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Net zero indicators warn banks are an investment risk

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The Institutional Investors Group on Climate Change (IIGCC) and the Transition Pathway Initiative (TPI) have released their latest analysis of bank performance on net zero, warning that ‘weak performance’ raises investment risk.

There is no question that, given the integral role banks play in directing capital across entire economies, aligning banks’ activities with net zero is key to delivering global decarbonisation. While their portfolios might be dependent on their investees, they should require transition action as a condition of investment.

IIGCC and investor members of its banks working group together with the Transition Pathway Initiative are developing a net zero assessment framework for banks to understand the extent to which this is happening.

Banks are taking action but only in parts of the business

Even where banks have set climate transition targets, Professor Simon Dietz at the Grantham Research Institute on climate change and the environment, who led the TPI research team says that “they often omit large portions of their portfolios (such as underwriting and advisory) or exclude certain high-emitting sectors.

Banks’ policies often still allow for continued finance to carbon intensive activities such as coal mining and deforestation, and evidence of engaging with high emission companies on transition plans is sparse.” Only one bank (UBS) has committed to full coverage across all its material business segments and sectors.

The need for an assessment framework for banks is underpinned by investors wanting to manage their own net zero alignment and stewardship of portfolio companies (which frequently includes banks), as well as recognition of the critical role banks have in helping deliver global decarbonisation through their activities.

As Stephanie Pfeifer, chief executive officer of the IIGCC says: “For investors considering their own net zero alignment and stewardship of portfolio companies, it is critical that they have sufficient information on companies’ transition planning, including banks.”

The latest analysis follows the establishment of a banks working group by IIGCC to help investors assess how prepared banks are for the low-carbon transition and the subsequent investor expectations for banks published in April 2021.

Banking: a sector in transition but a long way to go

The current framework of pilot indicators is organised into six key areas – net zero commitments; short- and medium-term targets;  decarbonisation strategies; climate governance; climate policy engagement; and audit and accounts. It was used to analyse the performance of 27 banks.

These that show while the banking sector has started its transition towards net zero, it still has a long way to go to align with a 1.5°C pathway. It’s important to note that the analysis was based on disclosures published up to 25th February 2022 only, so some performance may have improved.

Banks strong on governance, weak on climate engagement

Across the six areas covered by the pilot indicators, the 27 banks performed best on climate governance (‘Evaluating how a bank incorporates climate strategy into its governance structure and remuneration policies’), aligning with just under half (44%) of the sub-indicators in this area.

The 27 performed worst on climate policy engagement. It’s striking to note that no bank publishes a position statement that pledges to conduct all direct lobbying activities in line with the goals of the Paris Agreement). Performance was also worryingly weak on audit and accounts, with not one bank comprehensively incorporating material climate-related matters into its financial accounts.

Banks are not setting frameworks for greening finance

Decarbonisation strategy is the area containing the most indicators and sub-indicators and assesses the actions taken by banks to deliver on their financed emissions reduction targets. While some banks are making steps to develop and implement a decarbonisation strategy, with most progress made in setting milestones to scale up green finance, collectively they have yet to establish financing conditions that enforce accelerated decarbonisation efforts.

Dietz added: “The results from our pilot assessments clearly show an industry shift in the banking sector. Banks have increasingly committed to net zero targets for their financed emissions – our pilot assessments find that 18 out of 27 banks set 2050 net zero commitments … [even of those who have] banks have yet to show how they plan to meet these net zero targets.”

Few have committed to withdraw finance from activities that are not in line with a 1.5°C scenario. Only ING and HSBC have made comprehensive commitments – ING to end the financing of coal and HSBC to end the financing of deforestation and peatland conversion.

Banks must work with regulators to achieve effective change

It is important to remember that there is an iterative connection between the regulatory environment and institutional financing frameworks. The importance of the role of financial institutions in achieving the goals of the Paris Agreement are also shaping the regulatory environment. The EU’s Sustainable Finance package and the introduction of the EU Taxonomy, the publications of the Climate Financial Risk Forum in the UK, even the SEC’s proposal on climate risk disclosure in the US – It is critical that momentum towards the goals is maintained both within the regulatory and institutional environments.

The IIGCC and TPI plan to publish the final framework for banks later in 2022. This should provide investors with a comprehensive picture of banks’ net zero transition plans, and provide an effective basis for benchmarking different banks performance on climate.

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