It’s the UN secretary-general’s Climate Action Summit this week, and the air is thick with initiatives from the financial sector about how to do more to tackle the climate emergency.
Just as the conversation in society at large has changed markedly in the past two years, so it has in the financial world.
Until recently, climate change was rarely a news item. Now, it is rarely out of the headlines. Greta Thunberg has told the US Congress to pull its finger out.
In banking and finance, up to now many have considered it enough to issue, lead manage or invest in green bonds, and once or twice a year to make a policy statement about how the organisation is committed to sustainability. No longer.
At long last, people are connecting the dots. We have to get from where we are now — an economy that Natixis banker Karen Degouve said this week was “on between a 4.5° and 5° trajectory” — to a sustainable one.
The pretence that sustainable can mean anything other than carbon neutrality has been swept away. The question is now whether carbon neutrality in 2050 is enough, or whether we should be pushing for 2030.
In reality, if humanity became carbon-neutral tomorrow, we would still be locked in to what is likely to be catastrophic global warming.
But, however narrow it is, there is only one crack through which we can escape, and that is to get carbon emissions down as fast as possible.
Finance is now having the right conversations — at least, some people in finance are.
This week in New York, pension funds and insurance companies with $2.4tr of assets — about half the market capitalisation of the London stockmarket — have joined a Net Zero Asset Owner Alliance.
The group, which includes Allianz, Calpers, CDPQ, Folksam and Zurich, has committed to transitioning its portfolios to net zero greenhouse gas emissions by 2050, hoping to “limit the rise in global temperature to no more than 1.5°C global warming”.
They will set public progress targets, and have pledged to immediately start to engage with the companies they invest in “to ensure they decarbonise their business models”.
Banks go responsible
Meanwhile, 130 banks have become founding signatories of the UN Principles for Responsible Banking — a parallel to the Principles for Responsible Investment.
The PRI has been hugely influential in promoting and developing responsible investing in securities markets, and it is long overdue that the banking sector should have a similar movement.
If it works as the PRI does, the PRB can act as a mixture between a university, community centre, public library and church — a forum through which best practice can be discovered and disseminated, and a degree of moral pressure exerted.
The PRB principles are six in number, like the PRI’s. They lack the simplicity and clarity of the PRI — perhaps a sign that they were difficult to negotiate. But they offer a good basis for banks to make their operations more responsible.
Principle 1 says “We will align our business strategy to be consistent with and contribute to individuals’ needs and society’s goals, as expressed in the Sustainable Development Goals, the Paris Climate Agreement and relevant national and regional frameworks.”
The second promise is to “continuously increase our positive impacts while reducing the negative impacts on, and managing the risks to, people and environment”.
The membership of the PRB is impressively broad — they have $47tr of assets. Most of the biggest capital markets banks have signed, though a few very big names have not — from the US, Bank of America, Goldman Sachs, JP Morgan and Morgan Stanley; from Europe HSBC and UniCredit; and from Asia Agricultural Bank of China, Bank of China, China Construction Bank and Nomura.
Many of those banks, including all the US ones, have made very public commitments on sustainability, so they may have some reservation.
HSBC has said it supports the PRB and wants “to engage our clients on these principles before committing”.
A subset of these 130 banks — 31 with $13tr of assets, including the four main French banks, BBVA and Santander, ING and Standard Chartered — have pushed further, signing a Collective Commitment to Climate Action.
They see this as putting their vows under the PRB into practice, by promising to align their portfolios to “reflect and finance the low carbon, climate-resilient economy required to limit global warming to well below 2°, striving for 1.5°”.
They plan to work with clients to help them transition, and develop roadmaps for how each industrial sector can reach sustainability.
One of this party has pressed ahead of the pack. Natixis announced this week the completion of an 18 month project, on which it has communicated with remarkable transparency at several stages, to introduce a new internal rating system.
All its loans to non-financial companies, governments and projects will be graded with one of seven colours, from dark green to dark brown.
Natixis will alter its economic capital calculations, according to each loan’s colour rating. This means Natixis will consider a dark green loan as up to 50% smaller, from a risk-weighted assets point of view, than a neutral loan. The worst loans will be penalised by up to 24%.
This is a unique experiment in creating internal financial incentives for Natixis’s own bankers to make more green loans and fewer brown ones. It may seem puzzling that Natixis does not simply command its bankers to change the loan portfolio, but the bank appears to prefer a system of carrots and sticks — and believe that regulators may one day mandate such a system.
Natixis has openly said that half its RWA at the moment are brown. It wants to align its portfolio with a Paris pathway, and will announce in a year’s time when it thinks it can get there.
Commendably, the bank is not basing its adjusted capital weightings mainly on perceived risk to the bank — but primarily on the desire to achieve an impact in the real world.
All these are efforts that tend in the right direction: they explicitly mention the Paris Agreement and Sustainable Development Goals, and in some cases a 1.5° or 2° target.
Where the initiatives differ is in how explicitly the declarers have bound themselves to finding a path to 1.5°, and how fast they will do it.
The asset owner group are talking the right language, by emphasising Net Zero and setting a date. But getting their portfolios aligned with net zero by 2050 is too slow.
If the whole economy has to get to net zero by then (and really, sooner is needed), the portfolios of the world’s most woke asset owners need to be getting there much sooner.
The 31 banks have not given such a clear date, and they talk about “low carbon” rather than “net zero”. But their commitment to developing sectoral models for how the economy can actually get to well below 2° is welcome.
Both groups emphasise engaging with invested companies.
Natixis’s approach is highly original and puts it streets ahead of most banks in developing the intellectual apparatus to really green its balance sheet. But the most promising part of its initiative is its honest admission, in Degouve’s words, that “The Paris Agreement sets a maximum of 2°C. If we want to achieve that we need to reduce our brown portfolio. We are giving ourselves one year to set a target of when we will be Paris-aligned.”
What will be required, for all these investors and banks, is making a plan to get to zero carbon, as soon as possible.
Reach for the red pen
That can only be done through a combination of all three main responsible investing techniques: choosing to invest in the best sectors, and the best names in a sector; putting pressure on companies to do better, known as engagement; and divesting from the laggards.
In that context, a comment this week by Mark Haefele, chief investment officer of UBS’s global wealth management division, struck the wrong note.
“Divesting fossil fuels alone won’t help the climate” he declared. The note argued for engagement, and quoted Bill Gates as having said divestment had “reduced about zero tons of emissions”.
If that is true, it is a measure of how little divestment has been tried.
If the banking and investment sectors in the US had, 10 years ago, decided not to finance new oil exploration, the US shale boom, with all the carbon emissions it has created, would not have happened.
Instead, all the major banks and asset managers financed it, while mouthing platitudes about sustainability. Millions of boxes were ticked, but finance made a bad thing happen.
Polluting companies and irresponsible governments can cope with any amount of demands for disclosure, ESG ratings and rankings, shareholder motions calling on them to publish strategies and so on. The one thing they really fear is divestment.
Natixis is starting to put its money where its mouth is, by saying brown loans will have to meet higher return targets than green. It’s perhaps not as direct as banning those loans, but it’s a start.
Climate consciousness has passed a watershed. In the next phase, it will not be enough for banks and investors to list their green achievements. They will have to identify and clean out the brown.
The best institutions will be those who can claim they are “the firm that likes to say No”.