We are already experiencing climate change. The increasing frequency of severe floods, droughts, wildfires and hurricanes emphasises the ominous consequences of changes to the climate caused by human activity. A report by the United Nations Office for Disaster Risk Reduction (UNDRR) cites 7,348 disaster events from 2000 to 2019 – 75 per cent more than similar events recorded during the previous two decades.1
The implications for human prosperity are serious. If the risk of disastrous climate change is to be addressed, the Paris Agreement target of limiting global warming to no more than 2°C above pre-industrialisation levels must be achieved by mid-century – and finance has a critical part to play in achieving that.
Major global economies including the European Union, China and the United Kingdom have declared net zero targets that align with the Paris goal. But how can net zero be achieved at the same time as increasing prosperity and improving living standards, especially in developing countries? Banks’ ability to develop financing solutions that promote comprehensive, cost-effective decarbonisation outcomes will be key to this vitally important balancing act.
What is net zero?
We will achieve net zero when measures to contain carbon emissions balance or cancel out the total volume of greenhouse gases emitted. The aim is not to eliminate all carbon emissions at source, but to reduce them while improving methods of decreasing atmospheric levels until a balance is achieved.2
Net zero will only be achievable by 2050 with a comprehensive, co-operative approach from governments, businesses, NGOs and individuals. All sectors need to take stock of their climate impact and introduce measures to reduce the emissions caused by their operations. But financial institutions must play a leading role because of the unique way in which they can influence the decarbonisation of other sectors through the capital they provide.
Solutions differ widely according to the decarbonisation challenges for each sector. Power companies are investing in solar and wind technology, for example, while shipping companies are designing vessels that are more fuel-efficient or powered by alternative fuels such as electricity or liquid natural gas (LNG).
Businesses that are primarily service providers, like banks, also have levers they can pull in order to reduce their emissions. They can minimise and disclose the carbon emissions they generate by running their business, either directly or indirectly through their supply chains. Today, many financial services firms report on the carbon emissions generated by the buildings, vehicles and other transportation used in their operations.
But, beyond these so-called Scope 1 and 2 emissions, financial services companies also exercise considerable influence over the carbon footprints of the companies that they lend to or invest in. Cutting these Scope 3, or “financed emissions,” is recognised as the biggest contribution that the financial services industry can make to reaching net zero.
Growing numbers of financial institutions are committing to delivering net zero financed emissions. They aim to achieve this through applying their capabilities and networks of relationships to support customers in their own transitions towards net-zero. For example, HSBC will work with customers to facilitate more sustainable ways of doing business through innovations in financing, with plans to deliver between USD750 billion and USD1 trillion of finance and investment by 2030 to enable customers to achieve net zero in their own businesses.3
The methods and approaches banks can apply in providing this funding support are collectively known as sustainable finance. This includes financing that incorporates Environmental, Social and Governance (ESG) criteria as well as lending and investment that supports the UN Sustainable Development Goals (SDGs).
For clients in ‘hard-to-abate’ sectors where emissions are heaviest and reducing them most difficult, banks are adding to the transition finance solutions they offer. Transition finance can enable companies in these sectors to progress toward net zero in a stable manner over time.4 Banks are also increasingly opting to factor climate considerations into all financing decisions, which should accelerate progress towards net zero in financed emissions.
Banks’ financing and investment expertise is also critical to delivering the large-scale sustainable infrastructure projects that are needed to support economic growth. Traditional transportation, educational and medical facilities are expensive and often carbon intensive, but these massive projects require significant investment – USD6.9 trillion a year, according to the OECD – as well as co-operation between a network of institutions. Making sure infrastructure avoids ‘carbon-lock in’ by scaling it up in a way that minimises future emissions is critical to enable the best chance of achieving the net-zero outcome.
The Finance to Accelerate the Sustainable Transition-Infrastructure (FAST-Infra) programme is creating a standardised, universal investment labelling system for sustainable infrastructure projects that will enable private investors to easily assess an asset’s sustainability and make investment decisions with confidence.
