Strengthening Financial Institution Strategies to Adapt to the Climate Crisis – EQ Mag Pro
In the lead-up to COP26 this November, financial institutions are ramping up their climate commitments, allocating additional investment to clean energy and reducing fossil fuels investment.
All 10 major North American banks have set net-zero or Paris-aligned targets within the past year. On April 13, 411 businesses and investors representing $4 trillion in annual revenue and $1 trillion in assets signed an open letter to President Biden in support of the most recently updated U.S. Nationally Determined Contribution (NDC) to the Paris Agreement. The update sets a new target of halving greenhouse gas (GHG) emissions by 2030 and achieving net-zero emissions by 2050.
Globally, four major initiatives have emerged to help financial institutions reduce emissions in alignment with the Paris Agreement objective: the Net Zero Asset Managers initiative; the United Nations-convened Net-Zero Asset Owner Alliance; the Science Based Targets initiative (SBTi); Paris Aligned Investment Initiative (PAII); and the Climate Action 100+ investor-led initiative.
These initiatives aim to increase the use of science-based targets by creating or implementing a standardized framework for reporting emissions, increasing investment in renewable energy, and divesting from fossil fuels. Some of these initiatives have overlapping missions but have stated intentions to collaborate in carrying out climate targets.
Setting a Framework
The majority of emissions associated with financial institutions are Scope 3 emissions, or emissions from the companies in which they invest. For this reason, financial institutions require targeted guidance when it comes to setting and reporting on their Paris-aligned climate targets. Their respective approaches to such guidance are outlined below.
The Net Zero Asset Managers Initiative reports their progress toward climate targets against the Task Force for Climate-related Financial Disclosures (TCFD)
The UN’s Net-Zero Asset Owner Alliance released a 2025 Target Setting Protocol in October 2020 that outlined a process for individual companies to set their own emissions targets.
CDP’s SBTi developed a temperature-scoring tool to help financial institutions assess how their targets adhere to Paris Agreement goals and the 1.5-degree Celsius scenario. The SBTi also published a guide for financial institutions on how to report their progress on the goals.
The PAII published their Net Zero Investment Framework 1.0 in March 2021, advising investors on how to develop net-zero investment strategies.
The Partnership for Carbon Accounting Financials (PCAF) was founded after the Paris Climate Summit in 2015 to develop a global, open-source GHG accounting standard called the Global GHG Accounting and Reporting Standard for the Financial Industry to assist financial institutions in aligning their portfolio with the Paris Agreement.
Government regulations mandating corporate climate disclosures may also play an expanding role in determining how financial institutions report their progress on Paris-aligned climate targets.
The EU Taxonomy’s proposed “Green Asset Ratio” mandates banks to disclose their sustainable loans and equity holdings, and the Bank of England recently introduced a “climate stress test” to assess the resilience of U.K. banks and insurers against climate change.
Most recently, the Swiss Federal Council introduced mandatory reporting requirements for large companies based on the TCFD recommendations, including banks and insurance companies above a certain size which will now be required to report publicly on climate issues in 2024. With President Biden’s recent Executive Order directing a whole-of-government approach to climate-related financial risk, U.S. government agencies are anticipated to introduce regulations in this space in the near future.
Investing in Renewable Energy
Financial institutions have been increasing their investment in the renewable energy sector. Annual U.S. private sector investment in renewables reached $55.1 billion in 2020. Banks were the largest sector to issue sustainability bonds in 2021, with $5.31 billion in sustainability bonds linked to targets to increase the share of renewable energy generation in the same year. Nineteen Fortune 500 financial institutions have also set renewable energy procurement targets for their companies’ operations.
JP Morgan and Bank of America have been the biggest tax equity investors for U.S. solar and wind projects over the past five years, with JP Morgan financing 15 gigawatts (GW) of wind and solar projects and Bank of America financing 20.6 GW from 2015 to the first half of 2021. BloombergNEF projects that 53 GW of solar projects and 22.1 GW of wind projects will be financed by tax equity from 2021-2022.
Divesting from Fossil Fuels
Financial institutions have also set divestment targets necessary for reaching the Paris objectives. Achieving Paris targets will not be possible without eliminating emissions from coal power plants and halting further production of fossil fuels. As of May 2021, financial institutions have made 167 fossil fuel divestment commitments.
At least 34 banks introduced policies to restrict investments in oil and gas, and 71 implemented financing restrictions for thermal coal. According to BloombergNEF, divestment strategies consist of ceasing lending to fossil fuel and other high-emitting sectors, and halting other forms of business, such as equity offerings with companies expanding fossil fuel and high-emitting operations.
However, more remains to be done. Investment in fossil fuels continued to outpace divestment from the sector last year. According to BloombergNEF, fossil fuel bond underwriting by big banks rose 50% from 2019 to 2020.
More Renewable Investment is Needed to Achieve Paris Objectives
Current investment in renewables lags behind what is needed to reach the Paris climate goals. According to BloombergNEF’s latest New Energy Outlook, new U.S. investment in renewables needs to reach between $20.5 trillion and $28.5 trillion by 2050 to achieve net-zero emissions.
In ACORE’s 2021 report on private sector renewable energy investment, Expectations for Renewable Energy Finance, we found that achieving $1 trillion in U.S. private sector investment in renewables and related grid infrastructure between 2018 and 2030 would require annual private sector investment to increase by 59% above 2020’s investment amount of $58.3 billion.
This investment level could reduce carbon emissions by up to a 60% – exceeding the Biden administration’s goal of reducing carbon emissions by 50-52% in the same period. Fortunately, investors surveyed for the report indicate a willingness to expand their investments in the sector if there is smart federal policy reform that provides a long-term level playing field in support of carbon-free electricity generation.
Overall, financial sector interest is clearly growing for the transition to a clean energy economy. We look forward to seeing further steps in the upcoming months as countries and organizations prepare to update their progress on climate commitments in COP26.