SUSTAINABLE FINANCE, MACRO AND MARKETS
How banks contribute to COP26
28 October 2021
Climate protection is gaining importance around the world. However, more speed is needed to limit global warming to 1.5°C. flow’s Desirée Buchholz reports on what to expect from the upcoming UN climate conference in Glasgow – and how the financial sector sees its role
Scotland’s Glasgow has undergone several transformations over the last decades. Between 1850 and 1930, it flourished due to the abundance of coal and iron. The port attracted traders and shipyards; and the city became one of the wealthiest urban centres of the world. However, the 1960s saw the start of a decline: Steel mills, heavy industry and coal mines were closed, mass unemployment fueled a rise in crime. When Glasgow embraced the service sector in the 1990s, there was a welcome improvement. And now, the city is preparing for the next transformation: Carbon neutrality by 2030, in accordance with the promise made by the city council in 2019.1
This week, the world has the opportunity to see how much progress the city has made over the past two years. Glasgow is hosting the 26th UN conference on climate change, dubbed COP26. From 31 October to 12 November, policymakers, business leaders and scientists from all over the world will come to Scotland to discuss how the goals of the Paris Agreement can be achieved. In 2015, at the UN climate conference in Paris, 190 parties agreed to limit global warming “to well below 2, preferably to 1.5°C, compared to pre-industrial levels”.2
It is time to act
Time is running out: In August 2021, the Intergovernmental Panel on Climate Change (IPCC) – a UN body of international scientists – published a report calculating that for a 67% chance of limiting warming to 1.5°C, the world has a remaining carbon budget of only 400 billion tons of carbon dioxide. This translates into 10 years of emissions at 2020 levels.3
This week, the UN environment programme warned that greenhouse gas emissions need to be halved over the next eight years to stand a chance of limiting global warming to 1.5°C.4 No matter which data you take, the message is clear: If progress on reducing emissions is not made faster, the gap in meeting the Paris goal will grow larger (see Figure 1).
Figure 1: Scientists calculated the gap of CO2 reduction based on national action plans to cut emissions
Source: Climate Action Tracker: https://climateactiontracker.org/publications/global-update-september-2021/
Reacting to the IPCC report, UN Secretary-General António Guterres spoke about a “code red for humanity”.5 He warned: “If we combine forces now, we can avert climate catastrophe. But […] there is no time for delay and no room for excuses. I count on government leaders and all stakeholders to ensure COP26 is a success.”
Net zero alliance is growing
The good news is that the global coalition of countries fighting climate change is growing. In more and more countries around the world, it is becoming common sense that global warming needs to be stopped. According to the United Nations (UN), more than 130 countries have now set targets on reducing emissions to net zero or are at least considering doing so.6
At the same time, the goals are getting more ambitious: The EU now plans to cut greenhouse gas emissions by at least 55% by 2030 – a substantial increase compared to the previous goal of at least 40%7. The UK has even committed to slash emissions by 78% by 2035 compared to 1990 levels. According to the British government, this would bring the UK more than three-quarters of the way to net zero by 2050.8
However, this not enough, especially since the two largest greenhouse gas emitters are sending discouraging signals prior to COP26: While China has ramped up coal production to fight energy shortage, the US Congress is blocking President Biden’s plans to pass a law forcing the country to halve its emissions by 2030 from 2005 levels.9
Financial sector calls for policymakers
In the light of these developments, the financial sector is urging G20 countries to take more action on fighting climate change. At the beginning of October, the Glasgow Financial Alliance for Net Zero (GFANZ) has published in which it calls policymakers to
- establish practical steps to cut emissions;
- clarify the roles expected to be played by different agents; and
- ensure a regulatory framework that supports and incentivises green investment.
GFANZ represents more than 295 firms from across the financial sector in 40 countries, collectively responsible for more than US$90trn in assets. Deutsche Bank was one of the founding members when the group was launched in April 2021.10
“We can only be successful in transforming to a net-zero economy, if all the stakeholders – regulators and policymakers, businesses, banks and the capital market – are working together,” says Lavinia Bauerochse, Global Head of ESG Corporate Bank at Deutsche Bank. “The financial sector will play a key role when it comes to accelerating this transition. By providing the required financing, banks and capital markets are enabling companies to invest in transforming their business models.”
