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Banks: net zero in 2050 is not enough

Oil drilling rig climate from Adobe 21Oct20 575x375
By Jon Hay
21 Oct 2020

One by one, banks are taking responsibility to help fight climate change, by setting targets to eliminate carbon emissions from their whole financing portfolios by 2050. This will not suffice. Banks must learn a new way of interacting with clients.

HSBC is the latest bank to have joined the small knot that has pledged to reduce the net carbon emissions of all the people and organisations they finance to zero by 2050.

Barclays made such a pledge in March, Morgan Stanley in September, JP Morgan in October.

The commitments are a huge advance on where banks were until recently: talking big about the green finance they were doing, often setting eye-catching targets such as JP Morgan’s $200bn of sustainable finance in 2017-20, but drawing a veil over the rest of their balance sheets as if these had nothing to do with the climate.

At last, banks are recognising that climate change — and other environmental threats such as biodiversity loss — are not about green finance, but all finance.

No one could suggest for a moment that making any financing portfolio net zero is easy. Even windfarms require some carbon emissions, and the whole economy cannot consist of renewable power plants.

Hot world

Nevertheless, the green groups and responsible investment leaders who have criticised even these banks — which are well ahead of many of their peers — are right.

First of all, the idea that reducing net emissions to zero in 2050 will enable the world to avoid disastrous climate change is wildly optimistic. Even at 1.5C above pre-industrial levels, the world will be a much less hospitable place for humanity and millions of other species.

We have already got 1C of global warming and even if all human emissions ceased tomorrow, the carbon-rich atmosphere would be likely to keep heating the earth for hundreds of years. More likely, we are heading for several degrees of warming even if we do everything right from now on.

Second, banks like HSBC and JP Morgan are at the pinnacle of the global economy. They finance the best companies and many of the wealthiest consumers. If the world as a whole is to reach net zero in 2050, the portfolios of top banks ought to have got there years before.

Bank J Safra Sarasin, which aims to follow a Science-Based Target, reckons it can get to net zero in 2035, with an all sector portfolio.

Go early

Third, the pace of decarbonisation is all-important. The curve between here and net zero has to go down steeply in its early stages, then bottom out, rather than the other way round. Crucially, decarbonising earlier will be much cheaper, because it will reduce the damage from climate change. Cheaper means fewer losses for the economy, which is good for banks.

That is why 2030 targets, as envisaged in the Paris Agreement, are so important. The European Union has promised a 40% reduction from 1990 levels by 2030 and Ursula von der Leyen, European Commission president, is leading a negotiation to increase that to 55%.

Banks should be going at least as fast. Granted, they operate in many places with more carbon-intensive economies than the EU. But China, too, has set its face towards net zero in 2060.

Emerging markets are also rich in low-hanging fruit. Total electricity demand in Africa today is 700 terawatt hours a year, according to the International Energy Agency. Europe produces 2,940 TWh, Eurostat says.

Of Africa’s demand, 70% is in the north African belt and South Africa. The IEA thinks the total will grow to 1,600TWh-2,300TWh by 2040, with most of the growth in sub-Saharan Africa. That means something like 200GW of brand new power systems will have to be built in sun-rich countries. Existing solar technology could satisfy much of the need; banks can bring in the capital.

Banks that understand climate change, and are starting to be serious about taking action, must set targets for 2030.

As ShareAction, the responsible investment NGO, argued in a report on Friday about HSBC, the Intergovernmental Panel on Climate Change recommends a 45% global emissions cut by 2030, from 2010 levels, if there is to be any chance of staying within 1.5C. Top banks should be setting more ambitious targets than that.

Fossil fuels cannot be dumped overnight. But if we need to cut emissions as fast as possible, banks should carefully question any continued support they give the fossil fuel economy.

Targets need rules

Fourth, banks have to work out a new set of principles for doing business, to complement that 2050 end point. This is particularly clear when it comes to capital markets business, as opposed to loans.

Last year, JP Morgan, Morgan Stanley, HSBC and Barclays were all bookrunners on the IPO of Saudi Aramco. It was a miserable experience for those involved, insiders say, but they put up with it for the fees, kudos, league table credit and in hope of more business in Saudi Arabia.

