Earlier this fall, from October 31st to November 12th, leaders representing the world’s major countries met in Glasgow, Scotland to discuss renewed and enhanced commitments to mitigate climate change. The organizations, commitments, and frameworks that emerged from COP26 represent significant progress in tackling climate change across a number of sectors, including significant efforts in the financial sector. A number of the world’s largest financial institutions made sweeping commitments in funding more sustainable causes in the coming years through a number of initiatives and groups. While these commitments represent a major step forward in financing the race to net-zero emissions and mitigating climate change, the extent to which these commitments will be implemented, as well as how effective they will be in mitigating climate change, is unclear. Ultimately, stronger compliance mechanisms and regulatory frameworks are required in order to ensure that these financial institutions deliver on their commitments, and equity must be central to these deliveries.
The commitments made by the Glasgow Financial Alliance for Net Zero (GFANZ) were perhaps the most significant of the pledges made to finance a more sustainable future at the conference. The coalition, which was launched in April 2021, is made up of 450 of the world’s biggest financial institutions that are committed to aligning their portfolios with the goals set forth by the Paris Agreement. At COP26, it committed over $130 trillion to decarbonize the world’s economy and accelerate the transition to net-zero emissions. These efforts parallel the explosive growth in environmental, social, and governance (ESG) investing and capital allocated to impact funds as investors have become increasingly concerned with driving positive change alongside financial returns.
The alliance is made up of many of the largest asset managers, banks, insurers, and other institutions across the financial ecosystem, including financial giants like BlackRock, HSBC Holdings, Morgan Stanley, and Deutsche Bank. The commitments made by these institutions represent the amount of capital needed to abate 1.5 ºC of warming (above pre-industrial levels), as outlined by the Paris Agreement, and to achieve net-zero greenhouse gas emissions by 2050 at the latest. This commitment refers to the funds that these firms already have invested (rather than new investments), so in order to achieve this goal, firms will have to divest from unsustainable companies and reinvest in more sustainable companies, or push issuers they are already invested in to reduce their emissions. It will also reform the lending practices of financial actors, who are likely to provide loans to more sustainable entities.
In order to achieve these targets, GFANZ requires its members to report the emissions they finance every year and undergo a review every five years to measure progress relative to these targets, using transparent reporting and accounting in line with the UN Race to Zero criteria. Additionally, GFANZ has pledged to create a new body to set standards for the climate-related goals and disclosures of investors and companies. More specifically, institutions join the alliance by signing onto one of the financial sub-sector net-zero initiatives, including the Net-Zero Banking Alliance, the Net Zero Asset Managers initiative, or the Net-Zero Insurance Alliance, amongst others, each of which has its own reporting requirements. For instance, the Net-Zero Banking Alliance requires members to commit to aligning their lending and investment portfolios with net-zero goals by 2050, and set targets for 2030, and publish their emissions on an annual basis.
While these commitments present major signals for the financial services industry and the broader market of where the industry is headed and the seriousness of which climate change is being considered, their success is predicated on the ability of the stakeholders to be able to transform these commitments into actions. The commitments are entirely voluntary and lack a formal compliance mechanism, which raises concerns about a lack of delivery on the goals similar to the aftermath of the Paris Agreement, of which hardly any countries are on track to meet their emissions reductions targets. Further, the commitments do not mandate a halt on new investments in fossil fuels, a necessary requisite for meeting 1.5 ºC targets as outlined by the International Energy Agency.
Ultimately, the gaps in the GFANZ commitments point to the weakness in regulation from federal governments and international institutions which can ensure that these commitments are delivered in an effective and timely manner. The ability of financial actors to publish their emissions is predicated on the transparency of companies in disclosing their emissions performance, which virtually no companies are currently required to do under federal or international law. The United Kingdom was the first country to move the needle forward on companies’ reporting, announcing at COP26 that most big firms will be required to publish detailed plans on how they aim to achieve net-zero emissions by 2050. While these efforts may serve as a signaling agent and other countries may follow suit, governments worldwide are currently lagging in creating mandatory disclosure requirements for companies.
Beyond mandating emissions reporting, international bodies must create a standard for these disclosures in order for financial institutions to be able to accurately report their emissions. Currently, sustainability reporting is haphazard and disjointed across a number of frameworks, which makes gauging and comparing companies on their climate performance an impossible task. The new International Sustainability Standards Board (ISSB), which was unveiled at COP26, seeks to provide climate disclosures that will be used on a global scale. This follows efforts in Europe, in which the Sustainable Finance Disclosures Regulation (SFDR) and the EU Taxonomy have created standardized, legally binding frameworks that companies and investors have to use to report their emissions. The United States is following suit as well – the Securities and Exchange Commission (SEC) is currently developing climate-related disclosures.
The commitments made by GFANZ at COP26 represent a momentous shift towards decarbonization and the willingness of financial institutions to step up to the plate and take responsibility for mitigating climate change. Beyond these aspirational commitments, coordinated and robust regulatory frameworks are needed in order to enable financial institutions to follow through with their promises in an effective way. This will require governments, financial institutions, and companies to work together to establish systems and frameworks for companies to report consistent, comparable, and reliable information on their emissions and other sustainability metrics. This information is critical for financial institutions to be able to accurately gauge company performance, which is crucial in achieving their net-zero aims and abating 1.5 ºC of warming.