By Charles Di Leva and Scott Vaughan

Last November, at the UN Climate Change Conference (UNFCCC COP 26), roughly 450 financial institutions joined the Glasgow Financial Alliance for Net Zero (GFANZ). With much fanfare, some of the world’s biggest banks, investors, insurers, pension funds, asset owners, and asset managers pledged to create a new, climate-attuned financial architecture, described by one of its members – Brookfield Asset Management – as “essentially changing the incentive structure for decarbonization.” A common goal uniting global financial leaders was their pledge to meet net-zero climate goals.

With that architecture in place, details of how to implement, measure, and verify net-zero pledges turned to an array of technical areas like accounting standards for climate risk disclosure, climate stress tests, and other details that were referred to as the “plumbing.”

A seemingly innocuous ratchet in that plumbing was a June 2022 update from the UN Race to Zero, which spelled out what most people conversant with climate mitigation know well: net zero requires the “phase down and out of all unabated fossil fuels as part of a just transition” and avoiding, in particular, the financing of new coal projects.  

Net Zero Pledges Face Internal Strains

The reaction of several high-profile GFANZ members to the coal investment ban could now threaten the unity of the GFANZ initiative. In September, reports circulated that several US-based members – including J.P. Morgan, Bank of America, and Morgan Stanley – were considering leaving the alliance because of the criteria. Other reports noted Canadian banks might follow. At least three GFANZ members have already left, including two pension funds from Australia and Austria.  

After the June criteria reportedly raised legal liability concerns around possible anti-trust exposure and other matters, Race to Zero issued updated criteria in September clarifying that net-zero actions should comply with “all legal and professional obligations,” and that new fossil fuel investments could continue to 2030 in Organisation for Economic Co-operation and Development (OECD) countries and to 2040 in developing countries. It is unclear if these changes have stabilized the coalition.

Profits, Politics, and Standards

Could other reasons lie behind this apparent backtracking? Profits may be a good place to start. Recent estimates suggest that eight of the top ten bond and shareholder coal financiers – accounting for USD 688 billion in financing – come from US-based institutional investors. Blackrock and Vanguard, both GFANZ members, each have an estimated USD 100 billion or more investments linked to coal. With cascading energy shocks, investments not only in coal but all fossil fuels have jumped sharply over the past year, from a tripling of investments in Canadian oil sands to steep increases in shale fracking. Oil giant Exxon reported its largest quarterly earnings ever between July and September, posting an almost USD 20 billion profit.  

Politics have also crept into climate financing with attacks from both the right and left. Railing against “woke capitalism” – a curious term that seems to defy the notion of free markets in general, and higher returns on clean energy in particular – several Republican-controlled US state legislatures have banned contracts with investors that have climate or broader environmental, social, and governance (ESG) goals. In early October, Louisiana divested USD 800 million of Blackrock financing linked to ESG goals, joining Utah, West Virginia, and Arkansas. In the opposite direction, a group of non-governmental organizations (NGOs) recently launched legal action against BNP Paribas, referencing France’s duty of vigilance laws to require France’s largest bank to cut all fossil fuel financing.

Behind profits, politics, and legal action, disclosure requirements represent another cause for the financial sector to reflect upon its net-zero pledges. Specifically, several jurisdictions, notably the US, EU, as well as the most important international corporate accounting standards body, have adopted or are moving towards mandatory climate risk disclosure standards, largely based on voluntary recommendations from the Task Force on Climate-related Financial Disclosures (TCFD). Recent EU SFDR standards, proposed new rules by the US Securities and Exchange Commission (SEC), and proposed international standards of the International Sustainability Standards Board (ISSB) of the IFRS Foundation are reshaping how banks, investors, and others will be required to calculate, disclose, and report their existing climate exposure and emerging climate transition risks, as well as disclosing how they actually intend to achieve net-zero targets through interim actions backed by scenarios. The ISSB standards have moved remarkably quickly to narrow fragmentation across standard bodies, with the Global Reporting Initiative (GRI) ready to release a new reporting standard at COP 27 that will complement ISSB’s.

While the days when a financial company could claim to be net zero, with no credible roadmap to get there, may not be over, these new reporting standards should help to limit greenwashing.

