What we need from Financial institutions after COP26: from ‘pretty words’ to ‘systemic change’

COP26 in Glasgow did not disappoint in terms of the volume of announcements from the financial sector. But what is behind the hype? While buried in an avalanche of ‘pretty words’, there was notable progress by financial institutions. They now look at the ‘alignment’ not just of what – but also of who – is financed. However, as has been proven time and again, the devil will be in the details as each financial institutions translate what has been announced into practice. Alice Pauthier and Ian Cochran interpret what we have seen over the two weeks of COP26 in Glasgow.

An avalanche of “pretty words” on the role of the financial sector at COP26

The financial sector has been increasingly present at COPs since Paris in 2015 – and was particularly present at COP26. On the private finance side, the Climate Finance Champion Mark Carney made multiple announcements demonstrating that beyond the management of climate-related financial risks and opportunities, Paris alignment strategies are becoming mainstream across the financial sector – with a growing focus on real economy impact. This culminated in a pledge of the “alignment of $130 trillion of private finance to science-based net zero targets and near-term milestones” by the Glasgow Financial Alliance for Net-Zero (GFANZ).

On the public finance side, the multilateral development banks both reiterated their collective ambition to support the low-greenhouse gas climate-resilient transition and shared an update on their progress to developing and implementing a framework to align their strategies, investment policies, activities and operating procedures with the Paris Agreement. Additionally, the International Development Finance Club (IDFC) launched an operationalization framework for Paris Alignment (developed by NewClimate Institute and I4CE). Finally, the broader development finance community was present via the Finance in Common, which reiterated how they are moving forward on their 2020 joint commitment to Paris Alignment.

Notably this year, the importance of the alignment of counterparties and clients has come to the forefront for both direct finance – or intermediated finance. Financial institutions appear to increasingly recognise that they cannot only focus on what is being financed – ie whether the project or activity is aligned with climate goals. Rather, it is essential to also look at the overall strategy of who is being financed and whether they are aligned – or have a credible commitment to alignment with the Paris Agreement. Discussions on this “alignment” of the entire ‘financial chain’ have grown over the course of 2021, reflected for example in the informal Financial Institution group convened by UNEP FI and Mainstreaming Climate in Financial Institutions with the support of Finance in Common. For all financial institutions, the COP confirmed that what matters is not whether their portfolios are net-zero at an aggregate level, but rather that they support net zero-aligned projects, companies and clients.

Shared commitments are important, but the devil (and impact) is in the implementation by each Financial institution

The scope, depth and resulting operational implications of the announcements made around COP26 will take time to fully come to light. Nevertheless, a number of notable examples of progress were made on technical issues from across the financial sector:

• Setting coherent long-term “alignment” goals consistent with 1.5°C warming, medium term milestones, and  short term action plans based on retroplanning: There are indications that this may become expected common practice over time as the GFANZ included in its guidelines: “Pledge at the head-of-organization level to reach net-zero GHGs as soon as possible, and by mid-century at the latest, in line with global efforts to limit warming to 1.5 degrees C; set an interim target to achieve in the next decade, which reflects maximum effort toward or beyond a fair share of the 50% global reduction in CO₂; and within 12 months of joining, explain what actions will be taken toward achieving both interim and longer-term pledges, especially in the short to medium term.”

• Requiring counterparts to develop transition plans themselves as a condition for investment/financing: Both the multilateral development banks and the International Development Finance Club have recognized this as a key issue in their alignment frameworks published prior to the COP and in their updates shared in Glasgow. Individual institutions are also already moving forward, notably the European Investment Bank who announced their PATH framework during the first week of COP in Glasgow. This idea of the importance of focusing on and supporting on the transition engaged by clients and counterparties is also of key importance for the private finance sector – with the announcement of UK Chancellor Rishi Sunk that UK firms and financial institutions will be required to publish net-zero transition plans. The GFANZ has launched two working groups on real economy transition plans and financial institutions transition plans.

• Clear guidance to limit the use of offsetting and the reliance on emission removal: This will be a key area of focus on the methodologies to be adopted for measuring alignment across the financial sector. Prior to COP26, some financial regulators had already begun to look at the role of offsetting in achieving carbon neutrality. GFANZ guidelines published in Glasgow recognized that offsetting can only be a short-term part of the net-zero process and that “offsets portfolios should transition to permanent removals by the time net zero is achieved; ensure that all offsets meet robust standards for additionality, permanence, accounting, etc.”

• Guidance and principles on how financial and commercial actors are moving forward voluntarily to mainstreaming climate into governance structures were taking much more concrete forms. In addition to the guidelines already mentioned, initiatives such as Mainstreaming Climate in Financial Institutions began to lay out more concretely the tasks and actions that professionals within financial institutions need to carry out to ensure that mainstream climate change within their organization. Their Climate Mainstreaming Resource Navigator aims to connect financial institutions with the resources and examples of how to move forward building on good and emerging practice.

A clear call for action moving forward: systemic institutional transformation rather than incremental change

The announcements seen at COP26 from the financial sector – whether public or private – are promising. However, ‘pretty words’ will not lead to the systemic change needed. Demonstrators from all backgrounds across Glasgow and around the world took up Greta Thunberg now iconic phrase: “blah, blah, blah” to encapsulate the frustration that too little is being done in practice too late. Many are already asking for details on each individual institutions will move forward – and demanding transparency on objectives and strategies as well as on progress to date. For example, UN Secretary General Gutierrez raised the key issue during the opening session of the COP asking what does net-zero means in practice, and that calling for transparency and reporting on progress that will be key for credibility.

As the climate and financial community moves on from Glasgow and begins to make their way to COP27 in Egypt, progress must occur to put these “pretty words” into practice. The challenge is to increase the pace of action dramatically and leapfrog past the incremental changes we have seen so far to rapidly roll out the systemic changes that must occur in terms of how the financial sector will “grease the wheels” of the far-reaching economic transformation needed before the end of the decade. Further transparency –at the level of each financial institution or development bank – is seen an essential by the expert community as the frameworks and principles that have been announced leave much room for interpretation and radically different timelines across institutions.

Increasingly, there is an expectation that beyond voluntary action financial regulation must be leveraged to require the changes in institutional governance that must be seen. As noted by European Central Bank Executive Board Member Frank Elderson, the European Union must introduce “a legally binding requirement for banks to have such Paris-compatible transition plans as a capstone to the legislative and private sector initiatives already being put in place.”

As on the one hand, civil society will keep high pressure on financial institutions to deliver and on the other hand, regulators are increasing likely to put in place a stricter supervisory framework, financial institutions may see themselves forced to act, no matter if they have participated in pledges or taken commitments. Many financial institutions have already begun the integration of climate change in a transformative fashion across their institutions. Now, it is essential that the financial sector as a whole quickly builds on the foundations announced at COP26 to rapidly achieve at scale the systematic integration of climate considerations throughout their strategies and operations.

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 Through the Network for Greening the Financial System (NGFS) 38 central banks have committed to climate-related stress tests and 33 central banks and supervisors have committed to issuing guidance to firms on managing climate-related financial risks. The Taskforce on Climate-related Financial Disclosures (TCFD) published new guidance on metrics, targets and transition plans. The IFRS Foundation announced the establishment of a new International Sustainability Standards Board to develop globally consistent climate and broader sustainability disclosure standards for the financial markets.