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HomePaperFinance for Zero: Redefining Financial-Sector Action to Achieve Global Climate Goals

Finance for Zero: Redefining Financial-Sector Action to Achieve Global Climate Goals

4 July 2023
Authors: Lisa Sachs, Nora Mardirossian, and Perrine Toledano (Columbia Center for Sustainable Development)
Presenter: Lisa Sachs (Columbia Center for Sustainable Development)

As of 2023, the financial system is woefully misaligned with the world’s climate goals. Six times the current annual level of investment in non-fossil fuel investments is needed between 2023 and 2030 to stay on a 1.5ºC warming pathway. The ratio of clean-energy lending and equity underwriting by banks relative to fossil fuels needs to reach 4 to 1 by 2030, whereas for 1,142 assessed banks, the ratio was between 0.8 and 1 at the end of 2021. As providers, underwriters, and fiduciaries of trillions of dollars of capital flows annually, financial institutions (FIs) play a critical role in decarbonizing the economy and scaling access to clean, affordable energy. Optimally, the roles and opportunities for the financial sector should be guided by an official pathway and associated policy tools, such as carbon pricing, public finance and guarantees, strategic subsidies, sectoral regulations, and so on. Unfortunately, that policy framework to shape and guide the financial sector does not yet exist. In the absence of strong government leadership, there has been a proliferation of bottom-up models, tools, metrics, methodologies, and initiatives designed to measure and evaluate the climate performance of financial institutions. While the rapid growth of these initiatives demonstrates the financial sector’s engagement, meaningful progress in realigning global finance to support climate goals has been limited. These frameworks and tools often overstate or misrepresent the extent to which they support meaningful action toward achieving climate goals, and at times rely on misaligned targets or metrics that undermine their effectiveness as tools for setting or assessing corporate commitments. Overall, existing commitments and strategies are not sufficiently aligned with the actions needed from financial sector actors to achieve climate goals. There are deep and inherent limitations to bottom-up approaches to achieving decarbonization, some that are within the capability of financial institutions to address but many that are beyond their remit. This report focuses on the things the financial sector can and should do even in the absence of a robust long-term policy framework. Part 1 of this report urges FIs and their alliances to be clear in their commitments, pledges, and communications about their climate-related objectives and corresponding strategies, their limitations, if any, and how they measure success. Current climate-related pledges, alliances, frameworks, and tools at times confuse or conflate risk mitigation with climate action, relying on targets and metrics that may not be fit for purpose. Whether intentionally or unintentionally, FIs and their alliances can misrepresent or overstate the effectiveness of their approaches in contributing to climate action. This misrepresentation can be exacerbated by the use of misleading metrics or strategies, such as selling or legally spinning off high-emitting assets or using offsets in net-zero pathways. FIs should communicate clearly and accurately about their climate-related pledges and commitments, including whether their goal is to contribute to climate action or to mitigate their own financial risk and how their business strategies will be aligned to achieve those goals. FIs should ensure that targets, metrics, and methodologies are aligned with their goals and business strategies and do not misrepresent the effectiveness of their strategies. FIs’ commitments and strategies are shaped by their financial interests and their interpretation of their fiduciary and other legal duties and obligations; because of perceived tensions between legal obligations and certain climate-oriented strategies, FIs and their alliances should provide clear, public explanations of how their interpreted fiduciary and other legal duties shape their climate-related strategies. Part 2 of this report proposes how financial institutions can and should contribute to, and not undermine, climate goals, under current policy conditions. While many of these actions are relevant for a risk-mitigating approach for FIs and their alliances, these recommendations go beyond risk mitigation in order to guide those FIs and their beneficiaries that seek to have real climate impact. The following are the key recommendations for FIs’ strategies to support global climate goals: Stop lobbying against climate action: The fundamental way that FIs can support the energy transition—as well as mitigate their exposure to climate risk, create clearer pathways for private finance in climate-related opportunities, and reconcile potential conflicts between fiduciary duty and climate action—is to ensure that their climate policy engagement and that of their financed entities do not undermine government regulations. Specifically, FIs should stop lobbying against government regulation, both directly and through any business associations, and they should require that their financed entities similarly stop anti-climate lobbying. Government policy, plans, roadmaps, and regulations are decisive for achieving global climate goals. Governments drive innovation, shift markets, assign costs and liabilities, incentivize important investments and behaviors, and define fiduciary responsibilities, among other things. Government policies are the most important determinant of corporate performance on sustainability issues, and public policies apply to all types of actors, both publicly traded and privately owned. Universal policies are necessary to address systemic risk facing FIs and their beneficiaries and to reduce the potential for the opportunistic behavior of industry laggards. Shift finance: The most decisive and important role for the financial sector in accelerating the energy transition is its ability to mobilize the trillions of dollars needed to close the growing gap in climate finance and achieve climate goals. The emphasis for the financial sector, therefore, should be on how new finance is being directed, and whether new investments, loans, underwriting, and other forms of financing are contributing to—and not undermining—a rapid and just transition. Current financial flows toward low-carbon solutions must be multiplied by a factor of four to six, financing for fossil fuel exploration and expansion must end, and all new financing should be conditioned on robust 1.5ºC alignment. Use FIs’ influence with their financed entities: To accelerate the energy transition, FIs should use their influence with the financed entities in their portfolios to support their transitions in line with a 1.5°C trajectory. Part 3 of this report discusses the importance of more robust accountability and oversight mechanisms for financial institutions and their alliances with respect to climate-related strategies. Currently, there is little consequence for FIs that misrepresent their strategies and their effectiveness, that do not align their business plans or practices with their stated strategies, or that miss their own targets. Without addressing this gap, there will continue to be little incentive for honest communication or for the hard work of changing business plans and models. Part 4 of the report discusses how FIs and their alliances can contribute to improving knowledge, data, and pathways that underpin FIs’ climate strategies and engagement. Climate action calls for urgent and transformative change in a complex and rapidly evolving environment, in which the answers, appropriate technologies, and tools are not all readily available. The transformation requires an analysis of regional, national, and sectoral pathways and for the coordination of public and private actors and other stakeholders. The report recognizes the key challenges confronting FIs in implementing the report’s recommendations, particularly those related to uncertain pathways, nascent and uncertain technologies, and insufficiently robust metrics and accounting methods, and suggests that FIs can actively contribute to resolving those uncertainties. Some of the recommendations in this report are bold relative to existing practice, which underscores the gap between existing approaches and the financing pathways that are needed to achieve climate goals. The opportunities and pathways for the financial sector will be clarified and bolstered by evolving public policy, and the financial sector ought to be supportive of that policy framework. We hope this report provokes and supports critical discussions among policy makers, financial institutions, and their stakeholders around the policy framework and appropriate set of practices and tools that are necessary to meaningfully orient financial institutions toward our global climate goals.

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