These standards are long overdue. A recent review found that 98% of industrial companies failed to provide sufficient climate risk evidence in their 2021 financial statements, according to a joint Climate Accounting and Audit Project and Carbon Tracker report.

Certainly, there are differences among the big three reporting climate standards – notably with the SEC being more flexible than SFDR and ISSB on the reporting of Scope 3 emissions – that is, the wider carbon footprint of value chains that are to be reported even if not the result of activities owned or controlled by the reporting entity. Overall, however, there is solid convergence among the three standards, notably in the common reference to metrics and measurements based on the GHG Protocol and carbon footprint analysis, referencing scenarios to identify transition risks, and providing preliminary clarity about how carbon offsets should be measured as distinct from mitigation. Still, much more work is needed on this front.

Clear Recommendations from the UN Integrity Matters Report

A welcome complement to tighter auditing standards is the ‘Integrity Matters’ report of the UN High-Level Expert Group on Net Zero Emissions Commitments of Non-State Entities. The Group, chaired by Catherine McKenna, sets out a series of clear recommendations to “prevent dishonest climate accounting,” concluding that there is no room for new investments in fossil fuel supplies.” Of note, the report recommends that net-zero pledges be verified by third parties, contain interim five-year actions, separate mitigation actions from any offset measures, and include embedded emissions that include fossil fuel reserves.

For coal, the report recommends that financial institutions’ net-zero pledges “include an immediate end of i) lending, (ii) underwriting, and (iii) investment in any company planning new coal infrastructure, power plants or mines” while working towards the phase-out of the entire coal value chain “no later than 2030 in OECD countries and by 2040 in non-OECD countries.”

Action by the private sector has always been vital to meeting the Paris Agreement on climate change and other big global objectives. Private climate financing has steadily increased over the past decade, to roughly USD 330 billion per year in 2020. Certainly, there are many important examples of companies within GFANZ that are advancing net-zero action, from Storebrand Asset Management’s extensive use of science-based climate mitigation targets, to the launch of a USD 15 billion climate neutrality transition fund – the world’s largest – by Brookfield, and, increasingly, ambitious lending and screening by PNB Paribas.  

Despite this growth, the climate financing gap remains wide. The latest stocktaking by the World Resources Institute (WRI) concludes that none of its 40 climate mitigation indicators are on track, with climate financing requiring a ten-fold increase. The annual ritual of announcing long-term goals and targets, while avoiding urgent action, now means we are on a path to a global warming of 2.7°C warmer world, with the latest Emissions Gap Report showing that the Paris 1.5°C target may now be impossible to meet.

Can multilateral finance help?

Reflecting on his tenure as President of the Climate COP during Glasgow, former UK Minister Alok Sharma pointed to the need for more first-tranche loss financing arrangements, whereby public finance takes on the front-end risk in low-carbon investments, and is prepared to accept any front-end losses as a means to attract more private sector financing.

Sharma’s example reflects the need for a more proactive and comprehensive role by governments to scale-up climate finance. Despite its mixed record, industrial policy provides the model for how governments need to show leadership in leveraging public finance to de-risk further net-zero financing. Since the 2008 global financial crisis, there has been a resurgence in industrial policy worldwide. World Investment Report 2018 estimated that 84 countries accounting for 90% of global gross domestic product (GDP) have adopted industrial policies. An influential 2019 economic study by the International Monetary Fund (IMF) titled, ‘The Return of the Policy That Shall not be Named,’ examined what it called “true industrial policy,” which revolves around government support that concentrates on public policies that accelerate favorable conditions for technological innovation leading to what economist Mariana Mazzucato calls a “moon shot” of ambition.   

Enabling public financing to leverage and attract private sector investments is needed urgently, and especially to close climate finance gaps in developing countries. With public climate finance now basically on par with private climate financing – at roughly USD 330 billion annually – there is an urgent need for new blended financing arrangements that involve leveraging domestic funding sources as well as international sources like the World Bank, IMF, other multilateral development banks (MDBs), and export credit agencies, a priority underscored in the ‘Integrity Matters’ report.

The US and Germany have stated their view that the World Bank (and, presumably, other multilateral and bilateral financial institutions in which they are members), should find ways to expand its balance sheet to finance renewable energy. They note that “measures the Bank could take include incentivizing action on climate change with better borrowing terms and using its money to de-risk clean energy investments in developing nations.” These urgings are consistent with recent comments by Larry Summers, the World Bank’s former Chief Economist, and Al Gore.

