Cop26 Perspectives

Reinventing Finance

Institutions have responded to COP26’s pledge to ‘mobilise finance’ with plans that will transform priorities and processes.

COP26 is not a finance sector event. In fact, there is only one dedicated ‘Finance Day’ across its two-week span.

The main purpose of COP26 – collective governmental agreements to significantly step-up efforts to mitigate and adapt to climate risks – will frame business and investment priorities for the rest of the decade. The decisions of the policymakers will play a leading role in the future direction and shape (and, in some cases, existence) of many industries. They will also touch countless lives, jobs, homes and lifestyles.

This is enough to ensure that the attention of the finance sector will be firmly locked on Glasgow in the first half of November. But there will be much more for institutional investors to chew on, thanks to one of the four pillars of COP26, ‘Mobilising Finance’.

More than any other, Glasgow’s COP will see a plethora of initiatives designed to remake the finance sector to better address climate risks and opportunities. Policymakers will be making decisions with profound implications for the finance sector, but the finance sector will come forward with its own proposals too.

Many will be of critical importance to the decision-making processes of the sustainable investment teams of asset owners around the world. In this article, we flag some of the most significant.

Global sustainability standards

Asset owners have long felt thwarted in their efforts to allocate capital to climate-positive and other sustainable investments by difficulties in obtaining accurate and comparable data, particularly from investee firms. In response, trustees of the IFRS Foundation, effectively the global standards-setter for financial reporting, are aiming to establish a new International Sustainability Standards Board (ISSB) in time for COP26.

The intention is for the ISSB to play the same role for sustainability standards as the International Accounting Standards Board (IASB) currently plays for the standards that frame ‘traditional’ financial reporting, meaning it will develop and oversee use of common sustainability standards across almost all major jurisdictions.

Existing voluntary sustainability standards bodies have already drafted a prototype standard for reporting on climate risks, leveraging their existing expertise and the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).

The IFRS has proposed the amendments to its constitution needed to create the ISSB and set IFRS sustainability standards; it has also opened up applications to head the new board. Subject to ongoing feedback, the ISSB and its first standard should be officially unveiled ahead of Glasgow, but much still needs to be done in the aftermath.

Once approved by IFRS Foundation’s Technical Readiness Working Group, the new standard must be assessed and approved by the International Organisation of Securities Commissions (IOSCO) before an exposure draft is sent out for a three-month consultation in Q1 2022. A recent IOSCO timeline suggested approval steps for official endorsement and adoption by its members in 130+ jurisdictions by June 2022 or soon after.

The Sustainable Stock Exchanges initiative, which represents more than 100 bourses, is also expected to outline its plans for the adoption of climate and sustainability reporting in Glasgow.

Clouds on the horizon

This activity could end the daily struggle of investors to compare the sustainability reporting of listed firms, which currently use one, some or none of the existing sustainability standards frameworks. The combined authority of the IFRS Foundation and IOSCO means that regulators globally will ensure that the vast majority of listed firms will report on their sustainability performance using the same framework.

Even so, there is still plenty of scope for difficulty for investors. One reason is that the US follows its own accounting rules and is still catching up with the rest of the world in terms of determining its approach. The US Securities and Exchange Commission’s consultation on mandatory climate-related reporting will yield proposals soon, but Republican commissioners oppose both these and the IFRS Foundation’s plans.

Another is the IFRS Foundation’s decision to eschew double materiality in favour of enterprise value, despite the fact that the European Commission and the UK have committed to reporting that covers both the impact of environmental and social factors on companies, as well as their impact on the environment and society.

Despite public commitments to cooperation and collaboration by the Commission, IOSCO and others, it’s not clear yet how interoperability between the two approaches will work in practice. Global leaders have backed TCFD and the IFRS Foundation in recent summits, but have also underlined the importance of double materiality in climate reporting, a stance which also informs UK’s planned Sustainable Disclosure Requirements regime, further details of which may also be released at or before COP26.

The ISSB does at least have one of the leading authorities on sustainability reporting on its side in Professor Robert Eccles, Visiting Professor of Management Practice at Saïd Business School, University of Oxford. “What matters to investors changes over time. As environmental and social issues become material to investors, the ISSB will deal with them.”

