[ co-author: Amber Pirson ]

As the world continues to experience the undeniable effects of rising global temperatures, governments and company stakeholders are acting to address climate change. In 2016, over 190 countries created the Paris Agreement, which is a legally binding global framework aimed at limiting the increase in the average global temperature to 2°C. As part of the Paris Agreement, individual countries developed Nationally Determined Contributions (NDC) necessary to reduce national emissions and to mitigate the negative impacts of climate change. On January 20, 2021 the United States officially re-committed to the agreement and its own NDC goals.

The U.S. has established an economy-wide target of reducing net greenhouse gas emissions to 50-52% below 2005 emission levels. The federal government has proposed advancements in carbon-free electricity, transportation, construction, as well as other industries, including agriculture and fisheries. The U.S. government has also committed money to research and development aimed at finding alternative ways to reduce carbon emissions, while funding the efforts of state and local governments that seek to create jobs and grow companies that have made commitments to net zero carbon emissions. To achieve net zero carbon emissions a company must remove at least as much carbon from the atmosphere as it adds via greenhouse gas emissions. Companies that release carbon dioxide, methane and other greenhouse gases as part of their production processes need to identify alternatives, such as wind or solar power, to reduce their carbon footprint. These alternatives, however, can be expensive. The government, along with private investors, can provide the money needed to make this transition a reality. The Paris Agreement has bolstered companies’ recognition that improving their Environmental, Social, and Governance (ESG) performance will make them better corporate citizens. As a result, investors are seeking out companies that prioritize the Paris Agreement’s objectives in the context of their ESG concerns and climate change actions.

Investor Perspective

The global economy transcends national boundaries. As a result, market and investment leaders are playing a critical role in shaping the future of sustainability and business. By putting pressure on companies to adopt sound sustainability policies and practices, institutional and individual investors can raise legitimate concerns for businesses when it comes to capital acquisition and the cost of capital. Those concerns can and should motivate companies to evaluate their impact on the environment and to act more sustainably. Even though they did not sign the Paris Agreement, investors have important incentives to invest in companies that align with the goals of the Paris Agreement: avoiding credit risk, enhancing reputation and credibility, meeting the needs and desires of clients and customers and minimizing legal and regulatory risk.

In terms of credit risk, investors are increasingly evaluating the environmental risks associated with companies that ignore the net zero emission goals. The potential legal, regulatory and reputational risks associated with negatively affecting the environment can be significant. Moreover, financial literature suggests that there is a link between a company’s poor environmental performance and lower credit ratings. Research also shows that companies with environmental concerns often pay higher costs on their bank loans.

When it comes to business reputation and credibility, investors aspire to fund companies that utilize sustainability as a marketing tool. In a recent study, over 90% of CEOs recognized that sustainable practices and messaging about those practices are fundamental to success. As the risks and effects of climate change become dire, investors are in search of both effective and measurable policies that mitigate environmental risks while ensuring financial success.

Overall, investor groups aim to align their funding with companies that have demonstrated a tangible commitment to the Paris Agreement. In the process, they consider climate action to be a reward that outweighs the risk posed by companies that ignore the agreement. The world’s largest investor groups are increasingly seeking out companies with a culture of global stewardship through climate action, with the Paris Agreement as the coveted standard.

Trends and Global Leaders

Investor organizations’ influence stems from their market power and their international presence. From institutional investors in Europe (i.e. Brunel Pension Partnership and the Church of England Pensions Board) to the Asia Investor Group on Climate Change, the Investor Group on Climate Change in Australia and investor networks based in the U.S. (i.e. Ceres), these organizations are redefining their funding commitments to align with the Paris Agreement and applicable NDCs. Internationally, more than 110 asset managers and owners are involved in the Paris Alignment Investor Initiative, which wields a staggering $33 trillion dollars in funding aimed at abiding by this international standard.

Challenges to Paris-Aligned Investing

Paris-aligned investing can present multiple challenges due to the nuanced and evolving nature of climate change as well as the scope and breadth of social and environmental regulations in place across the globe, including:

• Inconsistent approaches to achieving climate objectives outlined in the Paris agreement
• Inconsistent net zero pledges across industries.

