Nicholas Watson in Prague -

Inextricably linked to the food crisis is climate change, and this is set to dominate the headlines as countries from around the world meet up in Copenhagen December 7-18 to come up with ways to tackle the problem. Most of the money for any steps taken will have to come from the private sector, so what do investors want to see coming out of the summit?

The 15th Conference of the Parties (COP15) to the United Nations Framework Convention on Climate Change is considered to be the most important since COP3 in Kyoto, Japan in 1997, which generated the Kyoto Protocol, a document now signed by over 180 countries that set the stage for the world to take coordinated action to limit greenhouse gases. The objective this time is to agree a successor treaty to the Kyoto Protocol.

In the run-up to this conference, politicians and non-governmental organisations have all given their views on what they do or do not want to see in any treaty. However, the most important group is investors given that the vast majority of the money needed to implement any agreement will come from the private sector. "80% of the finance to mitigate climate change comes from the capital markets... we understand that any public financing at the global level needs to be part of an efficient mechanism that feeds into the market and frees up private capital," Paul Clements-Hunt, head of the UN Environment Programme Finance Initiative, which aims to develop linkages between the environment and financial performance, tells bne.

At the top of the list is a cap for greenhouse gas emissions; the Kyoto Protocol aimed to reduce industrial nations' emissions from their 1990 levels by about 5% by 2012 at the latest, meaning a follow-up treaty needs to be agreed. The private sector accepts the need for reductions, but what it doesn't like is a lack of clarity over targets; investors hate uncertainty. It appears that a consensus is coalescing around a target to reduce greenhouse gasses by 80% by 2050 - a level that experts reckon offers a realistic chance of keeping the average rise in global temperature to within 2°Celcius, another target. "As investors, we need a clear signal and strong commitment... toward an 80% cut in CO2 emissions around 2050, that is a target we investors can support," Francois Perrin, senior portfolio manager of green funds for Fortis Investments, tells bne.

This is looking like a forlorn hope. On November 4, US Senator John Kerry, who chairs the Senate foreign relations committee, signalled that the US administration has given up hope of reaching a global climate change treaty at Copenhagen and is working towards a deal late next year. "We have to be honest in the process and deal with the realities that we don't have time in these four weeks to put the language together and flesh out every crossed 't' and dotted 'i' of a treaty," Kerry told reporters.

Making matters harder, investors say that in addition to producing such long-term reduction targets, they want to see Copenhagen define short- and medium-term targets, which would act as milestones in the run-up to 2050. "After all, it is always easier for politicians to formulate very long-term objectives because they know that ultimately they cannot be held accountable for any failure to achieve them," points out Eric Heymann of Deutsche Bank Research.

Tools of the trade

Of course, targets require instruments to meet them. Few investors or utilities say they want to see the introduction of a globally agreed CO2 tax, meaning that the current system of emissions trading offers the best possible solution. Yet few would argue against Fortis Investments' Perrin when he says, "there needs to be a reorganisation of the carbon market."

The world's first effort at a cap-and-trade system, the EU's emissions trading system (ETS) from 2005 until 2007, saw too many emissions allowances distributed and too many given out free. This led to a slump in the price of allowances and allowed some participants in the scheme, notably those in the power industry, to report that they needed more permits and so managed to book windfall profits by simply adding the price of the permits they had received free of charge to the prices of their products.

An attempt to fix these problems in the revised ETS for 2008 to 2012 by reducing carbon emission allowances for countries came unstuck when several Central European countries sued the European Commission over the issue. On September 23, two of those countries, Poland and Estonia, won a huge legal victory when the Court of First Instance annulled the Commission's decision to lower the carbon emission quotas of both countries. This news sparked concern that the ruling, if upheld, could cause an unravelling of the whole system.

Utilities in Central and Eastern Europe, which are largely reliant on coal to generate electricity, would like to see a deal reached now over these carbon emission allowances, just as they would another outstanding related issue - the billions of euros' worth of greenhouse-gas emission permits that were awarded to them under the Kyoto Protocol, but which haven't been used.

According to EU estimates, countries in the former Soviet bloc still hold between 7.5bn and 10bn Assigned Amount Units (AAUs) granted under Kyoto, which have a combined estimated market value of €75bn-100bn. These countries still hold so many because their polluting industrial base collapsed in the 1990s in the transition from communism to a market-oriented economy. Under Kyoto's rules, governments should still be allowed to sell their AAUs after the protocol expires at the end of 2012, though the EU argues that allowing countries to use these permits would destroy any efforts to slow climate change. At a meeting of EU environment ministers in October, Poland, the EU state with the largest number of such permits, urged the bloc to agree minimal limits on their use.

As well as fixing the above problems, analysts say that emissions trading should be extended to more countries (Brazil, China, India), more sectors (aviation and maritime) and more greenhouse gases (methane and nitrous oxide). "At least all those countries that have made commitments to quantitative greenhouse gas reductions should participate in emissions trading," says Heymann." The longer-term ideal is a global emissions trading system whose participants include all the major emitters and that covers all the major greenhouse gases."

In the end, some investors like Roberto Cominotto, portfolio manager of the Julius Baer Energy Transition Fund, argues the world should be putting more emphasis on national plans rather than over-reaching for a nigh-on impossible global deal. "If countries can find domestic reasons to start investing in these new technologies that will limit climate change, then that would be a stronger driver than any pressure from the international community," he says.

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