Putting a price on it
Financial institutions can make another major contribution towards reaching net zero by applying their trading expertise to the development of carbon pricing and offset programmes. Carbon pricing is an effective tool for reducing emissions efficiently by redistributing the costs of carbon’s negative impacts to the industries which emit the most, creating a further incentive to decarbonise. A carbon price also encourages emitters to assess their options for making reductions – and enables investors to assess the true cost of projects that they are considering funding.5
Investors on board
Institutional investors’ influence over the transition to a lower carbon economy has grown as they allocate – or attract – more capital to strategies that invest in accordance with Environmental, Social and Governance (ESG) principles. This rapid growth in ESG investing is forecast to continue. Half of all managed assets in the U.S. could comprise ESG-mandated funds by 2025, according to Deloitte.6 In Europe, PWC forecasts that ESG assets will account for up to 57 per cent of total mutual fund assets by 2025, up from just over 15 per cent at the end of last year.7
In a 2020 speech at Columbia University,8 UN Secretary-General António Guterres set out four sustainability priorities for financial services providers globally. While the first three deal with actions to deal with emissions reductions and to prepare for climate disruption, the fourth specifically addresses arrangements to fund these programmes. Acknowledging that achieving global climate goals will require all forms of finance, including both public and private finance, it charges developed countries to mobilise USD100 billion per year from this year through public and private investments.
Furthermore, ahead of the COP26 conference in November 2021, the Bank of England has launched the COP26 Private Finance Hub9, a structure to marshal the private finance sector in developing standardised reporting for climate-related financial disclosures, providing climate-linked risk management tools for businesses, helping investors align their portfolios with transition criteria and bolstering private financing in emerging and developing economies. The mantra for this initiative is “to ensure that every professional financial decision takes climate change into account.”10
These commitments bind a substantial cadre of financial services entities from across the industry whose objectives for the lead-up to 2050 are closely aligned. In concert, their activities can catalyse investment on the scale necessary to address the significant challenge of financing the transition to net zero.
Achieving net zero by 2050 is a critical goal if the most catastrophic effects of climate change are to be avoided. Financial institutions can be instrumental in making possible this historic shift by working with governments, regulators and non-governmental organisations to deliver investment and financing instruments that will enable companies to move away from carbon-intensive business models and embrace a low-carbon future.
- UNDRR (2020, December). Human Cost of Disasters: An overview of the last 20 years 2000-2019. Retrieved from https://www.undrr.org/sites/default/files/inline-files/Human%20Cost%20of%20Disasters%202000-2019%20FINAL.pdf
- Climate Council, The (2020, July). What Does Net Zero Emissions Mean? Retrieved from https://www.climatecouncil.org.au/resources/what-does-net-zero-emissions-mean/?atb=DSA01b&gclid=EAIaIQobChMI4Pjf0e_q7AIVFqmWCh3OZQTkEAAYASAAEgKubfD_BwE
- HSBC (2020, October). HSBC Sets Out Net Zero Ambition. Retrieved from https://www.hsbc.com/who-we-are/hsbc-news/hsbc-sets-out-net-zero-ambition
- HSBC (2020, June). Why Transition Finance is Essential. Retrieved from https://www.hsbc.com/insight/topics/why-transition-finance-is-essential
- HSBC (2020, July). Investor Questions on Carbon Pricing and Offsets. Retrieved from https://www.sustainablefinance.hsbc.com/carbon-transition/investor-questions-on-carbon-pricing-and-offsets
- Collins, S and Sullivan, K (2020, February). Advancing Environmental, Social and Governance Investing: A Holistic Approach for Investment Management Firms. Retrieved from https://www2.deloitte.com/us/en/insights/industry/financial-services/esg-investing-performance.html
- PWC (2020, November). 2022: The Growth Opportunity of the Century. Retrieved from https://www.pwc.lu/en/sustainable-finance/docs/pwc-esg-report-the-growth-opportunity-of-the-century.pdf
- Guterres, A (2020, December). The State of the Planet. Retrieved From https://www.un.org/sg/en/content/sg/statement/2020-12-02/secretary-generals-address-columbia-university-the-state-of-the-planet-scroll-down-for-language-versions
- Carney, M (2020, November). Building a Private Financial System for Net Zero: Priorities for Private Finance for COP26. Retrieved from https://ukcop26.org/wp-content/uploads/2020/11/COP26-Private-Finance-Hub-Strategy_Nov-2020v4.1.pdf