“By providing the required financing, banks and capital markets are enabling companies to invest in transforming their business models”
Including ESG into finance
Furthermore, banks can support the transformation of the economy by developing products that are linked to the sustainability performance of their clients. Over the past couple of years, several companies, such as Danone, Ford or Bayer have included ESG targets into their credit line documentation. While the details vary, the general mechanism is very similar: if the companies fail to adhere to the targets, the cost of the loan increases and vice versa.
“The pricing mechanism is not an end in itself. Companies are using these tools to emphasise their commitment and increase transparency to their stakeholders,” Bauerochse explains. “It is key to make sure that targets are ambitious but within reach at the same time”, Bauerochse argues. “We need to see a credible transition journey.”
By 2022, Deutsche Bank Corporate Bank wants to increase the cumulative ESG financing volume to €22bn.11 Last year, the bank for example developed an ESG-aligned FX hedging program for the steel engineering firm Primetals Technologies, as flow reported in the June 2021 article ‘On the right track’. Any currency hedges executed by Primetals must now comply with the criteria of the Sustainable Finance Framework that Deutsche Bank published in July 2020.12
“In theory, it is possible to link almost every bank product to sustainability KPIs,” says Bauerochse. “Every company is different and therefore each transition path looks different.” While defining an ESG strategy will always be an individual task for companies, standards and uniform definitions are required, Bauerochse thinks: “This is why the EU taxonomy is so important.”
As a reminder, the taxonomy is a classification system establishing a list of environmentally sustainable economic activities. It is supposed to “protect private investors from greenwashing, help companies to become more climate-friendly, mitigate market fragmentation and help shift investments where they are most needed”, the European Commission states on its website.13
So far, final definitions have only been published for a subset of goals. The definition on “Pollution prevention and control” for example are only available as draft versions so far. Still, several companies and banks have started referencing on the taxonomy when establishing sustainable finance frameworks. This is due to the fact that – from 2022 onwards –, European corporates with more than 500 employees will also need to disclose their turnover and capex that is aligned with the EU Taxonomy (i.e. sustainable). European investment funds will need to disclose what percentage of assets held are aligned by 31 December 2022.
Companies are at different stages of their transition journey, according to Bauerochse, and understanding financing options is a key priority. “Sustainable finance follows a thorough analysis and definition of a sustainability strategy,” explains Bauerochse. According to her, companies should consider five building blocks:
- Conducting a stakeholder analysis: What has the company done so far to drive sustainability? What are key priorities for stakeholders and how material are they? What are the ESG related risks and business opportunities?
- Defining a comprehensive ESG strategy: What are the sustainability business priorities? What is the impact of external changes on the company and how does the business activity effect environment and society? Which ambition level do you target?
- Setting targets and performance management: How can the transition path be effectively measured? How do you track and report progress?
- Showing commitments and ensuring a transparent disclosure
- Deciding on financing options: What are required capital expenditure needs? What instruments are most suitable?
”Social aspects – the “S” dimension – are also gaining importance”
“Currently, the focus lies on environmental issues – the “E” dimension – when we talk about sustainability. However, social aspects – the “S” dimension – are also gaining importance.” In July 2021, the EU’s Platform on Sustainable Finance called for feedback on a first draft report of a social taxonomy. It suggests a broad approach including economic activities such as housing, healthcare, education and infrastructure.14
All of these developments indicate that the transformation towards a sustainable economy has just begun. In Glasgow, the world comes together to take ambitions to the next level. Policymakers, banks and companies can prove how serious they are about delivering on what they have promised.
1 See https://bit.ly/30St2L9 at glasgow.gov.uk
2 See https://bit.ly/2Zkyypj at unfccc.int
3 See Climate Transparency Report 2021
4 See https://bit.ly/3nDR58u at unep.org
5 See https://bit.ly/3Ci0Hff at unric.org
6 See https://bit.ly/3E1Wvka at un.org
7 See https://bit.ly/3C5lSAO at ec.europa.eu
8 See https://bit.ly/3m3lDAK at gov.uk
9 See https://cnn.it/3vwlVDe at cnn.com
10 See https://bit.ly/3pAh5UA at gfanzero.com
11 See https://bit.ly/3jAs0d3 at cdn.net
12 See https://bit.ly/3buFa7j at db.com
13 See https://bit.ly/3b8WFtw at europa.eu
14 See https://bit.ly/3jF6Iv9 at europa.eu
Global Head of ESG Corporate Bank at Deutsche Bank
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