From the point of view of a 2050 net zero commitment, engaging in such a deal is cost-free for banks. So is leading any bond or equity issue. Once the financing has been placed, the banks leave it behind. They are not tied to it, as with loans — though even loans can be sold.

The essential point is that in finance, which moves fast, a target set for a particular moment in time is a poor instrument for controlling the overall effect of what is financed over a period.

As ShareAction highlighted, three months before announcing its “net zero ambition”, HSBC led a $500m bond for Kepco, South Korea’s main power company, which not only derives 40% of its power from coal but is building new coal-fired power stations in Indonesia and Vietnam. In recent months HSBC has also raised finance for Enbridge, involved in Canadian tar sands; Exxon Mobil; and offshore oil extraction ventures in Norway and Brazil.

Invest or divest?

HSBC has a solid argument for such deals. A bank of its size, with a $2.8tr balance sheet, cannot easily divest from all sectors with high carbon emissions.

Moreover, it claims, this would not help. Cutting out even oil and gas production would remove HSBC from that industry, but it would lose its influence there. Better, it argues, to stay invested but help its clients — which represent, broadly speaking, the whole economy — transition to a low carbon future.

This is the same line that most institutional investors take: divestment is for student radicals — we have to keep investing, at least in the better performers in each industry, and engage with companies.

The argument is attractive, but only up to a point.

In the mid-2000s, US oil production reached a 50 year low of 5m barrels a day. In 12 years, the great fracking boom swelled it to 13m, making the US the world’s largest producer. The combined production of all regions bar north America stayed flat.

The shale bonanza was financed — through loans, bonds and equity raising — entirely by banks and institutional investors that were perfectly aware of climate change and in many cases had begun to talk about it.

Had these mainly north American, European and Japanese institutions decided that their knowledge gave them a responsibility not to invest, the boom — and the significant chunk of climate change it caused — could not have happened.

Would the US or the world have been poorer? On the contrary. The result of the US supply glut was the oil price crash of 2014-16, from which the price has never fully recovered. With crude at $80-$120 a barrel, as it was between 2004 and 2014, except during the depths of the financial crisis, the incentive for energy efficiency and alternatives to fossil fuels was much greater than it has been since. Without US shale oil, the country and the world would have progressed faster towards clean energy, creating jobs and growth that were sustainable, instead of destructive.

Shale has been a mixed blessing for investors, too. Over the past year, the S&P US High Yield Corporate Bond Energy Index has returned minus 6.2%, against a 4.4% positive return for the broad index.

Cut the cackle

An invest-and-engage strategy might work to steer some companies towards decarbonisation. After shareholder complaints, oil majors BP and Shell have accepted they need to change, and pressure from investors will probably make them accelerate in years to come.

But when a company is clearly heading in the wrong direction, even with just part of its activities, like Kepco with its coal plants, friendly nudging has failed.

Scale it up to the macro level and look at the world economy, with carbon emissions still rising — whatever responsible investors say, engagement isn’t working.

It is doubtful how much engagement banks do on environmental issues anyway. Their usual behaviour towards clients is obsequious servitude. Unlike some institutional investors, few banks disclose anything about their engagements.

Banks can no longer continue trying to please all the people all the time. With each client, they will have to choose. Either a proactive engagement that says: “you need to decarbonise quickly — how can we help you?” or, if that feels too presumptuous, banks can hide behind a much stricter set of exclusions: “I’m sorry, I can’t help it — the ESG committee says no fossil fuel expansion, only phase-outs.”

This new policy on client interactions and financing decisions cannot be left to evolve gradually, nor should it be kept in the shadows. It must be front and centre of any net zero ambition, and as public as possible, because these new targets need to start showing clear results in 2020 and 2021.

If banks duck these awkward conversations now, net zero in 2050 is a fantasy.

Most of the time, banks behave like the weaker party in their relationships with clients. In reality, they are the stronger. Murmuring “I think your shareholders would like it if you did this” might work on the converted. Rapping out “Do this or we’re out” is a message even the most recalcitrant dinosaur understands.

By Jon Hay
21 Oct 2020