Financial Institutions are making progress in navigating to Net Zero, but challenges lay ahead

Stakeholder expectations are changing

The IPCC’s sixth assessment report shows that the world will probably reach or exceed 1.5°C (2.7°F) of warming within the next two decades¹. The World Meteorological Organisation (WMO) says that there is now a 66% chance that we will pass the 1.5°C global warming threshold between now and 2027². Science is telling us that unless we get to Net Zero by 2050 we will see runaway climate change which will present widespread risks to the financial system.

The financial sector is particularly exposed to these risks through their lending and investment portfolios and their counterparties (borrowers and investors) if governments fail to meet the 1.5°C target. While banks cannot necessarily be expected to lead the transition, neither can they simply wait for others such as policy makers to act. By consciously re-allocating capital towards Paris-aligned activities, not only do they protect their own balance sheet and business model, but they reduce the economic and political costs of the transition. There is also an opportunity for banks from this transition as a low carbon economy requires high capital investment by real-economy companies and these are likely to be part-financed through debt funding.

The role of the banking and wider financial sector is “making finance flows consistent with a pathway towards low GHG emissions and climate-resilient development” (UN, 2015³) and accelerating the transition to Net Zero. Industry coalitions are forming to address this by focusing on the way banks can deploy capital to enable economies to decarbonise and prosper under Net Zero.

Global coalitions are driving more action

The Glasgow Financial Alliance for Net Zero⁴ (GFANZ) is a global coalition of leading financial institutions committed to accelerating the decarbonisation of the economy in alignment to the objective of the Paris Agreement. GFANZ was launched in Glasgow ahead of COP26 initially with 43 banking members which has now grown to 132 banks with $74trn of total assets⁵. The alliance was positively received on the day of its launch however it has since faced some challenges for reasons such as:

• There is a large gap between the commitments made by governments and what science is telling us we need to commit to. Financial institutions are finding it more difficult to drive this transition without the support of governments and policymakers; as one member put it “we have been left at the altar”. 

• There are challenges when it comes to decarbonisation depending on the composition of banks’ portfolios. For example banks with heavy energy books are finding it much harder to decarbonise whilst others with high exposure to mid-market companies are struggling to access good quality data making it difficult to measure emissions.

• GFANZ initially tied its members to align with the UN Race to Zero’s minimum criteria which required associated members to get out of all unabated fossil fuels causing some banks to not sign up to GFANZ as they couldn’t commit to this.

• Financial institutions are under political pressure particularly in the US, which has caused them to question whether they want to remain in GFANZ.

GFANZ has specific sector alliances such as the Net Zero Banking Alliance (NZBA) which today represents 41% of global banking assets. The World Benchmarking Alliance (WBA) found that sector specific alliance members outperform non-members on all climate related indicators e.g. 40% of GFANZ members measure financed emissions and 43% have engaged with the 1.5°C target compared to 11% and 12% for non-members respectively⁶. This market alliance is driving much needed action and commitment, but more is needed⁷.

Net Zero is a key strategic and transformation challenge, not a separate issue 

As Net Zero transition is an emerging topic, institutional knowledge is still being developed both internally and externally. Some big picture challenges that banks are facing include being able to balance their growth strategy, reputation and competing stakeholder priorities when making business decisions. On a practical level challenges include the fact that there is nascent technology, poor data coverage and market standards in this area making it difficult to make data-informed decisions. There is also talent scarcity when it comes to ESG- it will take time to build deep expertise and institutional knowledge in this area.

The transition to Net Zero is a strategy and transformation challenge by its very nature. There will be a global rewiring of the economy that is going to impact financial institutions and their customers in a material way over the next decade. Some of the key steps that banks should be taking when approaching this is:

• Setting up good governance structures: banks should approach this in the same way they would any other transformation projects. Banks should consider whether they have a transformation office to lead and coordinate their corporate level strategy and portfolio level strategy - they need to understand the decarbonisation levers in the sectors where they operate. Board competence and oversight on climate is also critical.

• Looking for the opportunities: banks that have a good understanding of the implications for Net Zero on their clients and engage in the challenges they face, will be better placed to act as trusted advisers and funders as companies transition their businesses; building front office capabilities will be key. Early alignment of operations with the Paris agreement can allow banks to grasp massive climate finance opportunities and secure a leading position in the new market.

• Embedding into risk management: banks should use a portfolio led approach to managing financed emissions. In the same way that they have a portfolio cap to manage risk, financed emissions requires embedding a portfolio cap within the industries banks operate in whilst being realistic about how quickly different sectors and countries will be able to achieve Net Zero.

• Improving data and systems: banks should develop a long-term embedded Net Zero technology and data strategy aligned to key business outcomes and overall corporate strategy to drive long-term value.

• Integration into reporting: banks should make sure the finance function is set on the path to fully own the reporting against targets needed to build trust in their Net Zero commitments. 

The above areas should form the backbone of a bank’s Net Zero Transition Plan, which can be used to set out the direction and pace of travel, and track and report on progress.

PwC can bring experience and the breadth of disciplines you need to develop your Net Zero transition plan 

Financial Institutions approach PwC to help them define their climate ambitions and design their climate strategy, because our experience combines two decades tracking the evolution of climate change science. Our experience and expertise allows us to support banks to identify the business implications and the pragmatic actions they can take to respond to the changing environment. We help banks by:

• Employing a strategic and pragmatic approach to anchoring Net Zero strategy and transformation to corporate strategy, business objectives and portfolio composition.

• Completing a rapid PCAF-aligned portfolio emissions heatmap to identify areas of focus and deploy an approach based on proportionality and materiality.

• Using actuarial-inspired models and tools to manage data uncertainties in modelling financed emissions projections against targets and reference scenarios.

• Accessing multiple sources of data to obtain emissions data at an asset level or develop proxies to fill data gaps and create estimations where emissions data is unavailable.

• Performing Transition Planning gap analysis to identify areas to be built, strengthened or disclosed helping banks to identify quick wins and longer-tem areas of focus.

• Supporting on front office transformation to help banks deploy extensive climate finance and deliver on ambitious Net Zero targets
• Deploying blended teams of financial services professionals alongside private sector and government teams, which gives our clients access to a pool of talent that can bridge policy, finance and the real-economy.

_References:

_{¹ IPCC Sixth Assessment report} 

_{² World Meteorological Organisation - Global Annual to Decadal Climate Update}

_{³ UN Paris Agreement} 

_{⁴ Glasgow Financial Alliance for Net Zero}

_{⁵ Net Zero Banking Alliance - Membership}

_{⁶ World Benchmarking Alliance - Governance and Climate Insights report} 

_{⁷ Glasgow Financial Alliance for Net Zero - 2022 Progress Report}