Since the adoption of the Paris Agreement in 2015, investors have paid closer attention to the ‘Conference of the Parties’ meetings, also known as COP. The Paris Agreement, which concluded the COP 21 summit, saw 196 countries pledge to keep global temperature rise “at or below 2 degrees Celsius” compared to the pre-industrial level. Governments around the world have since rolled out policies and regulations to drive the shift to a low carbon economy.
Each subsequent COP continued to produce a varying number of official international and country-level commitments or pledges which in turn stimulate policies and regulations to put them into practice. These pledges, along with accompanying policies and regulations, have significantly impacted investors, leading to a wide array of climate-focused investment strategies and benchmarks aimed at capturing the risks and opportunities associated with the carbon transition.
This year’s COP in Baku – also dubbed as “the Finance COP”, “the most important COP ahead of NDC 3.0”, and “the COP with the most uncertain outcomes” – endeavoured to reach agreement on two very important topics: new financing commitment for developing countries; and the operationalisation of Article 6 of the Paris Agreement on the establishment of a global carbon market.
The outcome was mixed with some important milestones reached but many others unresolved.
New Collective Quantified Goals and NDC 3.0
In 2009 at COP 15 in Copenhagen, countries agreed a target of providing $100 billion annually in climate finance to help developing countries build climate resilience and accelerate the low-carbon transition. This goal was eventually met in 2022 – two years later than the original target year of 2020. However, the climate financing needs for developing countries have significantly increased, with the latest forecasts from the UN estimating a requirement of $1.1 trillion per annum to shore up resilience and delivery on their net zero targets1.
At COP 29, an agreement was reached during extended hours to increase the New Collective Quantified Goal (NCQG) target to $300 billion annually by 2035, with the aspiration to scale up to $1.3 trillion per year by 2035 from both public and private sources.
The deal was not without controversies with a number of countries, including the least developed countries negotiating bloc, stating that the agreed amount fails to address the scale and urgency of climate change2. Another important point of contention was the lack of clarity on the proportion of non-debt-inducing financial support such as grants – much more favoured by the most vulnerable developing countries – versus loans.
The implications for the global economy could be significant if insufficient financing is provided to countries to accelerate the low carbon transition and adapt to a warmer climate.
One recent estimate shows that with every 1 degree Celsius of warming, global GDP could be reduced by as much as 12%, approximately six times larger than previous estimates3. Furthermore, as countries prepare for their renewed Nationally Determined Contribution (NDC) targets, controversies associated with the new NCQG could cast doubt on the credibility of these new NDC targets.
As a central part of the Paris Agreement, NDCs include country-level decarbonisation targets and climate-related policies. These new NDCs, also known as NDC 3.0, are supposed to incorporate not only a more globally coordinated approach on how to achieve the collective goal of keeping temperature rise below 1.5 degree Celsius, but also respective national transition plans to fulfil the pledges made at COP 28 on tripling renewable energy capacity, doubling energy efficiency improvement by 2030 and transitioning away from fossil fuels. Countries were, however, not able to reach agreement on any sectoral targets at COP 29 as a follow-on. Without a global consensus, it makes the upcoming announcement of new country NDCs even more important because these pledges will likely be embedded in the respective national transition plans.
A global carbon market
A landmark agreement was reached on the creation of a UN-sponsored global compliance market for carbon credits from sustainable development-oriented projects that reduce or remove greenhouse gas emissions (GHG), aligning with Article 6 of the Paris Agreement. Critical elements of a credible global carbon market such as environmental integrity, transparency, additionality and baseline setting were laid out.
This is not the same as existing compliance markets such as the emission trading schemes in various parts of the world like Europe, California, or China as they are essentially a ‘cap and trade system’ where a maximum level of GHG emissions is set within an industry sector and allowances, or permits to emit, are distributed to companies. These caps decline over time, which incentivises companies to reduce their emissions or adopt cleaner technologies.
Carbon credits, produced by a wide range of activities such as renewable energy projects, energy efficiency improvements, and carbon capture and storage under the new mechanism, can be used by countries to meet their NDCs. Discussions on how they can potentially be accounted for as a form of financial aid from developed countries to developing countries in NCQG is still ongoing and worth watching out for. This is especially important for developing countries that are rich in natural resources that can be utilised for carbon sequestration and storage.
