Reality bites as finance firms row back on their climate pledges

December 15 – In the run-up to last year’s United Nations climate conference in Glasgow, there was huge optimism that the financial sector was finally stepping up to its responsibilities on tackling climate change. The Glasgow Financial Alliance for Net Zero (GFANZ), set up by former Bank of England and Bank of Canada governor Mark Carney and encompassing net zero alliances of asset owners, asset managers, insurers and pension funds, promised to accelerate the transition to a green economy.

In the aftermath of COP27, the most recent U.N. climate summit, that optimism has been tempered, with a feeling that the sector has yet to address its biggest issues.

Progress has been too slow – in areas ranging from climate to biodiversity to deforestation – and there is a recognition that it will be extremely difficult to transform the system thanks to systemic inertia, political hostility and a bias towards incumbent providers.

According to BloombergNEF’s New Energy Outlook, we must spend almost $200 trillion to achieve net zero by 2050 – most of it private capital – and yet across the sector, there is a lack of transparency and mixed messages on how committed firms are to meeting the target.

A couple of years ago, JP Morgan chief executive Jamie Dimon was claiming his bank would align its investments in fossil fuels with the Paris Agreement. Yet this year, he told the U.S. Congress that the bank “absolutely does not” have a policy against funding new oil and gas projects and the idea of doing so “would be the road to hell for America”.

Vanguard, the world’s second largest asset manager, has just resigned from the Net Zero Asset Managers initiative in the wake of attacks from Republican politicians in the U.S., who have spoken out against investors that they say are hostile to fossil fuels.

Meanwhile, in China, which hosts the world’s fastest-growing green bonds market, analysis suggests “it’s almost impossible to know how the money is being spent – or whether it’s having the intended impact” because of “important gaps in disclosure and transparency”.

Republican politicians in the United States have spoken out against investors they see as hostile to fossil fuels. REUTERS/Dane Rhys

There has been consternation that members of the Net-Zero Banking Alliance (NZBA), which had agreed to use a methodology set out by the U.N.’s Race to Zero initiative, abandoned it after the methodology was made more stringent last summer, for the first time explicitly requiring members to “phase down and out of all unabated fossil fuels”.

“Race to Zero has a very robust approach to target-setting,” says Dr Adriana Kocornik-Mina, senior research and metrics manager at the Global Alliance for Banking on Values (GABV). “The NZBA has recently dropped this and allowed members to use alternative approaches, leading to a potential weakening of how organisations carry out net zero analysis and planning.”

Some alliance members are worried about legal repercussions if they rule out financing fossil fuels, but Kocornik-Mina says: “If you’re still financing fossil fuels and have net-zero targets for other parts of your portfolio, you’re not walking the talk.” There is a reluctance to be the first to act, she adds, because for now fossil fuels remain very profitable.

Following the NZBA’s first progress report, Jeanne Martin, head of ShareAction’s banking programme, says that there are crucial gaps and flaws in NZBA members’ targets.

“Most fail to capture the full range of greenhouse gas and financing activities, exclude heavy-emitting sectors such as chemicals, or use emissions-intensity targets, which can mask the fact that absolute emissions continue to rise.”

It doesn’t help that investors are not getting the full picture from the companies they invest in. According to Jane Thostrup Jagd, deputy director of net zero finance at the We Mean Business Coalition, almost none of the most polluting companies provide enough evidence that their financial statements consider climate impacts. In the words of a recent report from climate finance NGO Carbon Tracker, investors are “still flying blind

Carbon Tracker analysed 134 multinational companies, responsible for up to 80% of corporate industrial greenhouse gas emissions. Although they are all subject to engagement from Climate Action 100+ (CA100+), the investor-led initiative launched in 2017 to hold the biggest greenhouse gas emitters’ feet to the fire, 98% did not provide sufficient evidence that their financial statements include the impacts to their business from climate change.

Jamie Dimon, CEO of JPMorgan Chase, has changed his rhetoric on withdrawing from financing fossil fuels. REUTERS/Brian Snyder

Companies exposed to climate risks, such as the possibility of assets being stranded or overvalued, should highlight these in financial reports so that investors have the full picture.

In addition, the financial statements of companies with net-zero or emissions-reduction targets should explain how they will achieve this goal. But Carbon Tracker found that, even though a significant majority of the companies it examined had such targets, just 2% had aligned the information in their financial statements with achieving them.

This is the approach called for by the Taskforce for Climate-related Financial Disclosures (TCFD), whose recommendations are the basis for forthcoming rules from the European Union, the UK, the U.S. and the new International Sustainability Standards Board. These TCFD rules and regulations should bring the clarity and comparability that “the market has been begging for”, says Alexandra Mihailescu Cichon, executive vice-president at ESG data provider RepRisk.

