It is with mixed feelings that COP25, the 25th annual UN climate change summit, ended in Madrid on Sunday. After the longest climate negotiations on record, negotiators from more than 190 countries agreed on a compromise text. While they acknowledged that current carbon reduction targets were not sufficient to meet the goal set under the 2015 Paris Agreement of containing global warming to well below 2 degrees Celsius by 2100, they failed to formally commit to increase them by the end of 2020, despite recognizing "the urgency of enhanced ambition." True, 80 countries--mostly from Latin America and Africa--representing about 10% of global greenhouse gas (GHG) emissions, committed to putting forward more ambitious Nationally Determined Contributions (NDC) next year. Yet importantly, countries failed to make progress on one of the most technical aspects of the Paris Agreement, so-called Article 6, which aims to facilitate the trading of emissions reductions among countries, which would count toward NDCs. Discussions on financing adaptation to climate change in developing countries also made little progress.

If the outcome of the political process was disappointing to many, S&P Global Ratings also saw some positive signs beyond the official negotiations, in particular continued commitment from local governments, businesses, and multilateral institutions. While the Paris Agreement was a strong political signal, we believe that nonstate entities are likely to play a critical role in its actual implementation. Some important initiatives also emerged for the first time, such as finance ministers joining the negotiating table and emphasizing the role of nonenergy sectors, including forestry and agriculture, in ensuring the transition to a low-carbon economy (see "COP25 Special Edition: Climate Finance Takes Root," published on Dec. 5, 2019).

The Devil Is In Article 6's Details

The negotiations failed to reach a consensus on one of the most technical aspects of the Paris Agreement: the rules of the new global emissions regime set out in Article 6. It provides a framework for countries to reduce their carbon emissions and achieve their climate goals through three different international cooperation mechanisms: an international carbon-accounting framework, a carbon-trading system, and a work program for nonmarket-based approaches. Countries have to agree on the accounting standards to report their carbon emissions targets and the framework for trading carbon-reduction units. Put simply, this type of mechanism would enable a country that rapidly reduces its carbon emissions to sell carbon units to another country that does not manage to meet its commitment.

Divergences became apparent between some of the largest emitters (the U.S., China, Australia, India, and Brazil) and the EU together with countries most vulnerable to climate change. The most contentious questions included whether countries could carry over carbon reduction units generated before 2020, under the former Kyoto Protocol, and whether two countries could use those units, which presents the risk of double counting. Discussions were postponed to COP26 that takes place in Glasgow in December 2020.

Loss And Damage Remain Vulnerable

Following a year that saw extreme climate-related events, such as Hurricane Dorian and Cyclone Idai, inflict widespread damage in some developing countries, negotiators in Madrid were also tasked with reviewing the Warsaw International Mechanism for Loss and Damage, which was established in 2013 to deal with loss and damage from climate change in the developing world. Financing loss and damage has been a sticking point in climate negotiations given the massive sums involved. Indeed, the UN Environment Program forecasts adaptation costs in developing countries to be 4x-9x greater by 2030 than the total amount of international finance available today (see "Sink Or Swim: The Importance Of Adaptation Projects Rises With Climate Risks," published on Dec. 3, 2019). While parties agreed on the development of a new expert panel to consider support for loss and damage and a "Santiago network" to facilitate technical support, they did not answer the request from developing countries to create a dedicated fund. We expect this issue to remain on the agenda for negotiators in Glasgow.

Positive Signals In An Uncertain Geopolitical Environment

In our view, climate negotiations are not immune to broader geopolitical issues. COP took place in a context of rising political tensions among countries and a lengthening list of disputes such as the U.S.-China trade-technology war, Brexit, delayed ratification of the U.S.-Mexico-Canada Agreement, U.S.-Iran tensions, and the Japan-Korea technology dispute. We nevertheless believe the conference yielded some positive developments, which we outline here.

Climate change is becoming mainstream

Similar to what we are observing in the capital markets, climate change is starting to become mainstream for the political finance community. For the first time this year, finance ministers from more than 50 countries were present at the negotiations. As part of their new Santiago Action Plan, they committed to support the transition to a low-carbon economy by developing fiscal, economic, and planning instruments, and providing incentives for financial flows. They also committed to support the development of carbon reduction pledges and better evaluate their macroeconomic impact. International organizations such as the World Bank and the International Monetary Fund reaffirmed their commitment to support those efforts through their investment policies. The World Bank committed in December 2018 to invest US$ 200 billion in low-carbon projects between 2021 and 2025, as well as the development of new economic models to better assess the impact of climate risks on economic growth. Those initiatives followed the creation two years ago of the Network of Central Banks and Supervisors for Greening the Financial System, a network of central banks from more than 40 countries committed to managing climate-related risks on financial markets and mobilizing capital for green and low-carbon investments.

