Critics of the new science-based target for the finance sector say it doesn’t go far enough, while there are fears the EU's sustainable finance taxonomy will lack rigour. Mike Scott reports
If the world is to meet its Paris Agreement target to limit temperature rises to well below 2C, the financial sector has a crucial role to play. Financial institutions are increasingly aware that the changing climate poses material risks to their returns and that they must start redirecting capital to green solutions and technologies; the Intergovernmental Panel on Climate Change (IPCC) says energy systems need investment of around $1.6tn to $3.8tn every year between now and 2050 to hit the target.
“Banks are having to do a lot more due diligence to understand what net-zero means in sectors such as cement and steel, and to understand what that means for risks in their own portfolios,” says Helen Wiggs, head of climate at ShareAction. “Net-zero and science-based targets are bringing more transparency around decarbonisation strategies. Companies are going to have to be open about where their problems lie. Making TCFD [Task Force on Climate-related Disclosures] mandatory, as the UK is doing from 2023, will help companies and investors see the risks they are facing.”
But until recently, banks and investors had little guidance on exactly how to do this. Now the Science Based Targets initiative (SBTi) has released guidance on how financial players can align their lending and investments with the Paris Agreement, and 55 institutions have already committed to implement it.
The SBTi’s framework highlights the power of financial institutions to redirect capital to companies contributing to the low-carbon transition
To qualify for validation by the SBTi, the targets for scope 1 and 2 portions of financial institutions’ emissions – covering operations and purchased energy – must cut emissions by at least 2.5% for a well-below 2C target, and a minimum of 4.2% for a 1.5C pathway.
Financial institutions’ scope 3 targets, which cover their largest impact on climate change – their investments and lending portfolios – must meet specific criteria relevant to each asset class.
The initiative says investors must encourage the companies they own to set more ambitious emissions reduction targets. “There is a need for clarity,” says Cynthia Cummis, SBTi steering committee member and director at World Resources Institute. “The SBTi’s framework highlights the power of financial institutions to redirect capital to companies contributing to the low-carbon transition, and away from those that contribute to climate change.”
The standard will be updated every year as best practice evolves, she adds.
One of the characteristics of working towards net-zero is that there are a lot of non-competitive aspects to it, says Magnus Billing, CEO of Swedish pension fund Alecta. The fund is a founding member of the Net-Zero Asset Owner Alliance whose members, with $5tn assets under management, have agreed to set portfolio decarbonisation targets that follow the IPCC 1.5C scenario for the next five years.
“We have challenges around access to data and its quality. The alliance can work as a catalyst in tackling these issues. It’s a good way to challenge each other, to compare progress and encourage everyone to take the next steps.”
Alecta has started to stress-test its portfolio for various climate scenarios as well as financial scenarios to help it integrate the risks and opportunities properly, and applies an internal carbon price to the companies it holds stocks in. “The discrepancy between the market price and the value we come up with is a very strong tool for engaging companies,” Billing says.
We know that disclosure is not enough in itself. It needs to lead to further action
While about 85% of Alecta’s portfolio companies are reporting on their scope 1 and 2 emissions, the figure for scope 3 is just over 50%, “so we know we have not done enough engagement,” Billing points out. “Disclosure by companies gives us a starting point, but we know that disclosure is not enough in itself. It needs to lead to further action. Companies need to ensure that we feel comfortable with their net-zero plans.”
The science-based target for finance has already changed behaviour, he says. “It’s having a meaningful impact on how we report our own targets and the changes will only speed up. It aligns with the regulatory push for the reallocation of mainstream capital towards sustainable investment, which is very strong.”
There are still some issues, he adds. “The data needs to improve, and not just from companies but from investors as well. We need to better assess where our portfolio is today. We know where we want to be in 2050, but we don’t have a view of where we are. If we have that, then we can set a path towards 2050 and put in place indicators to ensure we are going in the right direction.”
Another key challenge is that there is no consistent carbon price to help drive investment. “When we looked for a relative carbon price that would bring about 1.5C alignment, we found a range from $100 to $870. That spread makes it very difficult to take any kind of investment decision.”
Sasja Beslik, head of Sustainable Finance Development at Bank J Safra Sarasin, believes the science-based target for finance will be important, “but we need to be clear on where the companies that we do business with are in terms of their emissions and what trajectory they are on”. He points out that emissions are still going up every year despite the trillions of dollars committed to integrating ESG issues into the investment process.
“There has been a surge of interest from the financial industry, given the regulations that are on the horizon. However, in the real markets, I don’t see any particularly big changes, except that fossil fuel demand has been hit by a combination of Covid-related reduction in demand and divestment. There is not much focus on the valuation of stocks."
We need to change the way we invest, but no one investor can do it alone. We need everyone to act at once
Beslik sees an inherent conflict of interest, with finance firms trying to position themselves as part of the solution but “still evaluating companies on a quarterly basis and not giving them the chance to shift their business model. … We need to change the way we invest, but no one investor can do it alone. We need everyone to act at once.”
But Lucie Pinson, director of Reclaim Finance, an NGO affiliated with Friends of the Earth France, believes it should be mandatory for investors and banks to stop financing fossil fuels.
“The ambition is not where it needs to be and even the Science Based Targets Initiative and the Net-Zero Asset Owner Alliance are clearly ignoring science,” she says. “The alliance talks about phasing out coal but it will still allow the financing of coal plants that are already under construction. There are currently 211 coal plants being built around the world. If you want to phase out coal, why allow plants to be built that will just end up being stranded?”
“These coal companies are not interested in transition and should be excluded right now.
Johan Frijns, director of Dutch NGO BankTrack, says there is too much focus on setting targets for 30 years from now, “but much less detail on what companies will do by 2030. I see it as a way of avoiding making a decision on financing fossil fuel companies.”
While most large banks are clear about moving out of coal, there is a huge hesitation to do the same for oil and gas, except the most damaging projects such as oil sands and Arctic exploration.
“We understand that banks with large fossil fuel portfolios cannot just dump clients overnight, but we would like to see an acknowledgement that the fossil fuel industry is a problem and needs to change,” he says. “There is no space whatever to expand production. It’s a no-brainer if banks want to become Paris-aligned. And companies won’t act until their banks act. We think banks can play a very important role in convincing their clients that they need to move in another direction.”
There are fears that the EU's Sustainable Finance Taxonomy may not be sufficiently rigorous
One tool that is being watched carefully is the European Union’s Sustainable Finance Taxonomy, which will help investors and businesses to assess whether certain economic activities are sustainable. Having a clear idea of what counts as green investment will help to direct more funds to climate-friendly projects that will help nations and companies to meet their net-zero targets.
“We will have to report how our products are linked with the taxonomy,” says Billing. “It is science-based and will have a meaningful impact on how we report on our science-based targets.”
However, there are fears that the taxonomy, which is currently out for consultation and due to come into force in 2022, may not be sufficiently rigorous. A group of scientists has written to the European Commission warning that the current draft has no reference to, and is not aligned with, the bloc’s 2050 net-zero target. “The current situation results in a disconnect between the definitions that will guide the implementation of the European Green Deal and the EU’s ultimate climate objective of becoming a net-zero greenhouse gas economy by 2050,” the letter says.
Mike Scott is a former Financial Times journalist who is now a freelance writer specialising in business and sustainability. He has written for The Guardian, the Daily Telegraph, The Times, Forbes, Fortune and Bloomberg.
This article is part of the in-depth Race to net zero briefing. See also:IPCC Paris Agreement Science Based Targets SBTi TCFD ethical investing Net Zero asset owner alliance climate change Alecta BankTrack Sustainable finance taxonomy