What COP29 means for our ESG portfolios

The annual climate conference currently taking place in Baku did not get off to the best start. Donald Trump has won the US elections with the slogan “Drill, baby, drill,” supported by a platform that certainly does not prioritise the fight against climate change. 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 for diplomacy. As every year, the COP conference—now in its 29th edition—takes stock of the many initiatives undertaken by governments, international organizations, and private entities. The goal remains to achieve some small progress in a challenge 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. This agreement is the result of diplomatic work carried out behind the scenes over the past three years under the direction of the UN.

Negotiators at COP29 have ratified a key framework for creating this new market, which will be regulated by a UN body. Once operational, this market could unlock billions of dollars in funding and restore confidence in carbon credits, which have faced heavy criticism in recent years.

How carbon credit markets work

Article 6 of the Paris Agreement is one of the most important provisions of the treaty. It provides governments and private entities with tools to internationally finance projects to meet their emission reduction targets. The core of the article lies in Sections 6.2 and 6.4, which establish two regulated markets for emission credits.

The logic behind these market-based policies is straightforward. Country A can purchase a credit, the proceeds of which fund a project in Country B to reduce emissions or preserve ecosystems. Country B receives financial support and an incentive to implement virtuous policies, while Country A can use the credit to offset its emissions and meet its targets.

This system theoretically mobilizes resources from high-polluting countries (often developed nations with more ambitious emission reduction goals) to developing countries, which have fewer resources and incentives to undertake such projects.

Another theoretical objective is to increase investment efficiency. Advanced economies may find it more efficient to fund reduction projects in third countries rather than invest heavily in domestic measures that yield limited environmental benefits.

While this approach has shown some effectiveness in regional or national systems — such as the EU’s Emission Trading Scheme — its international application remains voluntary, serving primarily to encourage sustainable project investments.

Criticisms 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 programs 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 likely have 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 programs, 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 over $2 billion 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 forward for voluntary carbon credit systems. According to COP29’s lead negotiator, the market could mobilise $250 billion annually for emission reduction projects—a small but vital step considering the $6.5 trillion annually estimated as necessary to meet Paris Agreement goals.

The US – China rivalry

On the sidelines of the conference, discussions focused on the potential impact of the Republican victory in the US elections, with 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 the United Nations 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. Below, we analyse the objectives of our Esg portfolios and the potential effects of a shift in US government policy.

• 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 channeling 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 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 to 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.