The enabling role of financial institutions in the transition to net zero

28 June 2021

This content is for professional investors only as defined by the MiFID.

In April, CDP (formerly, the Carbon Disclosure Project) published a report summarising the findings from the first round of responses to its questionnaire tailored specifically to the financial services sector.

The headline figure was that portfolio emissions of global financial institutions are on average over 700x larger than reported operational emissions, and only 25% of disclosing institutions calculate and report these financed emissions.1

Although this is the first time that this difference has been quantified so starkly, these figures did not come as a surprise. It is through the people, businesses and activities that they choose to support commercially, that financial institutions have the biggest impact and are most exposed to climate-related risks and opportunities.

The difficulty of measuring and managing these financed emissions and the corresponding risks and opportunities lies at the heart of our Carbon Impact approach to financial institutions, which we have developed with many of the topics raised in the CDP report in mind. As such, the key takeaway which we would like to underline is not those figures themselves – however striking they may be – but rather the message that “on top of providing green finance, the finance sector must become green”. As the authors of the report highlight, “While most financial institutions are focused on providing sustainable finance, they are less focused on ensuring that the entirety of their business is aligned with net zero”2.

Indeed, this rings true. If 2020 was the year of the net-zero commitment, 2021 is so far proving to be the year of the trillion dollar pledge, with some of the world’s largest banks fighting for the spotlight to showcase their green ambitions. US banks Citi, JP Morgan and Bank of America have all thrown their hat in the ring in recent months, announcing new 10-year sustainable financing targets, matching and indeed surpassing those made by their European counterparts over the last few years.

Yet, at the same time, highlighting so starkly this disconnect to which CDP was referring, the league table of fossil fuel financing compiled each year by the Rainforest Action Network confirmed in March that global banks provided $750 billion in financing to coal, oil and gas industries in 2020. This brings the total support to $3.8 trillion in the five years since the Paris Agreement.3 Despite the impact of the pandemic, which reduced global demand and resulted inage a roughly 9% reduction in fossil fuel financing across the board, the world’s 60 largest banks still increased their financing to the 100 companies most responsible for fossil fuel expansion by over 10%4.This stands in glaring contrast to the total overhaul laid out by the International Energy Agency (IEA) in its “Roadmap for the Global Energy Sector” published in May, which calls for all new oil and gas exploration projects to stop as of this year, if we are going to meet the net-zero goal of the Paris Agreement.5

Similarly, an analysis by Reclaim Finance and Urgewald of financial flows to all 934 companies on the Global Coal Exit List showed that institutional investors held investments totalling more than $1 trillion in companies operating along the thermal coal value chain. The report showed that at the start of this year, the world’s two largest institutional investors alone had a combined exposure of $170 billion to the coal industry – accounting for 17% of institutional investments in global coal6.

Ultimately, any carbon impact assessment of a bank or asset manager boils down to the simple question of how it is cleaning up or ‘greening’ its portfolio, and as these figures so clearly show, it needs to be as much a question of increasing exposure to green activity, as it is about reducing its exposure to ‘brown’ activity. In our opinion, it is most importantly about actively shifting the scales between the two, by supporting clients in their transition efforts through any levers at their disposal: active engagement, advisory services, green finance, sustainability-linked products, to name but a few. In the following pages we will explore in detail what this looks like in practice. The figures on either extreme will always be the ones to make headlines, but financial institutions and their investors alike would be wise to take a broader perspective than just those prescribed by prevailing definitions and frameworks and support all efforts to shift the scales and facilitate a reduction in real world emissions.

As positive as a tighter coal policy or a new green financing pledge may be, an isolated commitment on either end – however sizeable – does not guarantee the desired real-world impact on its own. The financial institutions that we rate most highly are not necessarily those with the lowest fossil fuel exposure today, or the largest green financing target, but rather those which demonstrate a fully integrated strategy across all operations and activities, not just detached efforts in particular hotspots of its business.

For the purposes of this publication, we will focus on lending and investment portfolios – excluding underwriting activities. Although insurance companies, both as asset owners and underwriters, undoubtedly have an important role to play in the transition – as all financial firms do – for the sake of simplicity, we apply narrow boundaries for this assessment of financial institutions, and consider only banks and asset managers, and their respective activities which pertain to capital allocation.

(1) CDP, “The Time to Green Finance”; April 2021
(2) CDP; 2021
(3) Rainforest Action Network, “Banking of Climate Chaos 2021”; March 2021
(4) Rainforest Action Network; March 2021
(5) International Energy Agency, “Net Zero by 2050: A Roadmap for the Global Energy Sector”; May 2021
(6) Reclaim Finance, “Groundbreaking Research Reveals the Financiers of the Coal Industry”; February 2021

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