As anyone who is still keeping to a New Year’s resolution can testify, kicking old habits can be a challenge but some commitments are worth the extra effort. The public commitments made last November at the 2021 United Nations Climate Change Conference demand perseverance; they are not the sort of resolutions that we can let slide. When it comes to averting a climate catastrophe, the cost of failure is simply too high.
The SEC Centre in Glasgow, where COP26 was held in November, witnessed 450 financial institutions commit more than $130 trillion of private capital, through the Glasgow Finance Alliance for Net Zero, to achieve the goal under the Paris Climate Agreement of limiting global warming to 1.5°C above pre-industrial levels by 2050.
Those firms – banks, insurers and pension funds from across 45 countries – manage 40% of financial assets worldwide and can deliver the estimated $100 trillion of finance needed over the next three decades to decarbonise our society and transition the global economy to net zero.
Climate action is part of a wider transformation towards a more ethical financial sector, as banks and other financial institutions seek to improve their businesses’ performance against Environmental, Social and Governance (ESG) criteria.
Consumers no longer see banks, insurers and pension funds as providing a purely transactional service. Firms have to embody their customers’ values and principles. Consumers are demanding that financial institutions use their money more purposefully and behave ethically.
However, in practical terms what does this mean for financial institutions? It is one thing to commit trillions at COP26 but what is the clear, tangible action that needs to be taken now?
Governments and regulators are pressing for greater transparency and enhanced reporting on ESG criteria so that better and more widely available ESG data can drive investment decisions on the allocation of capital.
New mandatory rules will require most big UK businesses and financial institutions to state whether their annual financial reports comply with norms on climate-related financial disclosures. Regulated asset managers and asset owners will have to disclose how they take climate risk into account and also disclose the climate-related attributes of their products.
Government proposals are also afoot for mandatory reporting by banks of the energy efficiency of the mortgaged properties backing their loan books.
Funders in the capital markets are increasingly assessing ESG when making investment decisions. Financial institutions that do not align their businesses with ESG factors are exposed to the risk that their sources of funding will dry up or become more expensive.
Innovative financial products – such as green mortgages, green loans or green bonds – will have an important role to play in delivering the financial sector’s COP26 commitments. However, climate action and, more broadly, ethical finance are about more than just the products and services that a financial institution offers.
Banks also need to start having tough conversations with corporate borrowers in environmentally damaging industry sectors about their net-zero transition plans. In addition, they also need to start walking the talk by aligning their corporate culture and remuneration policies with COP26 commitments.
Now is the time for financial institutions to double down on their COP26 commitments and start to articulate what they mean for themselves and the businesses, customers and communities they serve.
While laggards who drag their heels on climate action face the risk of losing their market share, there are clear opportunities for firms in the financial sector that persevere with their commitments to transform their own businesses and support the transition of the wider economy to net zero. One thing is certain, if change does not happen quickly across the sector then the discussion may well become academic – climate change will not wait for others to catch up.
Peter Alderdice is a Director in Shepherd and Wedderburn’s banking and finance team, and Clare Foster is a Partner and the firm’s Head of Clean Energy.
This article was first published in Business Insider.