How relevant is this potential evolution of multilateral financial institutions to the larger commercial sector? Is it reasonable to expect the profit-making financial sector to ramp up investments in renewables and energy efficiency in response to incentives that the public sector multilateral financial institutions (MFIs) are being urged to adopt? We contend there is no choice but to do so and that it is also good business sense. 

Lowering the Cost of Clean Energy Capital 

The economics of this approach is laid out by Sachs and Sachs in an article titled, ‘Financing Decarbonization.’ As they articulate, making the transition to clean energy is the key to meeting the Paris goals. And key to this transition is lowering the cost of capital so that it makes more financial sense to support investments in renewables, rather than traditional fossil fuel. Unfortunately, all too often, the current state of global affairs allows for a more rapid rate of return on traditional fossil fuel investment, and commercial banks and other investors may take the position they have fiduciary obligations that continue the incentive to finance lucrative fossil fuel investment. As they point out, at least two changes must be broadly in place to allow for this essential transition. First, it is fundamental to factor the social cost of carbon in fossil fuel use, which can include various means such as ending fuel subsidies or imposing carbon prices or taxes. Second, it is essential to lower the cost of capital for clean energy investment. 

While MFIs have long advocated for the use of carbon pricing and embedding the social cost of carbon, it is toward the lowering of the cost of capital that the public sector needs to help provide incentives for commercial finance to increase its flows to renewable energy investment, in particular through the use of the uniquely positioned and structured, government-owned and -led MFIs, starting with the World Bank. Beginning with the G20 Independent Review of MDBs’ Capital Adequacy Frameworks, we see important research identifying ways for multilateral banks to encourage more private investment by helping to lower the risk. 

The report identified at least five actions that could unlock more MDB funding to help middle- and lower-income countries have access to “hundreds of billions of dollars”:

• getting MDB shareholders to be clearer and more ambitious in defining what risks MDB management should be willing to take;
• giving more recognition to the unique aspects of MDB access to callable capital and their preferred creditor status – these factors should help create headroom for larger investments and the transfer of risk;
• developing innovative tools (e.g., more outcome-based and less project-based financing) and risk transfer mechanisms, including with new types of non-voting capital;
• having credit-rating agencies continue to underscore the triple A ratings that help enable MDBs to raise capital, thereby supporting MDBs’ risk appetite, while also better harmonizing their risk rating methodologies; and
• enhancing the transparency of data on the flow of funds, and better sharing capital adequacy benchmarking to help demonstrate MDBs’ capacity for and approach to risk.

This brief outline is resonant of the calls from global finance leaders like Janet Yellen for the World Bank to lead the way in finding new and innovative ways to expand its climate finance. At this fall’s World Bank/IMF Annual Meetings, Prime Minister of Barbados Mia Mottley helped launch the ‘Bridgetown Agenda’ outlining new steps in international public finance like grants, low-interest loans, guarantees, and reissued and new long-term debt. With a nearly certain global sovereign debt crisis looming, the IMF has also begun re-examining a new generation of debt-for-climate swaps.

The stress these leaders place on expanding the reach of multilateral finance should also be seen in the light of challenges in the development of the “carbon market.” Indeed, the Paris Agreement Article 6 “market regime” rules needed to fully operationalize Articles 6.2 and 6.4 appear several years away. This challenge adds to the case, consistent with the Sachs’ view, that MFIs must join with governments to support Article 6.8 “non-market” approaches, by continuing to advocate carbon pricing and ending fossil fuel subsidies alongside the steps that enable large scale-up of climate finance and energy efficiency. In this way, governments can help embolden private capital to invest in a climate-compatible manner, even for those investors who are uncertain whether acting consistently with climate science meets their traditional fiduciary responsibilities.

These urgent calls for action, over and above private sector net-zero pledges, will be heard loudly at COP 27.

Scott Vaughan is International Chief Advisor, CCICED; and Senior Fellow, Former President and CEO, IISD. At UN Environment, he initiated the precursor to UNEP Financial Initiative (UNEP FI), headed the UNEP Environment and Trade work.

Charles Di Leva is Partner, Sustainability Frameworks; Adjunct Professor, American University; and former Chief Officer, Environmental and Social Standards, The World Bank.