How to align finance to the net zero economy
The United Nations Environment Programme Finance Initiative (UNEP FI) launched this week the first of two papers in a provocative series aiming to inspire financial actors worldwide to challenge their response to climate change.
In partnership with Climate-KIC, a climate innovation initiative, the series, “Aligning finance for the net-zero economy”, aims to show that a proactive response requires moving beyond a risk management perspective towards closer alignment with the goals of the Paris Agreement, challenging current assumptions and developing sometimes “uncomfortable” ideas.
Why is it important? Financing the transition to a greener economy is an essential condition to reach the Paris Agreement goals. With calls by the Intergovernmental Panel for Climate Change (IPCC) for urgent action in the coming decade to prevent climate change catastrophe, a paradigm shift is needed. The Paris Agreement does not just commit countries to cutting their emissions but also to “making their finance flows” consistent with climate action goals, as set out in Article 2.1c. Stakeholders in financial markets, therefore, have an important role to play in mobilizing investment needed to tackle climate change. Dr Kirsten Dunlop, CEO EIT Climate-KIC, said:
“In this context of present crisis and crisis ahead of us due to climate change, the financial system, industry and infrastructure has an extraordinary opportunity to do something dramatically different… and question the assumptions under which our finance is built. It requires inspiration, research and provocation.”
Eric Usher, Head of UNEP FI:
“Even if the current commitments are put into action, we’re still going to see catastrophic climate change… This is not about financial markets shifting capital from A to B but engaging with real economy sectors to realize change on the ground. We are building a platform with some of the world leading figures and innovators on climate finance and a low carbon economy … to encourage debate and show what direction we, as the financial sector, need to go to mitigate the climate impact on future generations.”
Bridging the gap between finance and climate goals: In his paper, Achieving Alignment in finance, Dr Ben Caldecott, founding Director of the Sustainable Finance Program at the University of Oxford, explores what climate alignment means for financial institutions.
“Alignment and how we use finance and investment to achieve alignment with the goals of the Paris Agreement and other aspects of the UN Sustainable Development goals is probably the biggest question in sustainable finance. This is an attempt to come up with solutions…We need to much clearer about what we are doing with different tools.””
Caldecott proposes three pillars to reach alignment with climate outcomes (AOC):
- Measuring alignment. Properly measuring, tracking, and targeting assets and portfolios to make sure they support the goals of the Paris Agreement and contribute to changes needed to achieve low greenhouse gases and climate-resilient development. Caldecott:
“What we do when we measure alignment or whether something is polluting in a carbon sense, we get very focused on the flow into the bath and not the difference it makes to the level of the bath. Example, take an old coal plant and replace it by a new gas plant that emits 50-60% less carbon. But the new gas plant will emit for at least 20 years (even 40 according to your assumptions) whereas the old coal plant will operate for only 6-7 years at which point it is replaced by renewables plus storage. The new gas plant actually results in much more cumulative carbon emissions over its anticipated lifetime… You can apply this approach to different sectors.”
- Real economy impact. Making a real economy contribution through finance: just because you hold a lot of Paris compatible assets, does not necessarily mean you made a contribution to AOC. Financial institutions should spend more time understanding the impact of their financial vehicles in real economy. They should prioritize assets and portfolios that create more opportunities to contribute to alignment. Caldecott:
“Spend more time understanding these pathways. Apply this framework on each thing: equity funds, bonds, sustainability linked loans. How does the instruments in question product or service what you are doing? How does it translate into a real economy impact? How is it changing the cost in capital? Is it contributing positively into risk management? Is it helping companies adopt sustainable practices? Is it contributing to pull forward this society of transition?”
- Perseverance and consistency. Governance, behaviors, and principles we need to stick to over time in order to deliver AOC. Financial institutions will have to systematically review how they can better support AOC and develop plans to embed alignment in everything they do – an ongoing process.
With action comes concrete solutions: In Transformation required for 1.5°C Alignment, Dennis Pamlin, a senior Advisor at the Research Institutes of Sweden (RISE), takes a look at the changes need in the finance sector to meet the climate goals set out in the Paris Agreement.
“We have long been discussing minimum standards – what we should not do- but the question now is: where we should go? … We need to talk about 1.5 alignment if we are going to claim any thought leadership. You can go business as usual and continue to emit all the carbon we do, or ask what are the smart solutions that we have and what kind of business models and values can drive new ways of providing nutrition, mobility access, living spaces. That’s’ the low energy demand scenario.”
Pamlin proposes a matrix identifying stakeholder roles and actions for climate alignment, compatible with a 1.5°C pathway. His matrix is constructed under two questions to help companies take appropriate actions to align themselves with the Paris Agreement:
What actions in society are seen as needed and possible to address climate change?
What role do companies, and those working with companies, see themselves having in relation to climate change?
It can be used to discuss possible ways forward, beyond symbolic measures and improvements (often incremental) in existing systems towards the actual solutions needed in society.
More papers to come. The “thought leadership” series is one of the few intiatives taken by UNEP FI to increase the financial institutions’ response to the climate crisis. Usher:
“The last decade did not bring the fall in greengas emissions we expected… However we are in many ways in a better place to take action today… The most impactful role we can play in supporting the Paris Agreement is to front what the science tells us is needed with what the most ambitious industry leaders think is feasible. Essentially, we need to get those two to coincide and align. We hope this series encourages debate and what direction we, as the financial sector, need to go to mitigate the climate impact on future generations.”