Listen to bank executives, and you’d be forgiven for thinking the industry was fully on board with the sustainable-finance trend.
Yet the world’s biggest banks reject the idea of cutting off financing to new oil, gas and coal exploration, even though this is the quickest route the financial-services world can take to get the companies they serve to reach net zero emissions by 2050.
And they do so in defiance of the wishes of Mark Carney, the former head of the Bank of England, who is advocating for such a step at the upcoming United Nations summit, called COP26, to be held in Glasgow starting from October 31.
Banks will rightly point to the governments haggling at COP26 as setting the pace for ensuring the world’s climate rises no more than 1.5° centigrade. This means cutting global emissions by at least half in the coming three decades – and it’s up to governments, not private enterprises, to determine the rules to get us there.
But regardless of what politicians agree, finance won’t thrive in the future we are currently on the road to face: one of a 3° temperature rise, according to MSCI, which this week said less than 10 percent of about 9,000 companies it tracks worldwide are behaving in line with what’s needed to cap the temperature rise at 1.5°, as originally agreed in 2014 at the Paris Agreement.
Even a 1.5° rise will represent a difficult new reality for societies and business, but a hike of 2° or more could tip the world into truly dystopian conditions.
Playing climate bingo
More than 300 banks signed up to a recent initiative backed by Carney to embrace sustainable practices – but they now say they prefer to adhere to a different set of milestones.
These other measures follow the United Nation’s International Panel on Climate Change, which has the same 2050 goal but doesn’t ban funding exploration or offer other prescriptions. It offers instead a nebulous scenario-based web of possible actions.
Are these financial institutions guilty of greenwashing: deliberately projecting a green image they don’t deserve?
From the banker’s point of view, that flexibility means a more pragmatic outcome.
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“Carbon-heavy business models have to migrate to carbon-lite or carbon-neutral, which will require a significant amount of investment,” Noel Quinn, group CEO at HSBC, said at the recent Sibos conference.
Banks prefer to remain engaged with oil-and-gas companies, carmakers, aviation companies, and other carbon emitters, to help them make this shift, rather than divest.
Abyd Karmali, managing director of climate finance at Bank of America, says transitioning requires companies to take risks such as getting earlier into new technologies or scaling up in unfamiliar geographies.
This requires not just a lot of financing, but clever ways to provide it, such as loans that match multiple “sustainable development goals”, or SDGs. For example, can funding align emissions reductions with food security or providing rural communities with access to energy?
“We’re innovating in blended finance, where we can get multiple hits on the SDG bingo card,” Karmali said at Sibos.
I’m a banker, you can trust me
The question therefore is to understand what “transition” means. Are bank loans and capital markets activities going to meaningful changes, or are they merely financing the exploration of yet more fossil fuels to burn?
It’s a big question because the funding required to transform our energy system is massive: new technologies, new ways to manage power grids, investment into batteries… The list is long.
Are banks arranging financing for these necessary and difficult things, or simply for business as usual, like digging up more coal?
Today it’s hard to know the answer.
Quinn, for example, says it’s through talking with clients that he senses a new urgency and sense of change. He’s excited about new technologies that will help the transition.
Do we just take his word for it?
In fairness to Quinn (who is in step with his peers), he recognizes that there is a huge need for disclosure, sourcing data, and analyzing it to demonstrate true progress.
Fintech’s biggest contribution right now is making disclosure possible, and data sharable in a responsible manner.
As with other aspects of banks’ technological challenges, most of the useful data already exists in their disparate databases. Piecing it together is difficult; so is creating the systems to share it. But this is the only way enable investors, regulators, and policy advocates to make critical judgements.
There are problems that fintech can’t solve: above all, political will. What does that look like? For starters, banks, like governments, are using “transition” arguments to suggest that we can delay the big changes until closer to 2050.
Yulanda Chung, head of sustainable institutional lending at DBS, says she is heartened by coal-fired power companies in Indonesia and China looking to reach net zero emissions by 2050 or 2060. “For clients in high carbon-intensive industry, the trajectory to reduce emissions is more like a cliff drop…these targets may be reached closer to 2050 than 2030,” she said at Sibos.
The problem with avoiding hard changes until 2050 is that it might be disastrously too little, too late.
COP26 is meant to come up with specific actions to cut global emissions in half by the end of this decade, as called for by IPCC. The quickest way to do so is electrification – of cars; of energy supplies; of agriculture; of how we construct, heat, and cool buildings; and how we power our data centers and digital infrastructure.