A market already exists for transacting similar type of carbon credits over-the-counter or bilaterally mostly without any regulatory supervision. The voluntary carbon market has come under intense scrutiny by media and NGOs over the last couple of years given the lack of quality assurance, resulting in a significant drop in trading volume. Agencies such as the International Organization of Securities Commissions (IOSCO) and the World Bank have introduced a set of principles4 with the goal of promoting financial integrity and orderly functioning of the existing voluntary markets. Organisations like the Integrity Council for the Voluntary Carbon Market (ICVCM) have already produced framework and procedure5 for the methodologies and assessment of voluntary carbon credits that are widely accepted by the market as best practices.
With complementary features and a different approach which anchors on compliance and regulatory supervision, the methodology that was adopted at COP 29 helped to reinforce many of the principles outlined in the IOSCO and ICVCM proposals. Furthermore, the new global carbon market, once fully operationalised with clear rules at the participating country level, can be another important source of carbon offsets considered by corporates, investors or individuals for their respective decarbonisation objectives.
Private sector financing
While the objective of COP is not to form specific policies or regulations, it has the power to convene government agencies and standard setters to discuss and agree on approaches to collaborating, especially around the mobilisation of finance. One notable announcement that is relevant for GSS+ bond6 investors and issuers: the launch of a Multi-Jurisdiction Common Ground Taxonomy (M-CGT)7 between China, the European Union and Singapore. This initiative builds on the bilateral EU-China Common Ground Taxonomy by the European Commission and the People’s Bank of China.
The expanded taxonomy outlines activities considered ‘green’ across all three jurisdictions, which can be leveraged by green bond issuance and fund investing. Global volume of GSS+ bonds is set to exceed 2021’s record of $1 trillion in 2024 based on self-reported data and Climate Bonds Initiatives. Initiatives such as M-CGT have the potential to create more regulatory coherency across different jurisdictional definitions of ‘green’ economic activities and ease compliance burdens on cross-border investors. This is increasingly important as investors are navigating diverging regulatory disclosure requirements and regulatory approaches to ‘greenwashing’.
Another area of focus for the public sector was to find ways to increase financing from the private sector for adaptation needs. These are estimated to be approximately $387 billion per annum up to 2030, but only $27.5 billion of international public finance was available in 2022. The UNEP’s 2024 Adaptation Gap Report8 shows that about one third of the adaptation finance gap is already in areas that are typically financed by the private sector and therefore could be an area of focus for private sector investors.
Beyond sovereign green bonds, two modalities were suggested as more practical for private sector to consider: (i) new financial instruments such as insurance-linked instruments and debt for adaptation swaps, and (ii) blended finance or co-investment by the private sector with multi-lateral development banks and/or sovereign wealth funds.
While no major agreement was reached during COP 29, no national budget is sufficient to cover the overall amount of capital that’s required to build resilience and adapt to a warmer climate. The need for more public-private-partnerships and innovative financing structures will continue to rise.
Conclusion
Amid great geopolitical uncertainty around the world, COP 29 reached two important milestones: NCQG to help support developing countries, and a global carbon market. While a lot of the details still need to be worked out, what had been affirmed presents countries an opportunity to rethink how they address climate-related risks domestically in relation to other countries and stakeholders. Given the global nature of climate change, cross-border cooperation is critical. One good example of this during COP 29 was Norway’s announcement9 that it would inject $50 million to Asian Development Bank’s Climate Action Catalyst Fund which aims at generating tradable credits under Article 6.4.
Where and how to find the money is the next big challenge. Government finances around the world are constrained given the current macroeconomic conditions. Private sector financing has to increase significantly. Innovative approaches to enhancing interoperability across various jurisdictional standards such as sustainable and green taxonomies, as well as creating more public-private partnership and new financing instruments can provide a new source of funding for governments, as well as investment opportunity for investors. For example, El Salvador’s recent $1 billion debt-for-nature swap helped to refinance portion of its debt in exchange for river ecosystem conservation. In addition, given how carbon removal was a key part of the plan for global carbon market, demand is expected to rise for related solutions such as afforestation and reforestation, and bioenergy with carbon capture and storage.
The only constant in life is change. Climate negotiation, like physical climate change, remains highly volatile and evolves quickly. That is why as investors we want to stay close to these international negotiations to assess potential investment implications.