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How investors will be affected by changes to a major Australian climate policy

The Albanese government’s revamp of a Coalition-era emissions reduction mechanism raises a number of issues for investors. Pendal’s MURRAY ACKMAN explains

INVESTORS should keep a close watch on changes to a major Australian carbon emissions policy, which could have wide ramifications for the economy and markets, says Pendal’s Murray Ackman.

The Albanese government is aiming for a 43 per cent cut in emissions by 2030 (compared to 2005) and net zero emissions by 2050 — in line with its new climate change law.

To help achieve this, the government is revamping an old Coalition policy known as the “Safeguard Mechanism“, which was designed to reduce carbon emissions by regulating the amount of greenhouse gases that big industrial facilities could emit.

Originally introduced by Tony Abbott’s Coalition government, the mechanism set emissions “baselines” for 215 of our biggest polluters.

Those that exceeded their baseline were required to offset the excess pollution with carbon credits bought from sources that had reduced their emissions.

But critics say the mechanism hasn’t worked. Baselines were too high, the policy was generally not enforced and since then new polluters have started operating.

From July, the Albanese government will strengthen the mechanism in a number of ways, including a 4.9 per cent annual cut on allowable emissions for the biggest emitters.

You can read more about the safeguard mechanism here.

What it means for investors

Investors and companies could be impacted in a number of ways, says Ackman, a credit ESG analyst in Pendal’s Income and Fixed Interest team.

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Here are some issues:

1. Policy certainty

“The first thing we’re looking for as investors is policy certainty,” he says.

“One of the challenges for investors is always that policy is proposed and then negotiated with the Greens and cross bench. That uncertainty can spook investors.”

In March, the Albanese government struck a deal with the Greens to implement the safeguard mechanism.

2. The problem with offsets

Under the Safeguard Mechanism, businesses that exceed their baselines can meet their obligations by buying offsets from approved emissions reduction projects.

But sustainable investors will want to take a close look at these offsets, says Ackman.

“There are certain classes of offsets that are pretty dodgy,” he says.

“If you ask a farmer not to clear certain land and get offsets for that, what if they had no intention to clear the land anyway? How do you know it’s not going to be cleared anyway in 10 years?

“Planting trees is also fraught with challenges in Australia — floods, droughts, fires. Just because you plant them doesn’t mean they are going to last to maturity.”

The key for investors seeking to understand the difference between effective and ineffective offsets lies in whether the carbon emission reduction is guaranteed or not, Ackman says.

“One of the offsets allowed in the safeguard mechanism is if you reduce emissions more than target you can sell the excess.

“That seems reasonable because you are measuring something that has actually happened.”

3. New fossil fuel projects can still go ahead

Despite an agreement with the Greens on a hard cap for emissions, the mechanism won’t stop all future fossil fuel projects.

“That’s robbing Peter to pay Paul,” says Ackman.

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Modelling suggests emissions from “financially committed new projects” for coal and LNG alone will generate 56 million tonnes of carbon equivalent emissions between 2024 and 2030.

That’s nearly 5 per cent of the mechanism’s entire emissions budget.

That means higher reduction rates could be required from the companies with existing facilities covered by the mechanism.

“This is the complaint of the Greens and the cross bench.

“You need to rule out new fossil fuel production because otherwise the safeguard mechanism is incomplete.”

4. Cost of living pressure

The mechanism is susceptible to cost-of-living pressures.

“Where the rubber hits the road is when these bigger emitters start having an impact on the cost of living,” says Ackman.

He points to two challenges.

“The first is basic supply and demand — if everyone’s doing this at the same time, the costs associated with reducing emissions could be more than we’re expecting.

“The second challenge is that complaints about higher costs in the community could weaken the government’s resolve.

“Every government has strong ideology until its starts to hurt the hip pocket.”

Winners and losers

The safeguard mechanism has the potential to create winners and losers in investment markets, says Ackman.

Companies that can reduce their emissions significantly will have the upside of a new revenue source from selling excess carbon credits.

Pendal Sustainable Australian Fixed Interest Fund

An Aussie bond fund that aims to outperform its benchmark while targeting environmental and social outcomes via a portion of its holdings.

Others face the risk of significant penalties if they don’t invest in cutting their emissions intensity.

“As a fixed income investor, we actually get quite good access to some of these emitters.

“A thorough understanding of a business and its transition plan is important for investors.

“It’s one thing looking at the balance sheet today.

But you also want to know how earnings will be able to be maintained over the policy cycle.”

About Murray Ackman and Pendal’s Income and Fixed Interest boutique

Credit ESG analyst Murray Ackman joined Pendal’s Income and Fixed Interest team in 2020 to provide fundamental credit analysis and integrate Environmental, Social and Governance factors across credit funds.

Murray has worked as a consultant measuring ESG for family offices and private equity firms and was a Research Fellow at the Institute for Economics and Peace where he led research on the United Nations Sustainable Development Goals.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

The team’s awards include Lonsec’s Active Fixed Income Fund of the Year (2022) and Zenith’s Australian Fixed Interest Manager of the Year (2020).

Regnan Credit Impact Trust is an investment strategy that puts capital to work for positive change.

Pendal Sustainable Australian Fixed Interest Fund is an Aussie bond fund that aims to outperform its benchmark while targeting environmental and social outcomes via a portion of its holdings.

This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current at March 22, 2023. PFSL is the responsible entity and issuer of units in the Regnan Credit Impact Trust (Trust) ARSN: 638 304 220 and Pendal Sustainable Australian Fixed Interest Fund (Fund) ARSN: 612 664 730. A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund and Trust are available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or Trust or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com

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