The Inclusive Transition to Net Zero Is the Only Way Forward

Hendrik du Toit and Katherine Tweedie of Ninety One sent me a guest comment on how the drive to avert harmful climate change needs global inclusiveness to achieve total net zero:

Our firm is committed to the goal of net zero carbon emissions by 2050. But we will not pretend that decarbonizing portfolios is the same as decarbonizing the real world. It is time to be honest with ourselves, for the sake of the planet.

While we are a global investment manager, we are dual-listed in London and Johannesburg, rooted in South Africa and the first firm from an emerging market to sign up to the Net Zero Asset Managers Initiative. We joined the NZAMI because we believe we have at least two important responsibilities. To help make the case for curbing harmful climate change. And to help make the case for a fair transition to a net zero that will work for all the markets of the world.

The Net Zero Asset Managers Initiative has attracted 128 signatories, managing a combined $43 trillion. All have committed to achieving net zero emissions by mid-century or sooner.

There is a problem, though: The absence of a consensus on how to cut carbon emissions in the real economy – or how we are going to get to a net zero that encompasses the whole planet.

Many investors and asset owners are responding to the challenge with hasty plans to reduce their own portfolio carbon intensity or reported carbon.

Let us take the standard MSCI index of global equities. A portfolio manager need simply double the weight of Apple, Amazon, and Facebook to achieve the 7.6 percent annual reduction demanded by the most ambitions United Nations scenario. On the other hand, doubling allocations to three of the largest clean-energy solution providers – Enel, NextEra, and Iberdrola – would actually increase emissions by 5 percent. (The reference in these cases is to Scope 1 and 2 emissions.) Would those reallocations to big tech make the tiniest jot of difference to the quantum of carbon emissions?

Similarly, in a typical global equity portfolio, a reduction of 50 percent exposure in the BRICS plus Indonesia will lead to a 3 percent reduction in reported portfolio carbon intensity. The weight of those countries in the index is just 8 percent, another reason divestment may be more attractive than engagement. This gives institutional investors an incentive to avoid these markets. Our experience in emerging markets tells us a very different approach is required.

Here are some hard truths. While emerging markets are today responsible for more than two-thirds of annual global emissions, OECD member countries are responsible for three-fifths of cumulative historic emissions. That is seven times more than the rest of the world on a per capita basis.

Now is not the time for rich countries, their investors, asset owners, and institutions to abandon the rest. If they do, they are effectively leaving developing markets to deal with a vast fog of emissions that has been everyone’s making. Discrete actions without coordination, patience and financial investment into the markets that need it most will not achieve net zero.

It is not just the rebalancing of portfolios that could, and already do, create perverse outcomes. Let us look at a couple more examples that would, at scale, actually mask or even exacerbate the problem. Would the sale of a high-emitting physical asset in fact reduce carbon? Or would it simply assign the asset to a new owner? Would pulling investment from a country with high emissions help cut those emissions? Or would an exit just deprive that already needy country of capital and complicate its path to a cleaner outcome? When Anglo American demerges its South African thermal coal assets into a new company, Thungela, who wins? Anglo has cleansed itself of coal but Thungela continues to mine. Not an ounce of carbon is reduced.

If an effective “buy developed, sell developing” takes hold, emerging markets may be starved of investment capital at the very time they need an extra $2.5 trillion a year to finance their energy transitions. In addition, these markets might actually be punished for relying on their existing energy systems to fuel the growth that will generate the revenue to finance large parts of planned transitions. An example is the border taxes proposed as part of the Fit for 55 package by the EU. Valdis Dombrovskis of the European Commission is even advocating the use of trade policy to enforce compliance with EU environmental standards.

Now that so many European and other developed markets have “offshored” substantial portions of their carbon emissions to poorer nations via complex supply chains, it cannot be right for them to tax the products of those countries where people are doing their best to escape from poverty.

The race to net zero is not a race between countries. It is a race against time.

The way to address these issues is to focus on long-term transition plans consistent with net zero by 2050 for companies and countries, rather than near-term reductions in reported carbon or carbon intensity. The solution lies before us. It requires patient pragmatism rather than instant purity – or a focus on “transition finance” instead of on “net zero finance.”

The rich world, with its substantial official and private financial firepower, could create a compelling set of incentives for developing countries to embark on an ambitious energy transition. This calls for a modernisation of the multilateral international financial architecture. We do not have the time to build new infrastructure. We need to repurpose part of the existing infrastructure to finance the debt-for-climate incentives which will be required to shift the system at scale.

In simple terms, results on the climate front should be rewarded with a combination of debt forgiveness and access to official capital. The private sector is ready and willing to participate. Although it cannot alone provide the kind of incentives we need drive the early momentum of the intended transition, the private sector can provide green finance at scale. For governments, policy makers and capital allocators, this is the longer path to take. It is also the right path, and the investment opportunity is in the tens of trillions of dollars.