Carney’s cadre

At the broad industry level, efforts to secure commitments from financial institutions to achieve net zero emissions by 2050 are being coordinated by the Glasgow Financial Alliance for Net Zero (GFANZ). Launched in April, GFANZ aims to coordinate existing net zero finance sector initiatives and secure ambitious commitments from individual institutions. It was established and is led by UN Special Envoy on Climate Action and Finance Mark Carney and the COP26 Private Finance Hub, in partnership with the United Nations Framework Convention on Climate Change’s Climate Action Champions, the Race to Zero campaign and the COP26 Presidency.

GFANZ’s 160 members are responsible for US$70 trillion in assets. This includes members of the Net-Zero Banking Alliance, with more than 50 members (US$37 trillion AUM) required to set 2030 and 2050 reductions targets within 18 months of joining, which are “reviewed to ensure consistency with the latest science”. Overall, GFANZ should result in the widespread adoption of credible, ambitious and practical net-zero strategies which support companies and countries in aligning with the goals of the Paris Agreement.

Although it is intended to guide finance sector efforts well into the future, GFANZ has four pre-COP26 objectives. First, it will broaden finance sector participation in the UN Race to Zero, by ensuring “credible sub-sector net zero vehicles” for banks, insurers, asset owners and managers. Second, it will actively engage with the finance sector to “deepen the pool” of institutions committing to net zero and developing transition plans. Third, it will establish forums and facilitate coordination across the sector to provide access to the expertise and tools needed to help member institutions develop their plans and strategies. Finally, GFANZ intends to unveil at Glasgow the individual and collective progress of member institutions in developing ambitions net-zero strategies.

Will these announcements be another case of finance sector greenwash? There are many examples of firms across the industry dragging their heels on exiting carbon-negative business, imposing relatively few restrictions on financing and investing in fossil fuel industries. But the targets and plans of all GFANZ member initiatives are scrutinised by Race to Zero, which recently ratcheted up its expectations, increasing the rigour and credibility of firms’ net-zero targets.

Building momentum

The net-zero plans and performance of banks may well attract a lot of attention in Glasgow, but other financial institutions will be building on existing commitments. Established late last year, the Net Zero Asset Managers initiative has grown rapidly, announcing 41 new signatories in July. It has added AUM but also detail, in terms of the short-term targets that member firms are expected to set. Ahead of COP26, the initiative is expected to publish its first annual report, outlining managers’ initial emissions reduction targets and coal phase-out positions.

Members of the UN-convened Net Zero Asset Owners Alliance set out their near-term ambitions at the beginning of the year, with five-year commitments to be achieved in accordance with its 2025 Target-Setting Protocol. Initially designed to reduce carbon emissions across listed equity, fixed income and real estate portfolios, the alliance is due to set out its plans for expanding the protocol across more asset classes before or at COP26, also publishing its annual progress report.

With US$6.6 trillion AUM collectively, the alliance’s members are in the vanguard of decarbonisation, blazing a trail for others to follow. The protocol sets expectations and guidelines on how to reduce portfolio emissions, but leaves the detail to individual members, based on their precise exposures, and analysis of the transition pathways of companies and industries. These may be supported by the release of the Inevitable Policy Response’s 1.5C forecast, which aims to help asset owners to assess transition risk and guide asset allocation.

Mapping the path to 2050

Corporates will also be offered new guidance on eliminating climate risks and Scope 3 emissions in the run-up to COP26. The Science Based Targets initiative (SBTi) is due to officially launch its Net Zero Standard ahead of the Glasgow summit, designed specifically to steer companies through their entire journey to net zero, having previously focused on setting near-term targets for reducing emissions in line with two and now exclusively 1.5 degree Celsius climate change scenarios.

Recently roadtested by pilot corporates following a consultation earlier this year, it is expected to be of particular value to firms in capital-intensive sectors with long-life assets and 30-year investment horizons.

The new standard is “very similar” to and integrated with existing SBTi target setting and monitoring processes, but it will take an uncompromising stance on how firms achieve their reductions. Targets must be used to take carbon out of existing processes, not relying unduly on offset schemes or removals solutions.

“There’s no substitute for reducing emissions, neither negative emission technologies, nor nature-based solutions,” according to Alberto Carrillo Pineda, Managing Director at SBTi, which recently declared that 1.5°C-aligned targets would now be a minimum for participant companies, as part of a new strategy.


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