Consultation on portfolio alignment with Paris goals may be distraction from short-term actions to accelerate transition.
New guidance on portfolio alignment metrics by the Glasgow Financial Alliance for Net Zero (GFANZ) has received a mixed response with some seeing it as a foundation for further efforts, while others have warned it may serve to dilute institutions’ focus on heavy emitters.
Open for consultation until 12 September, the report outlines the metrics used by GFANZ members to assess portfolio companies on net zero alignment and seeks feedback on recommendations for closing gaps in current efforts. The final report will be published ahead of COP27 later this year.
But the initiative could distract from more effective approaches to decarbonise lending and investment portfolios, according to Paddy McCully, Senior Analyst on the energy transition at NGO Reclaim Finance.
“I don’t think this guidance will help GFANZ members’ decarbonisation efforts,” McCully told ESG Investor.
“The complexity and non-transparency of the approach, combined with numerous methodological and operational problems – many of which are described in the paper – will only distract from effective approaches to decarbonisation. Effective approaches would ensure GFANZ members urgently adopt policies which reduce their financial support for major fossil fuels suppliers and consumers and ensure 1.5°C-aligned year-over-year reductions in their financed/insured/facilitated emissions.”
GFANZ’s proposed framework consists of three “conceptual steps”: translating net zero-aligned and scenario-based carbon budgets into benchmarks, assessing company-level alignment against such benchmarks based on cumulative emissions, and aggregating company-level alignment at the portfolio level. Each step is underpinned by nine key design judgements, including the selection of benchmark scenarios and how to express alignment as a metric.
McCully argued for a more targeted approach, calling for GFANZ members to focus on assessing the transition efforts of the 166 companies identified by Climate Action 100+ as being responsible for around 80% of all industrial emissions, rather than “becoming distracted tracking the supposed plans of the thousands of companies across their portfolios”.
“Financial institutions need to focus on meaningfully engaging with these companies and withdrawing financial services from them if they do not transition at the rate needed,” he said.
Foundation for convergence
The report is “a bit dubious” around its support for assessments accounting for investee companies’ Scope 3 emissions, however, according to Amy Owens, a Research Associate on finance and net zero energy transition at think tank Carbon Tracker.
Acknowledging the challenges around incorporating Scope 3 emissions into portfolio analysis, due to current reporting gaps from corporates, GFANZ says members should include these supply chain emissions wherever possible.
Daan Van Acker, Programme Manager at think tank InfluenceMap, said GFANZ’s guidance “has the potential to form the foundation for further work in encouraging financial institutions to converge on robust and ambitious portfolio alignment metrics”.
Ed Matthew, Campaigns Director at independent climate think tank E3G, further called for GFANZ to include “strong requirements to immediately end investment in coal and phase out investments in other fossil fuels”.
In response to updated Race to Zero criteria, GFANZ issued a statement asserting “there is no rationale for financing new coal projects” and acknowledging scientific consensus that new coal capacity (both extraction and power generation) is inconsistent with achieving net zero, signed by Co-chairs Mark Carney and Michael Bloomberg and Vice-chair Mary Shapiro.
In the new consultation document, GFANZ, an initiative with over 450 major financial institution members managing more than US$130 trillion in assets, investigated the portfolio alignment metrics most commonly used by financial institutions.
The four main categories are binary metrics, maturity scale alignment metrics, benchmark divergence metrics, and implied temperature rise (ITR) metrics.
While the binary approach measures alignment by calculating the percentage of portfolio companies with net zero decarbonisation targets, the maturity scale approach categorises firms based on whether they are ‘aligned’, ‘aligning’, ‘committed to aligning’ or ‘not aligned’ to a net zero pathway. Benchmark divergence metrics calculate a cumulative “over or undershoot” compared to a net zero-aligned benchmark, whereas ITR metrics calculate whether the portfolio is over or undershooting a science-based target, such as 1.5°C of global warming by 2050.
The “accurate representation of climate solutions, the suitability for use in broader asset classes such as private equity, and phase-out of high emitting assets” are not yet appropriately addressed in any of the outlined portfolio alignment measurement tools, it acknowledged.
Until short term assessment challenges are addressed, the binary or maturity scale metrics – or a combination of all four – may be preferable to some financial institutions, the report recommended.
“Some of the explanations of the drawbacks of the various portfolio alignment metrics are useful and may perhaps help to persuade financial institutions and others of the ineffectiveness of these approaches,” said McCully at Reclaim Finance.
Banking on change
Separately, the Institutional Investors Group on Climate Change (IIGCC) and Transition Pathway Initiative (TPI) are developing a net zero assessment framework to help investors assess the transition progress of banks.
The pilot indicators, which will be refined before the publication of the final framework later this year, cover six areas: net zero commitments, short- and medium-term targets, decarbonisation strategies, climate governance, climate policy engagement, and audit and accounts.
Dr Rory Sullivan, CEO of specialist advisory firm Chronos Sustainability, told ESG Investor that the IIGCC/TPI framework is “critically important”.
He said: “It addresses one of the fact that banks have sought to define their own performance benchmarks for the industry sectors that they invest in. Inevitably, this has led to the cherry picking of models and data. Hopefully, this will address the issue of ‘benchmark shopping’ and create pressure for all banks to set and deliver meaningful, credible 1.5°C-aligned strategies.”
Chronos Sustainability is the chief technical adviser to the TPI.
Using the framework to assess 27 banks on their current transition progress, IIGCC and TPI said the banking sector currently performs well on governance and management of climate-related risks, as they aligned with 44% of the sub-indicators in this area.
Banks also scored positively for 20% of sub-indicators on their decarbonisation strategies and net zero commitments. However, assessed banks fall short when it comes to climate policy engagement, aligning with just 1% of the indicators in this area, the report noted.
“The findings amplify our concerns that momentum in the financial sector for setting long-term net zero commitments has yet to be reflected in short and medium-term target setting and the climate policy engagement activities of the world’s largest financial institutions,” said Eden Coates, Programme Manager at InfluenceMap.
To date, investors have paid less attention to banks’ transition efforts due to lack of transparency, conflicts of interest and a lack of consensus around the specific responsibilities of banks in relation to the low-carbon transition, Sullivan added.
UK NGO ShareAction previously calculated that in-scope European Net Zero Banking Alliance members – who are part of GFANZ – have provided at least US$38 billion in financing to the top 50 upstream oil and gas expanders since the launch of the alliance in April 2021.
However, this US AGM season, investors filed a number of resolutions asking major banks – including JP Morgan, Bank of America and Citi – to scale back the financing of fossil fuel projects.
Heather McKay, Policy Advisor for the sustainable finance team at E3G, said: “The call by both IIGCC / TPI and GFANZ for greater alignment and interoperability of metrics and methodologies is critical to support the net zero transition, as investors need further clarity on the sustainability of their investment products and credible transition plans.”