The climate impact of financial institutions’ investment and lending is more than 700 times their direct impact, on average, according to CDP research. Yet, for many institutions that is not where the focus has been – with only 25% reporting less than 50% of the emissions associated with their portfolio, and 49% not analyzing their portfolio’s impact on climate at all.
Around the world, current environmental disclosure regulations are still not sufficient to ensure that risk and impacts from economic activities are correctly estimated. We expect that, following COP26, more countries and regions will regulate for mandatory environmental disclosure with financial institutions among some of the first organisations required to disclose. This must be done with urgency and enforced stringently across all regions and sectors, so that full compliance to consistent, comparable, TCFD-aligned reporting is no longer a matter of choice.
In June, a positive signal came when the G7 meeting concluded with a statement of support for mandatory climate-related financial disclosures based on the TCFD framework.
The TCFD recommendations are an important first step, but to fully support the shift of financial flows towards the goals of the Paris Agreement and the 2030 Agenda for Sustainable Development, high-quality environmental disclosure regulation should be implemented. This regulation should incorporate a wider spectrum of environmental issues alongside climate, include forward-looking metrics and science-based emissions reduction targets. Countries and regions including Switzerland and the EU are moving in this direction, as at COP26 we expect others to follow suit.
Taxonomies are one of the most effective tools in avoiding the risk of greenwashing financial products and will support investors and other capital market actors to compare investment opportunities
Policymakers and regulators must ensure that capital markets reflect the relevance of the risks posed by environmental degradation on both people and planet through the development of internationally-aligned sustainable finance taxonomies. Taxonomies are one of the most effective tools in avoiding the risk of greenwashing financial products and will support investors and other capital market actors to compare investment opportunities.
However, the rapid development of taxonomies globally presents a risk that may ultimately undermine their purpose if it continues to progress this way. There are currently several different taxonomies in development, some which risk being fundamentally incompatible. Regulators must work towards the alignment of existing and developing taxonomies, with some room for regional specificities. The recently launched Roadmap of the G20 Sustainable Finance Working Group suggests that jurisdictions should “consider developing sustainable finance taxonomies using the same language (e.g., international standard industry classification and other internationally recognized classification systems), voluntary use of reference or common taxonomies, and regional collaboration on taxonomies.”
Other actions are needed, too. More than half of banks, asset owners and asset managers assessed who disclosed to CDP in 2020 did not align their portfolios with a net zero world. Only 27% of insurers were aligning their underwriting portfolios. A majority of banks, asset owners, asset managers and insurance companies have not identified major risks in their financing portfolios, namely credit and market risks, which have a greater potential impact than those in their own operations.
More than 40% of financial institutions identify operational climate-related risks, compared with the 35% that identify credit risks and 26% that identify market risks. This is despite the fact that credit and market risks have a much higher reported potential financial impact of up to $1.05trn. Regulators and supervisors must facilitate the alignment of portfolios to a net-zero future by ensuring that these risks are efficiently reflected.
Economy-wide climate stress tests should be undertaken – something already happening across the EU, France, the UK, Australia, New Zealand, Canada, Brazil, Singapore and Hong Kong. Stress tests should focus on limiting global warming to 1.5°C through more stringent climate policies and innovation, in line with the warnings of the IPCC’s Sixth Assessment Report. They may start with climate, but it is critical that central banks seek to expand the focus of their activities to include a wider range of environmental issues such as deforestation, biodiversity and water security.
Governments should set internationally-aligned carbon prices. It is important that this discussion does not focus only on the price itself, but also on what percentage of the economy’s emissions are subject to an adequate level of carbon pricing.
Ultimately, COP26 must serve as a springboard for the transformation of the global economy. It will require a massive effort of international co-operation between governments, regulators and capital markets. If effectively mobilized, these resources can truly accelerate the transition to a net-zero, nature-positive economy.
Pietro Bertazzi is the Global Director of Policy Engagement & External Affairs at CDP, formerly the Carbon Disclosure Project
Laurent Babikian is CDP’s Joint Global Director of Capital Markets