This collaboration between environment and finance ministers at the political level mirrors to some extent what we are observing within many companies, where sustainability is increasingly becoming embedded in the broader corporate strategy and no longer the sole responsibility of the corporate social responsibility team. This is evidenced by new business and governance practices, such as linking carbon reduction targets to the remuneration of executives or interest rates on bonds and loans. Green bond issuance, which according to the Climate Bonds Initiative is expected to exceed $235 billion this year, is another example of this new form of collaboration between sustainability and finance teams within companies. In our view, this reflects a growing awareness across the board that the transition to a low-carbon economy can only be achieved through a multidisciplinary approach, combining public policies, private investments, and science.

From carbon neutral to climate positive

At this COP, "carbon neutrality" has become a prominent slogan, as an increasing number of countries have committed to net zero carbon emissions by 2050, including Japan, Norway, France, and the U.K. In countries such as Australia, local governments have set similar targets despite a somewhat less ambitious climate strategy at the national level. Businesses from various sectors have followed suit, including the French food producer Danone and the Spanish oil and gas company Repsol. Those announcements followed the landmark 1.5 degree C report by the International Panel on Climate Change (IPCC), which highlighted that slowing the release of carbon emissions into the atmosphere will not be sufficient to limit the increase in global temperatures to 1.5 degree C. The report argues that limiting global warming requires "reaching and sustaining net zero global anthropogenic CO2 emissions" over the long term.

According to IPCC, achieving carbon neutrality will require all sectors of the economy to adapt. While countries' efforts have so far focused on the transition away from fossil fuels in the energy and transportation industries, new sectors are moving into the spotlight. Forestry, agriculture, and other land uses were one of the main themes at COP this year, as these represent close to one-quarter of total anthropogenic GHG emissions (see "Could Agriculture And Forestry Be The New Frontier For Green Bonds?" published on Dec. 4, 2019). Technologies in this sector have an important role to play in mitigating climate change, as they have the potential to be "climate positive" by creating carbon sinks and removing carbon from the atmosphere. Finally, we note that the final text also calls for addressing "biodiversity loss and climate change in an integrated manner," suggesting that reducing carbon emissions should be done concurrently with reducing other environmental impacts such as pollution and toxicity.

Challenges And Opportunities Ahead In Glasgow

As the political process moves from negotiating the Paris Agreement to implementing it, we expect further difficult negotiations ahead. Raising ambitions to bridge the gap between the current GHG emissions trajectory and the 2-degree scenario, as well as agreeing on general Article 6 rules and financing resilience in developing countries, are likely to remain on top of the agenda for negotiators next year. Recognizing the contribution to the Paris Agreement of nonstate market participants is also likely to be an important topic of discussion as local governments, businesses, and international organizations continue to drive the transition. Indeed, new questions are emerging about COP's future role and opportunities to forge greater collaboration among all participants in the economy to meet the world's ambitious sustainability goals.

Related Research

• COP25 Special Edition: Climate Finance Takes Root, Dec 5, 2019
• Could Agriculture And Forestry Be The New Frontier For Green Bonds? Dec. 4, 2019
• Green Evaluation Analytical Approach, Dec. 4, 2019
• Infrastructure Seeks A Circular Solution To Sustainability, Dec. 4, 2019
• Sink Or Swim: The Importance Of Adaptation Projects Rises With Climate Risks, Dec. 3, 2019
• Delays In Addressing Global Warming And The Longer-Term Ratings Implications, Dec. 3, 2019
• European Airlines Prepare For Take-Off On Climate Change, Nov. 21, 2019
• Energy Transition: Renewable Energy Matures With Blossoming Complexity, Nov. 8, 2019
• Raising Ambitions: COP24 Tilts Toward Achieving 1.5 Degrees Climate Target, Dec. 19, 2018
• COP23: Two Degrees, With Separation, Nov. 23, 2017