With COP26 fast approaching, and the financial industry facing additional costs to comply with government actions on climate change, it needs to start asking itself some tough questions, namely: Are we acting responsibly for the future? Are we driving carbon neutrality in the businesses we finance? Are we acting as an enabler for investments to lower the cost and increase the deployment of low-carbon technologies?
Across day two and three of Sibos 2021, Finextra listened in to a clutch of panels on the green transition, to gain insights into how financial institutions are measuring, mitigating, and acting on climate risk.
What are the most impactful actions financial institutions can take on climate change today? According to Abyd Karmali, managing director of climate finance, Bank of America, there are four key areas banks should be looking into.
- Alignment: The first action point is aligning with global climate initiatives, such as the Paris Agreement. “What Bank of America has done,” explained Karmali, “is join the Net-Zero Banking Alliance and the Global Financial Markets Net-Zero Alliance. These give us a set of best practices around how we align our emissions, our lending, and other capital markets activity.”
- Ambition: The second area is around ambition, and conveying to stakeholders and clients alike that the transition to a net-zero economy is imminent. Bank of America, for its part, has done this through a $1.5 trillion 10-year business commitment, noted Karmali. “This ensures our clients are aware that capital is available, and that we will help them with their transitions, when it comes to the balance sheet and capital markets activity.”
- Advocacy: The third proactive step banks can take relates to advocacy. “It's one thing for the banking sector to try and help the economy decarbonise,” argued Karmali, “but we will be assisted greatly if policies give us supporting tailwinds, as opposed to problematic headwinds.” This also means working with different stakeholder coalition groups. Once again, Bank of America seems to be practicing what it preaches, and is, for example, supporting the Sustainable Markets Initiative, which Brian Moynihan is co-chairing with the Prince of Wales.
- Appetite: The fourth and final action point cited by Karmali relates to increasing risk appetite, and looking at “where there needs to be a step change in financing.” This could include, for instance, identifying and supporting key operations and geographies earlier that have the biggest need to scale up their transitions. It may also mean “innovating in areas like blended finance, where we can get multiple hits on the Sustainable Development Goal (SDG) bingo card, as we like to say” Karmali added.
Getting comfortable with a step change in disclosure
Taking a more granular perspective of banks’ challenge ahead was Amy West, managing director, global head of sustainable finance & corporate transitions, TD Securities. “Net-zero commitments must have teeth,” she began. “Large banks and financial institutions need to both understand where the emissions are actually coming from in their portfolios, as well set short and long-term science-based targets.” Once captured, the data should be supplied to investors and capital providers, the wider market, and even activists, argued West. “This will instil accountability in all large organisations.”
Disclosure - the linchpin of sustainable finance - has been important to investors for some time. The coalition of institutional investors is now sharpening its demands of all companies, and has made it clear that there is an inevitability around the net-zero movement. “Investors are asking the C-Suite tough, detailed questions,” observed Karmali. “That's what we've noticed over the past five years or so - the quality of dialogue between companies, investors and us as intermediaries, has improved significantly.”
“For many financial institutions, scope three emissions make up the biggest portion of greenhouse gas (GHG) inventory,” added Yulanda Chung, managing director, head of sustainability, institutional banking, DBS Bank. “If companies can report better, and to a higher standard, banks’ disclosure becomes more accurate. This also makes it easier for investors to scrutinise our performance.” In Singapore, there are several initiatives seeking to support this objective, such as the Common Data Platform, through which all financial institutions involved can contribute data to the inventory. “This represents a standard and source of truth, that we can base decisions on,” noted Chung.
Mandated sustainability reporting: Beast, burden, or the only way forward?
The upshot of initiatives like this is that, by Karmali’s summation, entities are finding it harder to get away with “superficial climate strategies”. Thanks to the increased rigour of the market, the growing popularity of ESG, and projects like Europe’s Sustainable Finance Reporting Directive (SFRD), greater detail is being divulged to investors.
But does this mean sustainability reporting should become mandatory? If regulation is the answer, can we align and address the divergence on ESG standards and formats adopted across industry stakeholders and participants? What would the trade-offs, associated costs and benefits of a globally recognised and harmonised framework be?
Fortunately, there are several groups looking to help the financial industry through these standardisation challenges, noted Sherry Madera, chief industry and government affairs officer, London Stock Exchange Group. These include the Future of Sustainable Data Alliance (FoSDA), the Financial Stability Board, and the International Financial Reporting Standards (IFRS) - which is looking to create disclosure standards and align them with an accounting standard.
To invest or divest, that is the question
Once banks are able to identify exactly where carbon emissions are coming from in their portfolios, the conventional wisdom is to divest. West, however, stressed the importance of engaging with these ‘problem’ clients, and working closely with them to expedite their decarbonisation. “Divestment is a simple solution and cleans the portfolio,” West conceded, “but it doesn’t reduce emissions in the real economy.” Indeed, divestment simply pulls exposure outside the banking sector. As such, financial players have a responsibility to engage with the sources of GHGs and help them go green.
Karmali does not believe divestment is a prudent tactic, either. “We have been with these clients part of the way - we're not just going to cut them off now,” he said. “We want to work with them, via innovative financing solutions, and by improving disclosure of their climate risks.”
Institutions like Bank of America have many lessons to impart to businesses, thanks to their experiences of working with Environmental, Social, and Governance (ESG), ratings agencies, and measuring disclosure through international non-profit organisations, like CDP. “We can come up with financing products that align the incentives for strong performance on climate, with strong financial returns,” Karmali said.
