UNEP raises bar for banks and asset owners delaying net-zero action

A United Nations banking group has warned financial institutions are failing to ensure they contribute to stopping runaway climate change.

Banks' and other financial asset owners' net-zero plans influence whether states can limit global warming to 1.5 degrees Celsius because they decide how much funding is allocated towards high-carbon and low-carbon assets.

But they aren't helping meet these aims because their plans rely on "different definitions of net-zero," according to a report published by the UN's sustainable development partnership with banks, the United Nations Environment Programme Finance Initiative (UNEP FI).

The partnership also hosts a group of banks holding 40% of global banking assets and looking to decarbonize, the Net-Zero Banking Alliance, which was launched within a new strategic forum, the Glasgow Financial Alliance for Net Zero (GFANZ) at US President Joe Biden's Leaders' Summit on Climate last April.

Net-zero advocates use the term as shorthand for 'net-zero CO2 emissions by 2050,' the year man-made emissions must cease to rise.

However, this milestone alone, UNEP FI found, won't limit global warming to a 1.5 degrees Celsius rise. Countries and companies must also comply with global carbon budgets for each of the years before 2050, as defined in a special report of the Intergovernmental Panel on Climate Change (IPCC).

In other words, a bank or another company "which carries on with business-as-usual emissions until 2049 and achieves a reduction of all its emissions in 2050" is not helping achieve global climate goals, UNEP FI argued.

To counter this, banks need to understand their "net-zero commitments which are not explicitly tied to, or do not follow specifically 1.5°C IPCC carbon budget (as derived from the consensus of IPCC 1.5 degrees Celsius scenarios) should not qualify as credible," the report found.

Finance utilities first, disclose

Banks and other asset owners must meet certain criteria to ensure their plans will have a real climate change mitigation impact, UNEP FI said.

One of the criteria they must meet is to measure and reduce different kinds of carbon emissions they are responsible for under various scopes, for example, Scopes 1, 2 and 3 under the Green House Gas Protocol developed by the World Resources Institute in 2001.

UNEP FI thinks they should switch to the broadest measure, Scope 3, as soon as possible.

Scope 3 emissions, those associated with the financial institution's portfolios or loans, constitute about 97% of their total emissions, the report said.

Banks' internal GHG aims should be disclosed as well. UNEP FI recommends banks pursue "transparent" reporting of their GHG emissions and their allocation to real assets as well as the sustainability impact of products and services in porfolios.

It also recommended transparency in how they grade product sustainability under various scenarios and metrics, alongside yearly public reports on progress towards them.

Banks should also strategically decide which sectors to finance first for their actions to stay aligned with IPCC budgets.

For example, the power utility sector has a role in decarbonizing other sectors: It powers electric cars in the transportation sector and electric arc furnaces in the steel sector.

The power and energy sectors, in particular, are primed for investment. For example, investment is required in renewable energy as well as fossil fuel production to decarbonize, explained IHS Markit vice president for energy research for financial services Roger Diwan in a recent webinar.

Asset owners, pension funds can align faster than banks

The report also explains that all large investors are not alike. Both asset owners and pension fund managers have fewer constraints on aligning their portfolios to net-zero than do banks and insurers. The former two can invest globally and have a much higher degree of liquidity than banks, for example.

"As a result, the different purpose and structure of a financial institution can affect the manner through which it can align its portfolio," said UNEP FI.

Likewise, institutional investors are more nimble than banks when reaching for net-zero alignment "as each individual loan must mature before it can be replaced with a 1.5°C aligned borrower."

"Because the bank cannot sell shares in an underlying company should it refuse to transition its business practices to become 1.5°C aligned, in many cases a loan portfolio is likely to transition more slowly than an investment portfolio from the point in time when a net-zero commitment is made," noted the report.

It suggested banks and insurers work with their clients one-on-one on modeling transition activities before capital is allocated with new clients.

But less hands-on asset owners — pension funds, endowments, sovereign wealth funds, and insurers — need to take care that their asset managers are following the criteria.

Catch-22 for divestment

Certain energy sector companies have made the argument that even should they divest from fossil fuel assets, alternative investors will step in and take over the assets, thus merely moving emissions from one company's spreadsheet to another's.

UNEP FI warns that banks and asset owners also should not prioritize their progress towards net-zero over the world's by divesting, but instead use their leverage to engage with clients.

It advises that they "engage with shipping, transport, steel and other hard to abate industries and work with them to invest the CAPEX and R&D needed to transition their business models."

Divestment in the laggards should only come when "low-carbon practices are well underway, and a critical mass of investors are committed to alignment," it said.

"Exiting now, particularly from heavy polluters who refuse engagement on the transition, should remain a component of a financial institution's engagement escalation strategy," the report found.

Posted 16 February 2022 by Cristina Brooks, Senior Journalist, Climate and Sustainability