negative, allowing overall global warming to remain in line with a 1.5⁰C rise over pre-industrial levels).
This massive investment is needed to transform energy production, infrastructure, efficiency, transport, and several of the world’s highest-emitting industries. Take steel production, for example. After energy, the steel industry is the biggest emitter of greenhouse gasses. Developing steel without emissions — so-called green steel — is among the biggest challenges in the battle to meet the Paris Agreement targets.
Parts of the steel industry are investing in full-scale pilot projects to explore the technicalities of producing green steel using new methods. Most of these are in developed economies, however, with some of the most advanced examples in Sweden and Australia. These two nations produce just 0.2% and 0.3% of the world’s steel output, while China alone produces 53% of the world’s steel, and the top 10 emerging market producers account for about 73%. On top of that, China currently generates twice as much CO₂ per tonne of steel as Europe.
Steel is just one industry, of course, but the energy industry and several other high-emitting industries are similar with respect to emerging markets.
“We know that the amount of money being deployed for transition finance and emerging markets is about 10% to 20% of what it needs to be if we’re going to achieve the Paris Agreement targets,” says Faith Ward, chief responsible investment officer at Brunel Pension Partnership.
Only 16% of asset owners in our survey are invested in emerging market transition finance, but those asset owners appear to have high conviction about the strategy.
Even among all respondents, 61% believe that emerging market transition finance will grow rapidly over the next three years.
More than half of our survey respondents (53%) say their fund is concerned about the risk-return profiles available in the universe of emerging market transition-finance assets. Ward believes that to grow transition finance in emerging markets, asset owners need to consider their investment objectives more broadly and over longer timeframes — recognising, as she puts it, “that if we don’t transition in emerging markets, then there isn’t going to be a transition at all”. Ward concedes that this may entail less transparency and more risk at times: “It requires courage, to some extent, but we can show that there is a huge opportunity in emerging markets.”
Pulling the biggest levers
Asset owners that take a divestment approach to net-zero targets are letting go of some of the most powerful levers in the fight against climate change. “The main task for the real economy is to focus on high emitters, because they can make the biggest impact on the climate,” says a senior executive from a public asset owner.
Asset owners can use their capital and influence to help major polluters to enable transitions to low-carbon alternatives and move closer to the Paris Agreement targets — a path that can often overlap with the path to long-term growth and responsible risk management.
It is also important that asset owners, investors, regulators and governments understand that there are some companies and sectors that have two sides. This point was made by a sustainability leader at a European asset owner, citing the examples of transportation, energy and utilities, “which on the one hand have the older business activities that are linked to fossil fuels, but on the other hand are growing a new business that fits into the clean energy world of the future.”
Next chapter:
Improving guidance for asset owners
About half (51%) of asset owners rely on consultants for advice about climate-related investments, so consultants can play an important role in supporting the growth of transition finance.