November 10, 2020
Waking up to the challenge
The banking industry is waking up to its financed emissions, the Greenhouse Gas (GHG) emissions it directly or indirectly finances through equity and debt investments. While some, such as ING, have been working on this issue for over two years, it has only been in the last six months that some of the world’s largest banks have made portfolio-level emissions commitments, including HSBC and JP Morgan.
Banking generally lags other sectors of the financial services industry, the asset management sector for example, has had the UN Principles for Responsible Investment (PRI) which embeds ESG considerations into investment processes since 2006. The Principles for Responsible Banking (PRB) launched in 2019 has a similar intent to the PRI. Some banks have gone further than agreeing to principles and signed up to portfolio commitments, such as the Katowice or Collective Commitment to Climate Action aiming to limit portfolio emissions in-line with the Paris goals.
These commitments are a welcome start and echo a wider trend towards the mainstreaming of sustainability into business strategy and investment. This is driven both by reporting requirements, such as the EU Taxonomy and SFRD, but also as a result of shifting attitudes towards the roles of companies from maximizing shareholder value to maximizing value to a range of stakeholders.
Reporting on and reducing banks’ carbon footprints also make business sense. Carbon intensive clients present transition risks as we move to a low carbon economy and the externalities of heavy emitters are internalized through carbon taxes, regulation, consumer sentiment and other factors.
Standards, measurement, reporting... but little change
In order to operationalize these portfolio commitments and bridge the gap between the complexities of varied financial instruments and GHG accounting new standards, frameworks and tools have emerged.
The Partnership for Carbon Accounting Financials (PCAF) has developed methodologies and standards to apportion carbon emissions exposure from clients to banks across a range of asset classes. The Paris Agreement Capital Transition Assessment (PACTA) for Banks tool provides banks with a framework and asset-level data to assess the emissions trajectory of their clients and their alignment with industry specific Paris-aligned emissions pathways. Both are important efforts to effectively measure portfolio emissions and their alignment with climate goals.
However, the primary assumption behind measuring emissions using these approaches and selecting investments for climate goal-alignment is that channeling investment to low carbon activities will result in lower carbon emissions in the real economy. Some such as Duncan Austin, with 25 years of experience in ESG research, point out that the relationship between investment and change in the real economy is loose at best.
To use a car metaphor, the ESG community has reached for the steering wheel of the global economy to turn it in a greener direction, only to find that the steering wheel is poorly connected to the main wheels and that inputs on the steering wheel may or may not be turning the vehicle in the desired direction.
Getting hands-on to transform
To have more direct impact then, a different, more holistic and in-depth approach is needed, beyond picking the strongest performers to show portfolio alignment to targets. Sustained effort is required to support those companies far from alignment and those closer to transition, while sunsetting industries with significant lock-in emissions. From large MNCs who may have already set science-based targets to mid-cap and SMEs who are likely less mature, banks have strong relationships and influence and therefore a key role to play.
Banks can to do three things to make real change happen:
- Engagement with all their clients to raise the issue of GHG emissions as being material to their financing process and align incentives by talking about transition risk
- Education and support to explicitly explain the benefits of carbon reduction, especially to small and medium sized companies. This can be especially material in driving improvements given the numbers of companies involved and the frequency of touchpoints a bank has with its clients vs. other actors trying to drive change
- Standardized technology and data combined with banks’ client networks can vastly improve the quality and frequency of data collection and reporting, especially among private companies who may not report. Peer benchmarking can drive real performance improvement, unlock efficiencies and offer the chance for banks to offer value-added services
Some of our most interesting client conversations on financed emissions have been around client interactions and support. Some raise concerns that they are providing a service and so any additional effort required from companies, for example in providing emissions source data, may reduce their competitiveness. Others take the opposing view, that providing high-quality digital sustainability tools will be a source of competitive advantage for their clients and allows them to provide additional value- added services which they can monetize.
More than competitive dynamics and the potential financial return from getting deeply involved in client decarbonization journeys is the social responsibility banks have given their position, to move the economy to a low carbon future. In taking on this responsibility, banks in the next decade could do much to restore their reputation as institutions which support a well-functioning society rather than as the sometimes scandal-hit and destabilizing forces of the last decade.
 Responsible Investor (Duncan Austin): RI long read: Should ESG view sustainability as a quicksand problem? (October 12th, 2020)
Article written by
ESG Advisory and Solutions Lead
Senior Sustainability and Carbon Expert