Michele Morra is a senior portfolio manager and head of ESG investing at Moneyfarm, a digital wealth manager with more than £4bn in assets. He is also a university lecturer.
COP29 did not get off to the best start. Donald Trump had recently won the US elections with the slogan “Drill, baby, drill”, and ran on a platform that does not prioritise the fight against climate change.
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If the US were to withdraw from the Paris Agreement, it would mark the third time in its history that the country has backtracked on a major international climate treaty. Nothing new under the sun (or under the CO₂ curtain).
Fortunately, the fight against climate change is not just a matter of diplomacy. As every year, the COP conference – now in its 29th edition – takes stock of the many initiatives undertaken by governments, international organisations and private entities. The goal remains to achieve some small progress in a fight where all advances are insufficient and necessary.
This year, the initiative that deserves the most attention is the implementation of Article 6.4 of the Paris Agreement, which establishes a single, independent and global market for carbon credits. Carbon credits allow buyers to produce a certain amount of greenhouse emissions. The proceeds of this sale are then used to fund projects that offset these emissions, with the ultimate goal of reducing their global output. The agreement comes after three years of behind-the-scenes work carried out under the direction of the UN.
The international body will regulate the key framework that negotiators ratified at COP29. Once operational, this market could unlock billions of dollars in funding and restore confidence in carbon credits, which have faced backlash over the years.
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By GlobalDataCriticisms of voluntary initiatives
So far, credits under the Paris Agreement system can only be traded and compensated through bilateral agreements between states (regulated by Article 6.2). Projects from recent years have highlighted challenges, including the complexity of implementing such agreements and questions about their integrity and effectiveness.
For example, Switzerland has been active in establishing compensation programmes and approved the first bilateral agreement under Article 6.2 in 2013. Using funds from a foundation financed by oil importers, Switzerland supported a project to renew Bangkok’s electric bus fleet. The emission reductions were accounted for in Switzerland and contributed to its targets. Critics argue, however, that Bangkok’s bus electrification would have likely happened by 2030 regardless, meaning Switzerland effectively purchased the right to emit more without creating additional environmental benefits.
These regulatory challenges, particularly for voluntary emission compensation programmes, often undermine the credibility of the system. Companies purchasing credits for self-imposed sustainability goals face increasing scrutiny over the quality of projects and accusations of greenwashing. Studies suggest that only 12% of voluntary carbon market credits represent actual emissions reductions. As a result, companies have distanced themselves from carbon credit markets, leading to a drop in demand and prices – especially for forestry-based credits. The voluntary carbon market’s value has shrunk by 61% in the past year, after peaking at more than $2bn in 2022.
The Baku agreement
The Baku agreement, which establishes a global carbon credit market under Article 6.4, aims to address these issues. It includes rules to enhance market integrity, such as methodologies for evaluating project quality. Participation in the UN-backed market should guarantee credit quality, potentially attracting companies back, boosting demand and increasing credit value to incentivise emission reductions. The system’s independence from government participation further enhances its appeal.
However, critics highlight shortcomings such as overlapping standards with existing Core Carbon Principles and a lack of sector-specific methodologies. Unresolved technical issues, like credit pre-approval and measures to prevent double-counting, could pose operational barriers. While conference organisers claim the Baku agreement is sufficient to launch the market, critics argue that key elements are still missing for full functionality.
A global market would be a significant step forwards for voluntary carbon credit systems. According to COP29’s lead negotiator, the market could mobilise $250bn annually for emission reduction projects – a small but vital step considering the $6.5trn annually estimated as necessary to meet Paris Agreement goals.
The US – China rivalry
On the sidelines of the conference, discussions focused on the impact of Trump’s win in the US elections given his promises to dismantle Biden’s green policies. Much of this agenda, however, targets measures in the Inflation Reduction Act, which includes various industrial policy incentives for sectors like electric vehicles.
An example of this is the recent trade tensions in the automotive sector between Europe and China. Promoting these industries has now become part of the strategic interests of states. Beyond political rhetoric, developing these new industries (including in the energy sector, as demonstrated by China’s investments in green energy) becomes an opportunity. To quote the words of UN secretary-general António Guterres: “Those desperately trying to delay and deny the inevitable end of the fossil fuel era are attempting to turn clean energy into a dirty word. They will lose. The economy is against them.”
Diplomatically, the US repositioning cannot be underestimated. Every significant climate agreement, including the Paris Accord, hinges on a US – China consensus. At COP29, the US delegation was led by John Podesta, a Democratic negotiator with a weakened mandate, creating an opportunity for Beijing.
China, the world’s largest emitter, has also recently surpassed Europe in historical emissions – and is soon expected to surpass the US. It remains committed to Paris Agreement goals, emerging as a global leader in renewable energy with billions invested in green projects at home and abroad. This strategy strengthens China’s economic and geopolitical influence, making it the key partner for poorer nations seeking to transition from fossil fuels.
Conclusion on ESG investments
From a portfolio perspective, while we closely monitor the evolution of diplomatic developments and assess their potential impact on various sectors, this does not change our long-term view on ESG investments. We believe this investment approach will remain important over the long term and are convinced it represents a sound choice not only from an ethical standpoint but also from a financial perspective.
It is important to note that our ESG portfolios are not solely focused on investments tied to the energy transition, whose short-term performance is more volatile and influenced by political decisions. Objectives of our portfolios and potential effects of a US policy shift include:
- Reducing exposure to controversial companies. Moneyfarm’s ESG portfolios exclude companies involved in social controversies (such as human rights violations) or with high revenue exposure to fossil fuels. This approach remains independent of any potential slowdown in the energy transition. In a context of potential deregulation, the importance of channelling private investments away from sectors that negatively impact society becomes even more significant.
- Mitigating risks associated with sustainability factors. Moneyfarm’s ESG portfolios consider the sustainability risks of exchange-traded funds (ETFs) through ESG rating analysis, aiming to reduce exposure to companies whose revenues might be affected by the phase-out of fossil fuels. Sustainability risks include reputational risks, challenges in managing the transition and physical risks (such as floods devastating regional economies, which are increasingly frequent). While in a scenario of more permissive environmental regulation companies highly exposed to fossil fuels might find short-term relief, the broad range of sustainability risks (not all tied to regulation) will continue to attract investment focus.
- Increasing the share of sustainable investments. Sustainable investments involve economic activities that contribute to environmental or social objectives. In Moneyfarm’s ESG portfolios, we have chosen not to pursue specific sectoral interests but to include only ETFs with greater exposure to sustainable companies. We also include ETFs focused on green bonds issued by governments or highly rated companies to finance projects with environmental benefits. These asset classes generally exhibit much lower volatility compared with thematic equity investments, and the risk remains contained due to their bond-like nature, diversification and the creditworthiness of the issuers.
- ETF manager activism. The active exercise of voting rights to support ESG resolutions by asset managers can be directly or indirectly influenced by government actions and positions. We have observed this in recent years, with a decline in activism among certain issuers. However, it is our responsibility to continue monitoring and integrating asset managers’ behaviour into our investment decisions.
While the tension surrounding the future of the Paris Agreement concerns us as citizens, it does not alter our medium and long-term positioning on ESG portfolios.
