The spectacle of thousands of political luminaries flying in from all over the Earth to discuss the importance of reducing emissions is not necessarily an inspiring one. Nor does the fact that the dialogue invariably runs beyond its allotted finishing time and only when the prospect of a collapse in negotiations manages to manifest itself does anyone really start to take matters as seriously as they should and strenuously strive to strike a bargain.
Yet it would be misplaced ever to allow fair scepticism to corrode into outright cynicism. International agreements are a lot like sausages. It is better to focus on the final product rather than dwell too much on how they are made. Much the same is true of Cop-27 which despite exhibiting all the above traits (the talks overran by more than 40 hours before an agreement was secured – close to a record even by the excruciating standards of climate change deliberations) did reach a result.
The truth is that talks like these are inherently challenging. We need to recognise this to resist the temptation to slide into cynicism.
First, this is the only process that we have on a global scale to solve a global problem. It might well be infuriating but there is no alternative mechanism to progress. Either this effort is made through the United Nations or, realistically, it will not be embarked upon at all. A multinational enterprise involving the better part of 200 countries will never have the cool efficiency of an Investment Committee. It will never appear quick or slick.
Second, the central issue is both simple and complicated. It is simple in the sense that almost all of us now acknowledge (that the temperature of the planet is rising at a disturbing and dangerous level and that it is human activity which is overwhelmingly responsible for that outcome. Conceding this is not difficult allowing for the weight of evidence that is available to us. Exactly how we stop this is, however, complicated. Exactly which activities and where should be the highest priority to curtail and how to offset the costs (financial and social) of this overhaul is not straightforward.
Finally, a host of deeply entrenched national interests must be allowed for. In the United States, for instance, the evenly split nature of the US Senate has meant that a single individual who happens to represent a state (West Virginia) where coal production is a primary industry has enjoyed a vastly disproportionate political influence. China accepts the principle of addressing climate change but is also concerned that the West is exploiting it to slow its rush towards the sort of Industrial Revolution that Europe and the US conducted without any heed of the environmental side-effects. India and Brazil harbour similar suspicions. The likes of Switzerland and Sweden can urge an end to the use of fossil fuels without the same internal impact as would be the case for Saudi Arabia. There are countries such as the Maldives where the risk of utter devastation from just a small increase in the sea level is not abstract but imminent, whereas there is no such apocalyptic threat for Mexico. In short, there is not an equality of sacrifice in operation here and agreeing an accord is a hard stretch.
Central to the agenda at Cop-27 in Egypt was whether or not to accept the notion of a “loss and damage fund” to be financed by the wealthier nations to provide for the rescue and the rebuilding of vulnerable areas which are on the front line when it comes to the menace that is posed by climate change. This consideration has been awarded additional importance in the eyes of those in the developing world by the utterly unprecedented floods seen earlier this year in Pakistan, which many would argue did not receive the attention they merited. Hence, especially with the conference occurring in a developing nation rather than Glasgow in the United Kingdom last year, it was an emphatic “must have” for scores of nations to get such a fund.
Europe and the United States were less enthusiastic about this concept. This is partly because they took the view that are plenty of pots of money already about across various international bodies and that the creation of a bespoke specialist fund would inevitably take time and involve bureaucracy it would be preferable to avoid. If they were being absolutely candid, which in the realm of diplomacy is not always the first choice of language, they would have conceded that an aspect of their distaste about a new fund is that, to put it diplomatically, one would not always have complete faith that in every instance of such funds being deployed to any country which might be eligible for it, that every single monetary unit thus released ended up with victims of climate change and not their rulers
Despite this disadvantageous backdrop, at what was less the eleventh hour than the thirteenth hour, Cop-27 acquired an accord on creating such a fund and a “loss and damage” institution will occur. There are, admittedly, quite a few details yet to be finalised, such as how large the fund is, who will contribute into it, how it will be administered and what the criteria will be for payments to be made and when the whole operation will start, but because the notion of the fund was so significant for so many countries the fact that it is to be established at all in any form allows Cop-27 to be a success.
What next and what does it mean for the private equity sector? The relatively technical question of the loss and damage fund at this Cop meant that the more basic concerns as to whether the current target for emissions control, which is that the overall rise in global temperature should be limited to 1.5 degrees above pre-industrial norms, can (a) be realised with peak emissions seen before 2030 and a decline thereafter and (b) whether it could be tightened further and faster, were somewhat in the shadows.
That will not be the case moving ahead. They are destined to be the overwhelming themes when it comes to Cop-28 next year (in Dubai, a component of the oil exporting UAE) and for the rest of this decade. The spotlight might seem to have shone brightly in this area over the past few years (which in fairness has prompted an appropriately robust response from many in the private equity space), but it is about to become much, much, more intense. This will be even more overwhelming as the legacy of the COVID-19 pandemic starts to ease and if, hopefully, there is ever something akin to an acceptable resolution of the Russia-Ukraine crisis. Climate change, having been knocked a little bit sideways by these alternative global maelstroms, will return to being public concern number one.
So, private markets will need to move up at least one gear and probably more to respond to this. There will be nowhere to hide. The good news is private markets have the opportunity, financial means, and firepower to effect change. Private equity is well positioned to engage on sustainability with portfolio companies given the long-term holding periods, controlling interest and deep operational expertise. With each portfolio company, there needs to be a process of assessing sustainability risks to manage but increasingly also finding opportunities to enact change, create value and generate a financial return. Transitioning to low-carbon or net-zero economies will require innovation, leadership, and ambition. Over time every proposed deal will have to involve scrutiny on lowering emissions, not merely in managing them.
Private debt markets also have significant levers to drive change. Despite not owning the portfolio companies, private lenders can control which projects receive financing and the structure of that capital. The rise of sustainability-linked loans, where margins for the loan are linked to the achievement of sustainability targets such as reducing carbon intensity and improving diversity, demonstrates how debt markets are seeking to effect change. As a lender, private debt managers can also engage with companies receiving their finance to emphasize the urgency and influence behaviour to drive more sustainable economic growth.
Leadership from governments and changes from consumers play an important role in the fight against climate change, but changes in these sectors are likely to take more time to implement and take effect (as seen by the progress at Cop). Private markets can act now, to help drive the shift in mindset of business leaders, consumers, and other stakeholders. The stark reality is that governments will demand affirmative action here, society at large will expect to see a sea-change in this regard and individuals as consumers will anticipate a visible commitment.
Commitment is the key watchword. It is about to become the alternative “C” in Cop-28 and however many additional numbers there are to come (probably a very large series allowing for how long it will be before anyone can come close to declaring victory in the crusade against climate change). That commitment will need to be public, precise, and practical. The ERR (External Rate of Return) will have to be rated as highly as the IRR. Everyone involved to any degree in the private equity sector will have to think deeply but swiftly how they will deliver the commitment they must demonstrate.