COP26 finance pledges are insufficient for real change
The extent to which finance actually dries up for fossil fuel projects in the near future will be the true measure of COP26’s success
COP26 finance initiatives will have a limited impact on carbon emissions in the near term, according to green-focused financial firms.
This is mostly due to the time-consuming nature of implementing pledges and the strong likelihood that they then end up getting watered down. Observers also pointed to the significant flaws in the investment promises made by the private sector alliances, as well as the glaring absence of harder regulatory measures, such as the imposition of a carbon tax, more rigorous carbon counting or stricter prudential controls.
“What happens at COP26 is of interest, though not as much as you might think, as commitments made at the top are routinely watered down and ignored back in the home country,” said Garvin Jabusch, chief investment officer of Green Alpha, a research and management firm running five sustainability-focused equity strategies. “Joe Biden, for example, can promise anything he likes, but then the Republicans in Congress will block him.”
Exercises in shaming and signalling, which form the heart of multilateral diplomacy, are not enough to effect meaningful change, Jabusch continued, adding that he would not make any “equity bets” on promises made at COP26. Meanwhile, pledges from the private sector needed to be backed up with more stringent accountability and harder regulatory measures.
It is worth remembering that lending by the world’s biggest banks to fossil fuel projects has actually increased since the Paris Agreement in 2016. This has led to a high level of scepticism among committed carbon-free investors — like Jabusch — towards international diplomatic efforts.
“We need to send strong market signals,” Jabusch said. “The market needs to know that a certain company is going to decrease rapidly in value because it presents too much climate risk and there are better places to invest. So far this isn’t happening, nor will the COP26 pledges make it happen anytime soon.”
For Jabusch, the most important green transition progress to date had come not from signalling at UN summits but from the increasingly “cost-competitive” nature of new green technologies. Profit motives ultimately speak “more loudly to lenders and investors” than diplomatic “peer pressure”.
Luca de Lorenzo, head of sustainability at NIB, struck a similarly cautious tone. “The political process could be more ambitious,” he said. “You would think states could hammer a bit harder, whether though pricing signals, carbon taxes, or support for the transition through green subsidies of some sort.”
However, de Lorenzo also acknowledged that effecting real change was tough for governments. Even in open and green societies, such as Finland and other Nordic countries, “the level of fossil fuel dependence” is still high. Every time a government considers imposing harder limits, it must also evaluate the societal consequences. It would be difficult, for example, to compensate for rising costs in transport resulting from more punitive regulatory measures. As a result, authorities generally prefer a light touch.
The most important difference between COP21 in 2015 and COP26 is that “everyone is at the table now and everyone knows the direction of travel”. According to de Lorenzo, this was not the case five years ago when the Paris Agreement was declared. “We still have to wait to see if there will be any significant changes,” he added. “The ball is moving but won’t properly start rolling until 2025, it may take until 2030 to see a major impact on carbon emissions.”
“Today the culture and level of focus on the transition is very different to what it was five years ago,” said Arthur Krebbers, head of sustainable finance, corporates, at NatWest Markets. “Yet significant gaps remain. While some oil and gas companies are very serious about transforming their business models and have credible transition plans in place, others are really only in the starting blocks.”
For Krebbers, a key question was how long it would take for finance to start drying up for companies that continued to exhibit the wrong behaviour, such as opening new coal mines, or ramping up oil exploration. There is evidence from investor pledges and scoring methodologies that changes are starting to happen, although the timeline is still hazy at best.
“Regulatory action, such as clearer carbon pricing, enhanced climate stress testing, and alignment on green definitions, are all tools that can help accelerate this process,” Krebbers added. “The movement towards an expanded definition of fiduciary responsibility for asset owners is likely also helpful, taking into account also climate change accountability.”
Possible shortcoming: poor track record of banks in private sector alliances
According to the 2021 Banking on Climate Chaos report, 60 of the world’s biggest banks have provided $3.8 trillion of financing to fossil fuels since the Paris Agreement was agreed — a sign that the climate crisis cannot be mitigated without significantly stronger market signals and tougher regulation.
Moreover, overall funding in fossil fuels from large banks has risen year on year since the Paris Agreement, albeit with a slight dip in 2020 as economies shrunk during the Covid-19 pandemic.
These figures show that despite a change in rhetoric and the huge rise of ESG financial products, banks across the word continue to fund fossil fuel projects at an alarming rate.
It is little wonder that the inclusion of the world’s largest fossil fuel lenders in the most prominent private sector alliances have been met with incredulity. The Net Zero Banking Alliance [CJ(1] , for example, contains JP Morgan Chase, Citi, and Wells Fargo — the world’s three largest fossil fuel lenders.
Reactions to such alliances from green-focused market participants tend to range from cautious optimism to severe cynicism.
“COP26 will be recalled as one of the biggest greenwashing events of the finance sector in history,” said Lucie Pinson, executive director at climate-finance-focused NGO Reclaim Finance, one of the organisations responsible for producing theBanking on Climate Chaos report [CJ(2] .