RepRisk analyses a range of sources to get a true picture of a company’s approach to ESG factors, she says. “External sources hold up a mirror to what the company says it is doing, to give banks and investors a full picture. Report disclosures can be somewhat biased.”

Indeed, despite some improvements in disclosure, no CA100+ focus company provided all of the information required by the relevant standards or requested by investors, despite operating in high-emitting sectors such as oil and gas, mining, transportation and industrials, says Barbara Davidson, Carbon Tracker’s head of accounting, audit and disclosure and lead author.

“When companies don’t take climate-related matters into account, their financial statements may include overstated assets, understated liabilities and overstated profits,” she said.

Yet financial companies themselves have similar issues. A systemic transformation is essential, says Andrea Webster, finance system transformation lead at the World Benchmarking Alliance. “The financial system is one of the last pieces in the puzzle – it’s an amplifier for where we need to move at scale. But we are still a long way from our expectations.”

The alliance’s new Financial System Benchmark assessed 400 global financial institutions on their progress to supporting a just and sustainable economy. It found that just a fifth of institutions – from banks to asset owners and managers, insurers to development banks, pension funds and sovereign wealth funds – acknowledge their impact on people and the planet.

A protest against the use of and investment in fossil fuel, outside offices of Vanguard Asset Management on Earth Day in the City of London, Britain, April 22, 2022. REUTERS/Toby Melville

Without this acknowledgment they cannot put in place processes to identify and manage the impact they have, set targets and monitor progress, the alliance says.

More than a third (37%) of these institutions have made net zero and other pledges, but “despite global commitments, significant work is needed by financial institutions across all measurement areas to operationalise these commitments,” Webster points out. Only 2% of those with long-term net-zero targets have interim targets and only 1% are backed by science-based targets.

“It’s really important to have transparency on interim targets so investors can understand what progress is being made,” she adds.

Reporting on human rights risk and impact is almost non-existent. And funding for low-income countries, small businesses and other excluded groups is still exceptionally low. There is also virtually no tracking of the impact of institutions’ financing activities on nature and biodiversity, even though the U.N. Environment Programme says investment in nature-based solutions must triple by 2030, and private capital currently represents only 17% of investment in the sector.

The best performers in the WBA benchmark are European and Canadian banks, whose performance is lifted by the regulatory backdrop, along with development banks. “Those that do well have sustainability embedded into their mandate, C-suite commitment and clear policies in place,” Webster says. “You need accountability at the highest level, including linking targets to executive remuneration.”

The key to reaching climate targets is to go where the emissions are. For investors, that creates a challenge, says Daisy Streatfeild, sustainability director at asset manager Ninety One. “We could reduce the emissions of our portfolio very quickly by selling off the high-carbon assets, but it does nothing to achieve net zero. The ultimate test is how much emissions are reduced in the real economy, rather than in our portfolios.”

A new wave of transition finance is needed, according to Ninety One. “We must finance the reduction of carbon by directing capital to high-emitting regions and sectors where real-world change is most needed,” says the firm’s chief executive, Hendrik du Toit. “The worst mistake would be to isolate carbon-heavy places and enterprises by starving them of capital. Stepping back simply exacerbates the problem. Divestment may feel virtuous. But it would be ruinous. Heavy emitters cannot decarbonise alone.”

South Africa, for example, has the highest emissions intensity grid network in the world. “It’s a very clear, easily identified issue that needs addressing,” says Streatfeild. “In one sense, it’s very simple, but at the same time it’s very challenging because it’s such a big issue and Eskom, the state utility, is such a large company. The grid is very coal-intensive and South Africa’s mining industry is a significant employer, with more than 1 million people dependent on those salaries. We will see resistance to the shape and pace of change if the social impacts are ignored.”

The Sustainable Markets Initiative Transition Finance Working Group says that investment of about $4 trillion annually is needed to reach net zero by 2050, about a quarter of it in emerging markets. But only 15% of the necessary finance has been made available.

As Catherine McKenna, chair of the U.N.’s High-level Expert Group on the Net-Zero Emissions Commitments of Non-State Entities, says: “We know what we need to do: peak global emissions in just three years, by 2025, and cut emissions in half in less than eight years, by 2030. Money needs to move from funding fossil fuel infrastructure and instead be invested at scale in clean energy.

But this does not mean just selling out of problematic companies, she says. Investors must focus on their impacts in the real economy as a whole, not just in their own portfolios. And the need for a just transition must inform everything they do – net zero will not happen without public support, so due care must be taken to address the concerns of workers in carbon-heavy industries and countries.”

It’s a huge and massively complex task. Transparency, accountability and global consistency in regulations will all be needed for the financial sector to have a fighting chance of achieving it.

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