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Insight 04.08.2022

Banking on the transition – no net zero without lenders’ support

Banking on the transition – no net zero without lenders’ support

Whether high-income banks in developed countries or microlenders in emerging markets, the banking sector and its alliances will be indispensable in decarbonising the economy and ensuring a fair transition to net zero emissions.

The role of banks in the economy and why they are critical to delivering net zero at global level.

2021, culminating in COP26, was a massive step forward for net zero adoption. However, evidence shows that it is far easier to set Nationally Determined Contributions (NDCs) than to deliver them at corporate level. The number of companies meeting “minimum standards” for net zero targets almost doubled but remains small at only 207. The Science Based Targets initiative has identified a pathway for corporates to adopt a realistic plan for achieving net zero, but it is early days and incentives are uneven. This is where banks hold the key. Banks’ role in the transition process is sometimes described as that of a policeman: they have relationships with every sector of the economy and this privileged position allows them to bring about change at scale.

For banks to take on this mantle in a credible way, they need to be capable of measuring their full carbon footprints and show where they are on the pathway to 1.5°C. With as much as 99% of the banking sector’s climate impact stemming from their Scope 3 portfolio emissions, they will need to create comprehensive strategies for targeting customer carbon footprints.

Emerging and developed markets: what does positive impact look like for banks?

It is unlikely that net zero can be delivered without proactive support from financial institutions. The exciting news is that we have been able to identify a handful of leading banks in high-income countries with clear and credible plans to reduce emissions in their loan books. These banks can deliver impact at scale by influencing their customers, which we regard as strong financial stewardship.

In brief, we have created a simple but demanding framework that leverages a range of sources including the Net Zero Banking Alliance and ShareAction. The two overriding requirements are:

  1. Commitment to reach net zero emissions (own and portfolio) by 2050 or before;
  2. Commitment to interim targets consistent with a 1.5°C path using robust, science-based guidelines.

ShareAction published Countdown to COP26 in September 2021, focusing on Europe’s 25 largest banks. The report highlighted just three banks that have so far committed to halving their financed emissions by 2030.

Our approach in emerging markets is slightly different as the banking sector’s role is primarily one of financial inclusion and economic development. Distinct from the largely higher-income banks focused on above, EM financial institutions can be impactful when they channel liquidity to SMEs and individuals in regions where access to finance is limited.

While our primary impact objective is financial inclusion, we also want to encourage the companies in which we invest to achieve this in an environmentally conscious way. One of our main challenges in assessing their emissions performance is that they do not disclose loan portfolio emissions, which means we have to rely on third-party data. Many data providers estimate emissions based on models built on corporate banking data, which may include funding for large energy projects including ones relying on fossil fuels.

In our view, these models could significantly overestimate the loan portfolio emissions of micro finance institutions. Their loan books primarily consist of small-ticket loans to microbusinesses in rural communities, which are likely to be associated with much lower emissions. Therefore, a significant part of our engagement with microfinance companies is about encouraging them to disclose lending emissions so that their climate impact is correctly accounted for. We see the resulting disclosures as positive steps towards our goal of seeing lending and portfolio emissions data that give us a better understanding regarding the environmental impact of the various lending institutions in our portfolio.

Can the broader financial services sector contribute?

Asset managers have an important role to play and there is evidence that the sector is taking its responsibilities seriously. The Net Zero Asset Managers initiative is the largest of the seven net-zero alliances by number of signatories, and UBP is one of them. There are a handful of asset managers that we identify as leaders in this area, such as Impax.

One industry that we regard as a laggard is insurance. Insurers tend to have influence in two ways: through their sizeable asset ownership (estimated at 26% of global financial assets) and also through their role as risk underwriters for the global economy. So far, examples of strong leadership at the underwriting level are thin on the ground. However, there are some good proponents of best practice in terms of asset ownership.

As we generally find across all of our themes, low- and high-income countries are often equally significant parts of the solution, even if their starting points look quite different.

Rupert Welchman Rupert Welchman
Co-Head of European Equity

Global equities

Invest in companies with superior and sustainable value creation.

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