Firstly, she explained, the Net Zero Banking Alliance fails to include requirements for members to stop financing the expansion of fossil fuels. Secondly, while the $130 trillion investment in green transition projects promised by the alliance may sound like a big number, significant loopholes remain. For example, the 2030 target for Net Zero Asset Managers Initiative (NZAMI) members, which includes giants like Blackrock, only covers 35% of assets, meaning 65% of asset are still free to be invested in an way the 450 participating firms see fit.
Reclaim Finance argues that this loophole is large enough to allow firms to keep on investing in new fossil fuel projects while still being seen to make progress from a sustainability perspective. The policy of JP Morgan Chase for example — the world’s largest fossil fuel financier — has a particularly weak policy on financing new coal projects, according to Pinson. Although the policy prohibits the direct financing of new fossil fuel projects, it still permits the bank to finance companies that are developing new coal mines and plants, which means, she said, the policy is just an “empty shell”.
“The Net Zero Banking Alliance will not change the business model for banks such as JP Morgan Chase anytime soon,” she added.
However, that does not mean that financial institutions are doing nothing. Banks such as La Banque Postale and KBC have taken strong positions against fossil fuels, but Pinson and others lament the “voluntary” nature of such initiatives. The Net Zero Alliance cannot prevent its members from investing in fossil fuel expansion, if they so choose, it merely suggests they do not. Governments and their regulatory authorities could be doing more to police such initiatives and ensure a higher level of accountability.
“On the outset, private sector announcements, pledges, and initiatives are good,” said NIB’s de Lorenzo. “The finance industry needs long term targets, however, we should not make the mistake of thinking the job is now done. Many firms that form a part of such alliances have poor track records and will be effectively starting from zero, it is the follow up that counts.”
It is important to pay close attention to firms’ portfolio composition and the extent to which change is needed to determine whether alliance members are serious about meeting long term targets, de Lorenzo argued. Companies that fail must be held accountable.
“Financing fossil fuels will become stricter in the coming years,” he added. “It may take some time, but we should see an increase in cost for fossil fuel activities in time, especially as viable and cost-efficient sustainable alternatives become more widely available for hard-to-abate sectors like cement and aviation.”
Similarly, NatWest’s Krebbers said the private sector alliances, which facilitated collaboration and consensus-building, were a good starting point, though would ultimately only be as effective as their implementation methodologies. If 2021 was about signposting and pledge making, 2022 needs to be about implementation and scrutiny, or the alliances will quickly lose credibility.
“Greenwashing is a growing concern for many market participants,” Krebbers said. “Firms can sign up to pledges, but how are they putting those plans into action?”
Krebbers also stressed pressure from clients to deliver increasingly robust green products. There is now a growing business risk for banks that get caught greenwashing, arguing that such a dynamic would instigate “a natural race to a green top” as banks look to enhance their ESG credentials in order to satisfy client demand.
Possible shortcoming: absence of more rigorous carbon counting and carbon tax
“Making carbon counting more rigorous was discussed at COP26, but nothing came of it,” said Green Alpha’s Jabusch, who is a strong advocate of putting a hard price on carbon emissions. “While central bankers and former central bankers, such as Mark Carney, would like to see it happen, no agreements were made. However, at least the discussion was going on.”
Jabusch thought that enforcing a flat carbon tax was the best direction of travel — something that is only possible once more rigorous carbon counting measures have been implemented. A straightforward tax would be, for example, an improvement to firms “wheeling and dealing behind the scenes with derivatives and options and thereby still finding ways to emit”. Nevertheless, this behaviour also bears a cost, and “anything that increases the cost of destructive behaviour is welcome”.
“It would be better if we could start creeping towards a regulatory environment with more teeth,” Jabusch added. “For example, in the US, FASB [Financial Accounting Standards Board] standards for financial metrics are strictly policed and enforced. When we move into a world where carbon counting is as rigorously enforced, it will become more and more onerous to be an emitter, and if the regulations have teeth, as the accounting standards do, we will see change happening.”
“The cost of being caught in violation will be high enough to deter destructive behaviour,” he added.
Over the long run, Jabusch is optimistic that many jurisdictions will reach such standards. However, they are still “at least 10 years away”, which is too slow given the urgent nature of the climate emergency. Meanwhile, those who object to these standards will continue to lobby furiously against them and instil further delays.
“At a high level, asset management is responding far too slowly to the climate crisis,” Jabusch added. “The world hasn’t made the climate crisis an asset management crisis yet, and that’s a problem because the economy emerges from where assets are invested.”
With regard to carbon scoring and accounting, NatWest’s Krebbers stuck an upbeat note, saying the industry was making good progress on Scopes 1 and 2 of the carbon footprint calculations, which had led to clear standards, such as the greenhouse gas protocol. “Unfortunately, we are still a way off consistent and clear Scope 3 reporting,” he added. “Next year we will see more pressure around the targeting of Scope 3, in which the inclusion of fossil fuel sectors is critical.”