The range of financing instruments available today is blossoming, pointed out Laurent Adoult, managing director, head of sustainable banking, FI & SSA Europe, Crédit Agricole. In first half of 2021, sustainable finance bonds surged 76 percent year-on-year, reaching an all-time H1 record of $552bn. In the United States, meanwhile, a mergers and acquisitions (M&A) boom - involving sustainable companies - is underway, and interest in sustainable lending continues to flourish. Evidently, “the sustainable finance asset class is firmly rooted in the industry’s future, and the analysis of qualitative and quantitative data,” concluded Seelig.
Crédit Agricole, for its part, has incorporated a transition rating for all large customers. “This gives the bank a dynamic view on where client stand in their transition journey, and a base to help them achieve their CO2 reduction targets,” explained Adoult. Clearly, client engagement is a more nuanced - and effective - means for banks to take meaningful action on climate change, than divestment.
The impact of advocacy
Returning to Karmali’s action point on advocacy - and the impact of regulation - Ilya Khaykin, partner, head of climate risk and sustainable finance Americas, Oliver Wyman, asked what influence, if any, net-zero targets will have on the fight against climate change.
While it is encouraging to see both governments and private sector companies issuing climate-positive announcements, and convening at conferences such as COP26, said Chung, substance must catch up with the rhetoric. “A minority of companies coming out with net-zero commitments may not be sufficient. We need time to build a critical mass of support.”
Fortunately, among some of the most carbon-intensive operations in Asia, there are signs that the tide is turning. “When we speak to customers in the thermal coal business in Indonesia,” said Chung, “whether that’s upstream mining or downstream power generation, coal remains a dominant part of their business. However, these companies are actually looking at their net-zero commitments and have strategies in place to get from point A to point B.” Globally, around two-thirds of the economy has already made net-zero commitments, pointed out Elree Winnett Seelig, global head, ESG, markets, Citigroup. Whether this is enough to lower global temperatures by 1.5 degrees Celsius remains to be seen.
Some governments, like Indonesia, have adopted a similar timeframe as China - aiming to reach net zero by 2060. “That should translate into their Nationally Determined Contributions (NDCs), and hopefully, the next COP26 is going to bear that out,” added Chung.
The hope is that a country's NDCs inform the private sector, and more companies follow suit.
Incentivising the green transition
In the next few years, the question of how banks can incentivise decarbonisation throughout the wider community, will become critical. For West, there is no silver bullet. Nonetheless, “we need to be looking at how we ensure that the clients that are on this journey have access to capital, and more quickly,” she said. “Since the green bond market has been around, it has not been overly receptive to certain sectors of the economy. How we finance the transition has to be a focal point.”
The need for governments to come in on this area is questionable, West argues: “It's great if they do, it's great if we have standards,” she said, “but if you look at the EU, or North America, we do not yet have significant guidance on how things like nuclear and natural gas are going to count. Where are the goalposts? I'm encouraged that the private sector is going to lead on this front.”
Chung added that if we want to incentivise the transition credibly, we need to be able to see the destination. Indeed, there are no fewer than 100 International Energy Agency (IEA) pathways to get to net zero, so businesses belonging to carbon-intensive industries must be specific in their goals. “If you do nothing, in time, you are going to be priced out of the market,” she pointed out.
But what of financing cutting-edge technologies - the kind that are critical to combatting climate change? These projects often come with high technology-related risks, which have historically rendered them unfavourable financing targets for financial institutions. On top of this, these projects are - by nature - vast in scale, and require considerable volumes of capital in order to take off. As such, venture capitalists tend to shy away from them. Khaykin labels this the “the valley of death for financing.”
The answer to the challenge thus far, noted Karmali, has been the private equity sector. “In Europe’s renewable space, for example, private equity has stepped in to take some of the biggest plays in areas like offshore wind.” Indeed, Bank of America has been working with these kinds of clients, to first get them funding, and then help create partnerships with institutional investors at the right time - when there's a more predictable drip feed of return.
“We must also identify these climate disruptors sooner, and then work with them in a variety of ways to help them access capital,” added Karmali. On the equity capital market side, this may involve looking at Initial Public Offering (IPO) options, for instance.
Support from the ecosystem-at-large
Perhaps the most recurrent theme of all the Sibos 2021 sessions on climate change, was the need for support from the entire ecosystem - not just banks. Indeed, different forms of capital to help plug the multi-trillion-dollar gap will be imperative.
To surmount this global crisis, the world's largest banks and economies need to be in sync - and the United States must re-engage in the effort. This year’s historic G7 commitment to tackle climate change and halt biodiversity loss by 2030 was a promising move in the right direction.
Announcements such as this are also key for banks’ clients, who need more clarity in terms of the market expectations. As such, reporting - of the kind encouraged by the Task Force on Climate-Related Financial Disclosures (TCFD) - will become key. Just today, the TCFD issued its fourth status report, highlighting a bumper year for adoption; with 83 of the world’s largest 100 companies now reporting in line with their recommendations.
Once again, however, data availability is not enough to plot a course for decarbonisation. More definitional granularity is needed to enable apple-for-apple evaluations of one company - or one sector - against another, and ensure the borders we put on our maps are not also the borders we put on access to capital. Only then can we engender impactful change.
As the dust settles from August’s incendiary IPCC report, the focus of financial institutions is now homed in on COP26, and how they should best interface with the next global commodity - carbon offsets.