Sustainable Finance Targets Matter More Than Ever: Three Lessons for Banks
WRI takes a closer look at the recent commitments from JP Morgan Chase and Goldman Sachs
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This article was first published on WRI's website, here.
In the midst of the twin global public health and economic crises, concerns about climate change may fade, even though the threat of climate change still looms large and the need for a systemic shift towards a low-carbon, climate-resilient economy is pressing.
In this context, banks' financial decisions - those directly in response to the COVID-19 pandemic and more broadly - will continue to influence how we address climate change. This is why banks' sustainable finance targets matter, even in the middle of the pandemic, and why two recent targets offer lessons for other financial institutions.
If sustainability announcements are to go beyond public relations, they must limit fossil fuel financing as well as financing greener projects.
In December 2019, Goldman Sachs announced it would devote $750bn to sustainable finance over the next decade. The target is the largest yet from a private sector bank, more than double any prior commitment. In February, JPMorgan Chase (JPMC) announced it would facilitate $200bn in sustainable finance in 2020. While smaller than Goldman Sachs' total, on an annual basis it far exceeds that of any other bank.
Before these targets were announced, we analysed the active targets of the world's top banks. Drawing on this research and the new targets, we draw three key lessons for other banks.
1. Green Targets Should Be Paired with Reductions in Fossil Fuel Finance
Most large private sector banks with sustainable finance commitments still finance fossil fuel development. Over the last four years, JPMC and Goldman Sachs provided a total of $268.5bn and $83.7bn to fossil fuel companies, respectively. These sums include significant amounts to the most destructive of fossil fuel business, including coal mining, coal power and Arctic oil & gas.
This is not sustainable if we are to meet the Paris Agreement's temperature goals, which will require drastic cuts to global emissions and keeping a large proportion of fossil fuels in the ground. If sustainability announcements are to go beyond public relations, they must limit fossil fuel financing as well as financing greener projects.
The new commitments from Goldman Sachs and JPMC are encouraging. While both still finance fossil fuels, each recently announced new restrictions on financing for coal extraction, coal-fired power plants and oil development in the Arctic. According to the Rainforest Action Network, Goldman Sachs now has the strongest fossil fuel restrictions of any major US bank and JPMC's are essentially on par. While these still lag behind leading European banks, this is a welcome shift and suggests real change in how these banks do business.
Pairing fossil fuel restrictions with sustainable finance targets is not the only way banks can reduce financing to the sector. Making a specific commitment to reduce overall greenhouse gas emissions over time can also serve this purpose. This summer, the Science Based Targets initiative is set to launch methodologies banks can use to ensure their efforts to decarbonise their lending and investment portfolios are in line with the ambition of the Paris Agreement. This is another example of climate action commitments banks can make alongside new sustainable finance targets.
2. Go Big, But with Clear Criteria
Goldman Sachs' and JPMC's new targets are considerably larger than each bank's previous target: a 600% increase for Goldman Sachs and an 800% increase for JMPC on an annualised basis (more details about Goldman Sachs' and JPMC's previous commitments are available in our Green Targets tool). The world needs these steep increases. Preventing climate catastrophe and advancing sustainable development requires trillions of dollars annually; the energy sector alone will need an investment of $2.4trn every year through 2035. Financing from private sector banks will be critical.
But a big headline number isn't everything. Apart from size, we must also consider what activities the target will support, and through what financial services. In our previous assessment of 23 sustainable finance targets, we found very little consistency in the scope of sustainability activities these targets would support.
The new commitments from Goldman Sachs and JPMC demonstrate that the scope of sustainability can vary and evolve within a single institution. Goldman Sachs' previous target focused narrowly on clean technology and renewable energy. Its new target covers nine themes of sustainable development related to the climate transition and inclusive growth, including areas such as innovative healthcare, affordable education and financial inclusion. Similarly, while JPMC's earlier target was restricted to "clean financing," its new target centers around advancing the Sustainable Development Goals via green, social and economic development objectives such as supporting climate action, increased access to housing and improved infrastructure.
To ensure their targets are credible, banks must provide clarity on how finance will be allocated across different types of financial services and across sustainability themes. This is something that neither Goldman Sachs nor JPMC have outlined for their new targets.
Neither approach is inherently better. Some stakeholders welcome the wider target, as it recognises the role of banks in tackling critical sustainability issues beyond climate change, like clean water, affordable housing and public health. For example, within the last month, Goldman Sachs and JPMC have helped raise billions of dollars in bonds to support COVID-19 relief and recovery efforts (like this one in Latin America). But it remains unclear if the significant increase in these new, broader targets will translate into an increase in financing for solutions directly tied to the climate challenge.
The types of financial services included in the targets also matter. A target that only extends direct financing through loans or equity is quite different from one that includes indirect support via asset management or advisory services. Alongside financing and investments, Goldman Sachs' new target notably includes advisory services, which were not part of its previous target. On the other hand, JPMC's new target is focused on facilitating financing, which is the same scope as its previous commitment. This is further helpful context for interpreting the larger headline figures.
To become fully transparent and ensure their targets are credible, banks must also provide clarity on how finance will be allocated across different types of financial services and across sustainability themes. This is something that neither Goldman Sachs nor JPMC have outlined for their new targets. Greater insight into these issues would help stakeholders understand whether the level of financing for various activities will actually increase under the target, or whether it will be closer to business as usual.
3. Publish Accounting Methodologies
Because there is no widely accepted accounting methodology for sustainable finance, transparency in accounting practices is essential. Without it, stakeholders don't know what types of businesses, projects and transactions count toward the target, or how the bank will count different financing activities.
Neither Goldman Sachs nor JPMC have yet published an accounting methodology for their new targets on their websites. This is a serious shortcoming, one we identified for the majority of targets reviewed in our earlier research. In that sample, Goldman Sachs had in fact published a methodology for its previous commitment, whereas JPMC hadn't. Goldman Sachs has indicated it will begin reporting on its new target within a year, which we expect would include information related to its methodology; we are hopeful JPMC will do the same.
In general, banks should share their accounting methodology when they announce the commitment. This is key for the external credibility of the target and for signaling that the institution has a clear sense of what will count towards its commitment. That in turn helps drive incentives within the bank and pushes staff to do what is needed to ensure that the institution meets its commitment.
Preventing the Next Catastrophe
With the coronavirus pandemic, we are seeing firsthand how a global crisis can bring economies to a standstill and upend financial markets. As the international community faces an immediate threat to lives and livelihoods, banks will play a critical role in shaping how we weather this storm and ultimately recover from it. Banks will have a similar role in helping to navigate the climate crisis - but whether their sustainable finance targets are positioned to do so depends on more than a big number.
Ariel Pinchot is an Associate with the World Resources Institute Sustainable Finance Centre.