As for carbon tax, which is widely seen as a key policy lever to internalise the impact of carbon emissions, Krebbers thought that such a measure would need to be applied globally to create a level playing field and prevent the emergence of carbon tax havens, which would undermine efforts.
However, like Jabusch, Krebbers also thought that the introduction of a carbon tax was still a long way off, mostly due to the generally slow nature of multilateral diplomacy. “My hope,” he said, “is that the momentum built by COP26 will force such items on to the agenda, though of course they will require extensive consultation and dialogue at G20 meetings and other summits before they become reality.”
From a Nordic and European perspective, NIB’s de Lorenzo thought transparency initiatives and especially disclosures surrounding carbon footprints were moving “quite fast”. He hoped that in three years’ time, most of the big financial firms would be able to see what their portfolios were like from a carbon perspective. This, in turn, would help investors, journalists, authorities and NGOs to hold them to account.
Ultimately, more robust carbon disclosures will make enforcing a carbon tax easier to implement, even if the data isn’t 100% reliable. “First we need carbon disclosures to influence decision making, then, once that’s done, we can work on perfecting the data,” said de Lorenzo.
Possible shortcoming: absence of brown penalising factor, green supporting factor
Like the carbon tax, harder regulatory measures, such as changing the prudential requirements to penalise fossil fuel projects (brown penalising factor), or providing capital relief for bona fide green projects (green supporting factor), still feel like a distant prospect.
“Raising capital requirements for fossil fuel projects would wake up the big fossil fuel lenders,” said Jabusch. “However, no central bank has done this yet and dithering is costly.”
Reclaim Finance’s Pinson cited political problems behind “defining what is brown and what is green” as a major setback. To be able to penalise the brown, and support the green, states needed to be clear with their definitions — and in this instance politics has taken over from science.
For example, while the EU’s Taxonomy has been widely seen as trailblazer, Pinson expressed concern that its credibility is being undermined by countries such as France, which is lobbying the EU commission to integrate gas and nuclear into its definitions.
Meanwhile, the slow implementation of the taxonomy continues to reduce the likelihood of meeting the 1.5 degree targets. Pinson stressed the fact that societies cannot afford to wait for perfect data and tools but must act faster to achieve emissions reductions.
NatWest’s Krebbers also underscored the importance of the Taxonomy in enabling the use of other central bank tools, such as stress testing and changes to capital rules, in attempts to shift capital allocation to cleaner assets. “The Taxonomy is one of the first steps, and I think that’s the right sequencing,” he said. “There are also likely political hurdles to changing capital regulation as well as a broader debate around whether they are the right tools to improve access to financing for green companies and projects.”
Possible shortcoming: ESG Greenwashing
Perhaps one of the biggest setbacks to sustainable finance is the lack of consistency and standardisation in ESG scoring, which has heightened the risk of greenwashing to the point that zealous carbon-free investment funds, such as Green Alpha, prefer to do away with the term ESG altogether and adopt a cynical stance.
“Clients often ask which ESG ranking system is the most robust, but sadly none of them are,” said Jabusch. “Whatever portfolio you are considering building — whether retail or mutual funds or otherwise — you have to dig down into the firm’s list of holdings, which are found in their annual report, and make sure you agree that it is an appropriate response to the climate crisis. As for the banks, you have to look at lending books to see where dollars are actually flowing and skip over the empty promises.”
For example, the NGO Ran recently published a report that exposed a glaring mismatch between what JP Morgan Chase pledged and where its real financing activity actually lay.
“This month, JPMorgan Chase released 2030 targets as part of its ‘Paris-aligned financing commitment’”, the report reads. “These intensity-only targets for oil and gas, power and autos are fully compatible with expansion of fossil fuels and threaten to rubber-stamp increases in absolute emissions, as this initial analysis shows. Coming from the #1 banker of fossil fuels, calling such targets ‘Paris-aligned’ offers a fig leaf for fossil expansion.”
Because of the nebulous nature of what constitutes a green bond or an ESG score, banks and investment managers can still get away with whatever they want, Jabusch added.
“In our investor conversations, there is plenty of confusion around the ecosystem of ESG data, and especially the inconsistent scoring methodologies,” said NatWest’s Krebbers. “The correlation between ESG ratings is weak because they measure different things. Certain providers measure a sector relative ESG performance, based on specific themes and are heavily reliant on readily available public information. This means even a company in the tobacco space can land a AAA score, which then differs to other providers.”
However, consolidation in the sector is slowly starting to happen. In the EU, there is a push to regulate ESG scoring providers in the same way credit agencies are regulated. Tighter regulation should lead to more transparency as to how the scores are developed.
“ESG metrics are complex and can lead to weird outcomes, so you have to use them with a pinch of salt,” said NIB’s de Lorenzo. “Climate action should be kept separate. ESG is too complex, composed of too many moving parts, and has the potential to mislead. Carbon counting, on the other hand, is easily comparable, and can be employed across all sectors. It therefore lends itself more easily to the more immediate task of reducing carbon emissions.”