This requires a full stop to our burning fossil fuels, and relying on cheap wind and solar power instead, as well as innovating on batteries required to store their energy.
This is not what most big energy companies are emphasizing. They are focused more on hydrogen and natural gas as substitutes, or using fossil fuels to manufacture plastics. Many scientists regard these as wasteful, although LNG is likely to be an important bridge for economies weaning themselves off coal.
If banks’ lending and capital-market activities skew mainly to gas and plastic, instead of renewables and batteries, the planet will heat to unmanageable levels.
Data’s cans and cannots
Without clearly defined disclosures and access to that data, however, it’s impossible to judge the efficacy of transition finance.
This data is not required just to bash banks. It will also help them. Bankers are right: companies face huge unknowns as they reinvent themselves. Innovation is by nature risky, which is why we have venture capital. The scale of the climate transition is such that conservative commercial banks must become VC-like. Data and disclosure will make decision-making a bit less murky.
Data is also useful to show recalcitrant companies that they will be saddled with “stranded assets”, assets that unexpectedly become liabilities that must be written off, if the owners don’t make rapid changes.
“The most compelling argument [with clients] is the notion of stranded assets,” Chung said. “They are going to experience difficulties accessing capital before they see climate-change impact, because the capital markets will bring that risk forward. If you don’t act, you’re not future-proofing your market, and you’ll be priced out. This isn’t even about sustainability.”
However, free capital markets have never priced in the true costs of pollution, toxic waste, or emitting carbon. We can’t just assume the market will convince carbon-intensive companies to change their ways in time to avert climate disaster.
Disclosure, what’s an acceptable scope of emissions, and how to account for important nuances in financing change are all hard details. COP26 is meant to begin putting some structure around these questions.
Politicians are no more reliable than banks when it comes to making painful tradeoffs. The energy shortages of 2021 have stemmed in part from attempts by governments around the world to scale back fossil fuels.
They are a reminder that transitioning to clean energy is an incredibly difficult endeavor: imagine the setbacks to the green agenda if we all suffered from prolonged power outages. But they also remind us of the status quo’s fragility. COVID-19 has been another useful alarm, in case all of these crazy storms, heat waves and floods haven’t done the trick.
We’ll see at COP26 if world leaders crumble or if they find the gumption to advance the green agenda.
While it is true that finance can only do so much if governments shy from hard choices, that “so much” can still be significant. This includes improving corporate disclosure, working with ESG rating agencies, helping identify promising technologies, and coming up with clever structured deals to allow companies to reach SDG targets – although here again, “innovative” financial structures usually mean opacity. Only transparency can shed light on what banks are really doing with their lucrative but problematic clients.
“Net-zero commitments must have teeth,” said Amy West, global head of sustainable finance and corporate transitions at TD Securities. “We need to understand where the emissions are actually coming from in our portfolios, which is easy to say but hard to deliver.”
This comes down to data. “Not just data we supply to the market,” West added, “but data that investors, capital providers, and activists should look at. This makes us uncomfortable but it instills accountability in large organizations.”
She agrees that divestment is not a practical strategy: there will always be another lender, and the company will continue burning fossil fuels. But only science-based data can enable banks to hold difficult conversations with clients that emit a lot of carbon.
Governments set the pace; investors and activists put pressure on banks; market forces turn carbon-intensive assets into liabilities… but banks need data to make energy transition real – and to find ways to make significant reductions in carbon emissions by 2030, not by 2050.
But it’s exciting, too
Fintech is the missing ingredient, the tool to make this possible. Artificial intelligence and cloud-based services can help banks unlock and share the valuable data they already possess. Alternative data providers can track emissions with increasingly accuracy. Blockchain is a means of establishing provenance of emissions data. Decentralized finance is creating new ways to expand energy markets.
Fintech isn’t just “stuff”. It’s about data sharing, open-source development, and embedded finance. The same goals that banks are chasing with such ardor in consumer markets should be pursued in sustainable finance.
Indeed, figuring out how to use remote onboarding and personalizing a loan should be viewed as mere rehearsals. Banks that aren’t fully digitalized simply won’t be able to manage the complexities of climate transitions.
As with consumer fintech, banks can’t do everything by themselves; the ecosystem of corporations, stock exchanges, investors, data vendors, regulators, and even NGOs must be involved to make finance truly sustainable. DeFi models, alt data, and powerful analytics can turbocharge this and make it global and effective.
It’s actually quite exciting. But going digital and saving the environment will require banks to be honest about what “transitioning clients” with “innovative finance” really means.