Not all Government Net Zero pledges are created equal

But while a pledge to reach Net Zero emissions – typically by mid-century – may seem to offer a straightforward measure of a country’s commitment to addressing climate change, how a country plans to get there and its existing policy mix can reveal to investors a lot about relative climate risk.

Not all Net Zero targets are created equal. Depending on historical and current carbon emissions, some are more ambitious than others. And, crucially, many such pledges are inconsistent with nearer-term targets – the 2030 goals set out in the Nationally Determined Contributions (NDCs) as part of the Paris Agreement process – as well as countries’ existing suites of decarbonisation policies.

An analysis of these discrepancies can help investors gauge the risk incurred by countries that do not engage seriously enough to decarbonising their economies.

FTSE Russell funded a research project led by individuals from the International Institute for Applied Systems Analysis (IIASA) and the NewClimate Institute which resulted in a database on mitigation measures that was a critical input for the Net Zero Atlas published for COP26.

On average, we find that the current Net Zero targets will, if met, collectively deliver a global temperature rise of 2.1C, well above the 1.5C targeted by the climate talks. Among the G20, the most ambitious target is that of the UK, which is aligned with 1.5C, and the least ambitious is that of Saudi Arabia, which is aligned with 2.9C of warming.

The research also shows that few existing NDCs are aligned with Net Zero commitments: the average NDC implies 2.8C of warming, 0.7C higher than the average Net Zero target.

Countries’ current policies only slightly lag their NDC commitments, leading globally to a 3°C warming trajectory.

But this average masks some laggards, including several rich-world countries, whose current policies are some way behind their NDC goals. For example, current policies in the US and

Canada are tracking towards a 4°C+ trajectory, but their 2030 NDC commitments are aligned to 3°C. Germany and South Korea are also some way adrift.

This suggests that it could prove very challenging for carbon-intensive economies to align with 1.5C over the course of a decade through domestic action alone, and that they might need to turn to the growing carbon offset market.

Conversely, and perhaps surprisingly, a number of large emerging economies actually have more ambitious policies than NDCs. Russia, for example, has policies in place that are aligned to a 0.7°C lower trajectory than its NDCs. Turkey’s policies are 0.6°C lower, and China’s 0.3°C. These countries appear well-positioned to increase the ambition of their NDC commitments.

So what does this mean for investors? We believe this research has two practical applications.

Firstly, investors increasingly need to align their portfolios with the 1.5C Paris Agreement warming trajectory. While an entirely aligned portfolio would currently be impossible – or at least extremely poorly diversified – portfolios could be constructed that offer considerable improvement in alignment.

Secondly, a country’s Implied Temperature Rise provides a measure of climate risk. A country whose current policies, NDC or Net Zero target is substantially misaligned with the 1.5C trajectory is likely to face pressure to ratchet up its climate policies.

In addition to growing moral pressure from the international community and domestic stakeholders, climate laggards face more concrete economic penalties. For example, the EU’s proposed Carbon Border Tax Adjustment aims to penalise exporters that are not subject to an appropriate carbon price.

The announcement in Glasgow on November 1 that India has become the latest major economy to commit to Net Zero – albeit not until 2070 – illustrates the extent to which the international community now recognises the imperative to halt emissions. But it also shows that investors need to understand the detail behind each country’s commitments.