How Can Financial Institutions Deliver on the Paris Agreement?

2nd Jul 2018

The financial sector has a key role in shaping the net-zero carbon economy of the future

This is a critical year for climate action. Five years after the landmark Paris Agreement, world governments will convene in Glasgow this November to put more ambitious national climate action plans on the table.

The latest science tells us that emissions must peak this year and then start dropping quickly to stand a good chance of keeping warming to within 1.5 degrees C (2.7 degrees F) above pre-industrial levels to avoid the most severe impacts of a changing climate.

There are some signs of hope. The International Energy Agency announced this month that global carbon dioxide emissions from energy use remained unchanged in 2019 compared to 2018, a hint that emissions may have peaked. The EU Council is meeting in June to agree on steps to reach net-zero emissions by 2040.

In the private sector, more than 800 companies have committed to set science-based targets to reduce their greenhouse gas emissions in line the goals of the Paris Agreement, and corporate goals and ambition are growing daily.

These hopeful signs are important, but not enough. The latest reports by the Intergovernmental Panel on Climate Change (IPCC) have shown that the transition to a net-zero carbon world requires a systemic economic transformation, backed by consistent capital flows. Because systemic change can’t be allocated to any one sector, group or region, multi-stakeholder collaboration and shared responsibility are essential. To spur this transformation, we need a framework for financial institutions to set science-based targets.

Driving Systemic Transformation

To decarbonize the global economy in alignment with the Paris goals, all businesses need to reduce their direct greenhouse gas emissions quickly enough to stay within the carbon budgets established by climate science.

These emissions don’t occur in a vacuum. They are part of a broader economic and regulatory system that creates a complex web of incentives and disincentives for actors in the real economy to reduce emissions. Every actor in a given value chain influences the emissions of other actors and therefore shares responsibility for reducing them.

The Science Based Targets initiative (SBTi) makes the shared, cross value-chain responsibility between actors explicit by requiring companies to set targets not only for their direct emissions, known as scope 1, and emissions from the electricity they buy, known as scope 2, but for all significant emissions across the value chain, known as scope 3. This practice builds on decades of corporate emissions accounting through the use of the GHG Protocol Corporate and Value Chain Accounting and Reporting Standards.

The private sector is stepping up to embrace this shared responsibility. Over 90% of the 339 companies with approved science-based targets have set ambitious scope 3 targets, setting off positive ripple effect across a wide circle of companies around the world.

The Vital Link

Financial institutions are the vital link in enabling the kind of system-wide change we need. By lending and investing, they have the power to redirect capital to the sustainable technologies and solutions of the future and to the companies doing the most to prepare for a net-zero emissions economy. Through the finance they provide, financial institutions can influence companies to reduce their greenhouse gas emissions, even without direct control over those reductions.

The Science Based Targets initiative’s framework for the finance sector works to enable financial institutions to accelerate the transformation required by aligning lending and investment portfolios with the level of ambition required by science. This approach leverages financial institutions’ shared influence and responsibility to provide the capital needed to finance the net-zero transition.

Putting Science into Action

Keeping warming on 1.5 degrees C pathway will require a significant increase in energy systems investments, on a scale of roughly $1.6 trillion to $3.8 trillion annually between now and mid-century. This is triple the amount invested in climate friendly activities in 2017.

It is not yet clear which specific actions by financial institutions will reduce real economy emissions. Virtually no methods currently exist to adequately measure the climate impact of financial institutions’ actions, and it is unclear if they ever will. More research is needed to try to understand which actions by financial institutions work best to curb emissions; this will be valuable in informing the SBTi’s evolving approach to target setting.

At the same time, the urgency of the climate crisis requires action now, and thus an immediate need for an approach for financial institutions to take action today. The SBTi is focused on providing a practical solution that enables near-term action and impact at scale. Our framework is being developed in consultation with financial institutions, consultants, NGOs, academics and others through a transparent, inclusive, multi-stakeholder process.

So far, more than 50 financial institutions have publicly committed to setting science-based targets, including HSBC, Credit Agricole, AXA Group, Societe Generale and ING Group. This year, we will launch target-setting methods and tools, and target validation criteria and target setting guidance to help turn companies’ commitments into concrete targets. Target setting that redirects capital flows towards more sustainable investments and lending can lead to emissions reductions on a mass scale in the real economy.

Bringing It All Together

To have system-wide impact, measurement and transparency will be critical. Annual disclosure of a company’s target implementation strategy, and progress against their targets will be a key component of the SBTi requirements for financial institutions. This information will build understanding of the most effective actions financial institutions can take to drive emissions reductions and which metrics are best for tracking their progress, helping us refine our framework over time.

The SBTi framework will be updated on an annual basis with our evolving understanding of how financial institutions can achieve emissions reductions in the real economy. We aim to learn as we go and improve over time, acknowledging that while there is no perfect solution now, financial institutions need to immediately start moving in the right direction.

The launch of the SBTi methodology for financial institutions this year coincides with CDP’s first questionnaire tailored to the sector. Starting in April, publicly listed financial services companies will be asked about the climate risks and impacts of their portfolios, and how they’re being managed. We hope to see a mutually reinforcing relationship between increased awareness and transparency in the sector and science-based target setting.

With a spotlight on the sector to realize its potential as a game changer in the transition to a net-zero economy, it is the SBTi’s aim for science-based target setting to become standard practice among financial institutions.

The Paris Agreement and climate science have shown us the level of ambition needed to secure a thriving sustainable economy and avoid catastrophic climate change. The financial sector has a vital role to play in helping us get there and shaping the net-zero carbon economy of the future. With the future of our planet on the line, everyone has a stake in the outcome and a role to play. There’s no time to lose.

Sign up to join the Stakeholder Advisory Group to receive updates about the SBTi’s finance project and opportunities for contributing to its development.

This article was first published on Responsible Investor.