Investors have acknowledged that poor infrastructure and government funding often prevent national emission reduction policies from being fully realized. As such, some countries have compliance timelines that extend beyond the Paris Agreement’s deadline or simply do not direct net zero funding to the industries the agreement recommends. Other nations have posited that certain industries cannot become emissions-free by 2050. In addition, not all net zero company pledges are created equal. When a corporate policy lacks a plan for both upstream and downstream emissions or fails to incorporate realistic ideas to reduce job loss and build a reliable job transition network, it can lack credibility with investors. Moreover, long-term sustainability ambitions are not always clearly articulated or separated from reasonable and practical short-term goals. Subsequently, investors may find it difficult to determine if a company needs more capital to decarbonize or if the company is simply not doing enough to outline clear net zero objectives within its industry.

Solutions

The Net Zero Investment Framework created by Paris Aligned Investment Initiative details how individuals and asset managers can attempt to overcome these challenges. The framework identifies five pillars needed for investors to acquire clarity in their funding pursuits:

• Governance and strategy
• Targets and objectives
• Asset allocation
• Asset class alignment
• Policy advocacy.

The governance and strategy of Paris-aligned investing must be accompanied by accountability measures. One key strategy for investor groups involves hiring asset managers who are appointed to conduct risk assessments and present updates on new performance objectives as industry landscapes change.

When an industry develops, investors’ targets and objectives evolve. The framework encourages investors to set their own medium-term goals for emissions reduction, which will help them identify companies with similar frameworks and realistic impact measurements.

Asset allocation is a tool to assist investors that cannot immediately reconstruct their portfolio when decarbonizing. Investors should ensure that their internal climate impact objectives are progressive, clearly defined and easy to monitor. Moreover, they should attempt to identify the percentage of their portfolio in which they can reasonably invest in Paris-aligned companies in order to achieve their targets and objectives while maintaining profit.

In addition, investors should consider asset class alignment that is oriented to the future of companies’ respective industries. Sometimes, investors find it beneficial to use selective divestment to align their portfolio with their internal objectives or applicable NDCs. Investors should balance the risk of divestment plans against the benefit of acquiring financial gain through Paris-aligned investing and capital acquisition.

Finally, the rigor of Paris-aligned investing can be enhanced through policy advocacy. As investors propel their carbon reduction agendas through shareholder meetings and regulatory disclosures, as well as through traditional and social media, the companies in which they invest will be encouraged to align their internal procedures with investors’ goals. In this era of corporate transparency, investors will continue to prioritize companies that offer environmental disclosures and cooperate with Paris-aligned production practices.

* Amber Pirson is a member of the class of 2023 at Cornell University Law School and was a 1L Diversity Fellow at Fox Rothschild through a partnership with VF Corporation. David Colvin is Co-Chair of Fox Rothschild's Environmental, Social & Governance (ESG) Practice Group.

References

Aberdeen Standard Investments, “Paris Alignment - Our Approach for Investments”, Jan. 1, 2021, (last visited July 8, 2021).

United Nations Climate Change, “Nationally Determined Contributions," 2021, (last visited July 8, 2021).

United States’ Nationally Determined Contribution: Reducing Greenhouse Gases in the US: A 2030 Emissions Target, 2020, (last visited July 8, 2021).

Josh Burke, Grantham Research Institute on Climate Change, “What is Net Zero?," April 30, 2019.

Center for Climate and Energy Solutions, “Climate Basics: What We Can Do," (last visited July 8, 2021).

Andrew Hoffman, “The Next Phase of Business Sustainability”, Stanford Social Innovation Review, Spring 2018 (last visited July 8, 2021).

Bauer, Rob and Hann, Daniel, “Corporate Environmental Management and Credit Risk”, SSRN Electronic Journal, Dec. 23, 2010.

J. Jiraporn, P., Jiraporn, N., Boeprasert, A., Chang, K., “Does Corporate Social Responsibility (CSR) Improve Credit Ratings? Evidence from Geographic Identification” Financial Management, 505-531, 2014.

Simonetta Lein, “Why Sustainable Branding Matters," Forbes, Aug. 20, 2018.

John Donovan & Karen Shackleton, “Implementing the Paris Aligned Investment Initiative," Financial Review, May 13, 2021.

Jeremy Lawson, Eva Cairns, Craig Mackenzie, Aberdeen Standard Investments, “The Science and Art of Paris Aligned Investing," Dec. 10, 2020.

The Institutional Investors Group on Climate Change, “Net Zero Investment Framework," March 2021.

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