A partial net zero is no net zero at all. But if an inclusive transition succeeds, the whole world wins.

About Ninety One

Ninety One is an independent, global investment manager dual-listed in London and Johannesburg. Established in South Africa in 1991 as Investec Asset Management, the firm demerged from Investec Group in 2020 and became Ninety One. Now in its 30th year of organic growth, Ninety One manages more than USD$190 billion and offers active strategies across equities, fixed income, multi-asset and alternatives to institutions, advisors, and individual investors around the world.

This is a brilliant comment by Hendrik du Toit, CEO of Ninety One, and Katherine Tweedie, Ninety One’s country head for Canada.

I want to thank them both for writing this and sharing it with my readers. 

From time to time, I enjoy reading comments from experts. Katherine and I had a great discussion on emerging markets and net zero a few weeks ago and I was happy she and Hendrik followed up with this comment.

I typically do not allow asset managers to comment on my blog except when it is content that enriches the wider discussion on issues that matter to pensions.

And the transition to net zero matters a lot to global pensions.

The comment above highlights how important it is to have an inclusive transition to net zero which also considers emerging markets. 

Hendrik du Toit recently wrote another excellent comment on how emerging markets need an inclusive approach to net-zero which goes over many of the points brought up in the comment above.

Last week, the Independent quoted him stating it's time to avoid a climate disaster by helping emerging markets go green:

Rich countries should ditch privileged debates over the legacy of colonialism and pay off poorer countries’ carbon instead, an influential investor has told The Independent.

The call for former colonial powers to help foot the bill for developing nations’ carbon production comes ahead of the climate change conference, Cop26, and after the publication of a landmark report about the dire state of the climate.

Hendrik du Toit, founder of asset management company Ninety One, which has £130.9 billion of assets-under-management, believes such an approach could win more global support for the battle to combat climate change. 

At present, Mr du Toit said, rich nations are asking developing countries to give up on efforts to become prosperous, by cutting back the energy intensive industries that their economies rely on. Instead, wealthy countries need to make a more radical offer: buy up much of the carbon that these nations produce and help fund their transition to Net Zero emissions.

“Instead of all the intellectual arguments about decolonising things, let’s actually be fair in respect of decarbonisation,” du Toit said. “The rich world is aware of the damage of the colonial legacy. Instead of talking about that in lecture halls in the West, let us rather support the victims of climate change, ie people in emerging markets, to make their energy systems clean and green.” 

“Currently in the West we’re obsessed with righting the wrongs of the past. In this case we have the opportunity of avoiding a major disaster by being fair and inclusive,” he added.

Western countries like France, Germany, the UK and others, have enjoyed the wealth created by the industrial revolution and often outsourced the most carbon intensive industries elsewhere, exporting pollution.

Now, the EU has put a price on carbon produced by domestic industry and is seeking to do the same with carbon intensive imports. It offers “too much stick and too little carrot” Mr du Toit said. 

“They intend to punish the emitters of carbon outside their borders, that is not enough to encourage change. They should incentivise decarbonisation as well,” he said.

A global carbon pricing mechanism combined with richer countries buying the carbon generated by poorer nations could offer a solution. There should also be a “debt for carbon” mechanism to give something back to developing countries if they take on the risk of decarbonising their energy systems, he said.

“The carbon-heavy developing countries will not simply switch the lights off. That is why we [Ninety One] are arguing for a constructive approach from the developed world. Capital for transition and incentives in the way of debt forgiveness should form part of the plan,” Mr du Toit said.

Ninety One, of which Mr du Toit is chief executive, is also a member of the Institutional Investors Group on Climate Change which comprises asset managers who together oversee 39 trillion euros.

The Covid-19 pandemic was a good example of richer countries failing to see the benefit in supporting developing nations effectively.

“Until we have vaccinated the vast majority of the world population, we will face an uphill battle against the pandemic. The fight against climate change is similar,” he said. “It will only succeed if it is global and therefore inclusive. Emissions do not respect borders.”

I couldn't agree more, just like we need the entire world to be part of the solution against the pandemic, we need to figure out a way to incentivize emerging markets to be part of the solution in the fight against climate change. 

And seeking to price carbon imports from emerging markets isn't the solution. We really need to incentivize decarbonisation.   

I like the "debt for carbon" proposal Hendrik is arguing for because we cannot expect developing nations to stop growing to cut their carbon production. Instead, we need to incentivize the right (greener) growth.

Anyway, if it's one thing last week's UN report on climate change underscores, it's that time is of the essence and it's actually the richest countries which need to get their act together:

Below, Ninety One CEO Hendrik du Toit spoke to Bloomberg's Francine Lacqua on "Surveillance: Early Edition" recently to discuss the violence in South Africa and how it impacts confidence.