Frontline: London's Canary Wharf
At the start of this year, a high-level expert group on sustainable finance provided recommendations to the European Commission as part of its effort to deliver the 40% cut in greenhouse gas emissions by 2030 agreed at the Paris conference in 2015.
The Commission recognizes that this may require €180 billion a year in additional investment and that the public sector alone cannot foot the bill. Rather, flows of private of capital must be reoriented.
The Commission has now developed a first series of legislative proposals set to start coming into effect next year. At the core of these proposals will be a new EU-wide classification system, or taxonomy, to give businesses and investors a common language to identify what economic activities can be considered environmentally sustainable.
The aim is to ensure that asset managers, institutional investors, insurance distributors and investment advisers include economic, social and governance (ESG) factors in their investment decisions and advisory processes, as part of their duty to act in the best interest of end investors or beneficiaries.
Missing the target
This may be a welcome first step, but it is hardly radical. And by focusing on securities markets and tying this all up with the stalled project for capital markets union, the Commission risks entirely missing the right target.
If Europe is to mobilize its financial system in the fight against climate change, then banks must be front and centre. The banks move Europe’s money, not the capital markets.
Indeed, the Commission’s own high-level experts recognize this and had some much bolder ideas than an EU-wide label for green investment funds and green bonds.
The experts suggested that there may well be a case for lowering bank regulatory capital requirements against loans to the green sector to promote bank lending to projects that reduce long-term environmental risks to the European economy. There may also be a case for a countervailing increase in regulatory capital requirements against so-called brown assets – loans to activities that harm the environment.
The adoption of such principles will only have a true impact if they are pushed and promoted by the banks themselves
This would certainly shake things up – and fast – among the key providers of project and other term funding in Europe. In addition, the experts press for greater disclosure by financial institutions on ESG risks and how sustainability is factored into their decision-making, while also making sustainability part of the mandates of the European supervisory authorities.
Banks already produce voluminous sustainability reports. Almost no one reads them.
Until now, oversight has been outsourced to the fringe of financial markets. Activists around the world have drawn a key lesson from the furores over the Dakota Access Pipeline and the extension of the Trans Mountain Pipeline by Kinder Morgan to transport oil from Alberta to the coast. It is that while energy companies are often impervious to environmentalists’ lobbying, the banks they rely on for project finance are much more sensitive to the risk of losing customers, who may withdraw their business, and investors, who may withdraw capital and funding, if a lender is seen to be supporting environmental degradation.
BankTrack provides a handy list of banks that have announced they will end direct lending to new coal mines and plants. The Rainforest Action Network produces a fossil fuel financing report card that aims to measure total funding provided each year by leading banks to each of: tar sands, coal power, coal mining, Arctic drilling, liquefied natural gas and ultra-deep water oil extraction.
The biggest providers of finance tend to be the largest Chinese, US and Canadian banks, with China Construction Bank, RBC, JPMorgan, ICBC, Bank of China and TD leading the pack. The network grades banks, rating-agency style, across these most environmentally destructive activities related to fossil fuels. The Chinese banks tend to score Fs and Ds; the US banks mostly Ds and Cs; the European banks Cs and Bs.
Big next step
There are certainly some providers of capital and finance to the banking industry – such as Scandinavian pension funds – paying attention to the data behind these kinds of grades. But making sustainability a key consideration for bank regulators would be a big next step.
Sadly, these key ideas from the Commission’s own high-level experts have not yet found their way into the proposed legislation. They should.
Meanwhile, in November the United Nations will release its first draft of what it calls the Principles for Responsible Banking. It is, as Euromoney writes in this month’s cover story, “both a back-to-basics call and a radical new endeavour; and one that needs to be addressed now.”
Sustainability and the environment will naturally form a big part of the principles, but they aim to go much deeper into the broader role of banks in society. They should, too.
In the end, the adoption of such principles will only have a true impact if they are pushed and promoted by the banks themselves. They must be the agents of change. If they want it to be, banks’ rehabilitation is within reach. On that, only time will tell.