Net zero commitments need to prioritise impact
Over the past couple of years, the growing net zero commitments across financial institutions strengthened the focus on their portfolios’ greenhouse gas emissions. Yet, this focus does not guarantee emissions are truly reduced in the real economy. For that to happen, there is a pressing need for decarbonisation approaches focused on impact generation, with the appropriate indicators. According to Sarah Bendahou, public development banks are in a unique position to adopt such approaches and indicators, paving the way for private financial institutions.
Net zero commitments overfocus on reducing financed emissions
The net zero concept was originally introduced in the Paris Agreement, representing “a shift in framing climate mitigation action away from prioritizing ‘relative’ changes in greenhouse gas emissions to focus on the rapid reduction of total or ‘absolute’ emission levels needed to achieve a ‘net zero’ balance”.
Since then, there has been an increasing number of net zero commitments in the past few years across the financial sector, within the private sector (e.g. the Glasgow Financial Alliance for Net Zero – GFANZ in 2021) and within public development banks (e.g. at the Finance in Common Summit in 2020). The early priority of the financial sector was “to decarbonise financial portfolios, in the hope that divestments will alter the cost of capital for greenhouse gas emitters and reduce real world emissions”, but it’s still not the case for the entire economy, as recently highlighted by Finance Watch.
Key stakeholders in the net zero commitment space (e.g. the Science-based Targets Initiative – SBTi, and the GFANZ among others) are now highlighting that the focus should be on contributing to real world emission reductions, i.e. financing emission reductions rather than simply reducing their financed emissions, a view shared by I4CE. What does that mean in practice? For example, investors may divest from fossil fuel assets by selling them off, to reduce their portfolio emissions, without taking any further action to support these assets’ transition towards net zero, and therefore without any assurance that their divestment will lead to greenhouse gas emission reductions. Another financial institution with less ambitious commitments then invests in these assets, which would continue to have the same level of emissions in the real economy, and this divestment, even if it significantly reduced portfolio emissions for the first financial institution, will have no positive impact at all on the economy’s transition.
Also, emissive yet transition-enabling activities aligned with national and sectoral decarbonisation pathways in the longer term may be needed, particularly in a developing country context. They may allow other activities to make a significant contribution to climate change mitigation and to a country’s development objectives. One example could be investments in Paris-aligned infrastructure development such as public transport infrastructure. And in this case, the related greenhouse gas footprinting will not reflect these investments’ contribution to the transition.
Impact generation must be measured as well
While portfolio emission pathways are not necessarily relevant, moving away from emission-based indicators needs to come with safeguards to ensure that the quest for impact does not come at the expense of effective climate action. Specific indicators are needed to understand if the new impact approaches being adopted are sufficiently ambitious to achieve climate goals, and to ensure their robustness and credibility.
Fossil fuel asset retirement is one example that may help generate that credibility if appropriate approaches are followed. Robust retirement approaches are still lacking and require meaningful indicators to ensure compatibility with mitigation goals. Such indicators may include capital committed toward managed phaseout schemes that accelerate the retirement of high-emitting assets, as suggested by GFANZ. But more work is needed to ensure that such indicators are accompanied by others that allow checking on the right level of ambition as well as overall consistency of the followed approach within the portfolio, thus ensuring that positive efforts in one asset class are not undermined through inconsistent action in other asset classes.
Public development banks need to lead the way on these approaches, especially considering their mandate for development, and the required additionality of their intervention (i.e., only funding projects that are either too risky or not profitable enough to attract private finance). Although, like other financial institutions, public development banks may differ in their stakeholders, portfolio and client characteristics, and operating environments and geographic constraints, they share the same overarching goal of contributing to development and generating transformational impact, through financial and non-financial support. This means they should lead the way in their engagements to have impact on real economy. Their approaches can in fact be relevant for any other financial institution seeking to ensure its net zero commitments are ambitious enough and translate into tangible impact for economy transition.