One of the key features of COP26 was recognition that the scale and speed of the changes needed to transition to a more sustainable economy require all forms of finance. Public finance to develop infrastructure to transition to a greener and more climate-resilient economy, and private finance to fund technology, innovation, research, and sustainable business models.
As a result, last year’s COP confirmed the launch of the Glasgow Financial Alliance for Net Zero (GFANZ) to improve commitment to net-zero ambitions and establish a forum for addressing sector-wide challenges associated with the transition. As we head into COP27, GFANZ now has more than 550 members from over 50 countries and has developed a voluntary set of recommendations and framework for financial institutions looking to establish net-zero strategies, as well as guidance on how to increase the mobilisation of finance.
So, what has the finance sector learned over the last 12 months, and how can COP27 galvanise the finance sector to progress even further?
Developing specific pathways and targets
One thing that has become clear over the past 12 months is that in terms of developing pathways, setting targets and aligning portfolios, a bank needs to consider different aspects to, for example, an insurance company or an institutional investor. While pledges to the net-zero transition and the mobilisation of finance are increasing, delivery is being slowed down by the need for more tailored and customised guidance that answers the concerns of individual players within the finance sector. This challenge to develop more specific pathways and advice is one that GFANZ, amongst other alliances and working groups, is working on so that the finance sector’s ability to meet sustainable targets gains momentum.
Improve metrics and methodologies used
A current key challenge for financial players is measuring or evaluating the alignment of investment, lending and underwriting activities so that they can chart the progress of transitioning to a more sustainable economy. While a growing number of metrics and methodologies focus on sustainability, not all have the objective of measuring progress on changing the trajectory of the path we are on. Plus, depending on the methodology used, different results on how green a portfolio is can be produced and results often being misunderstood by investors who do not have sight of underlying assumptions made. While there is general agreement on the need to focus on metrics that reflect transition targets more accurately, current methodologies give too much room for interpretation and the need to make and substantiate assumptions that create barriers to adoption.
Transparency and disclosure are vital to mobilising finance
The ability of financial institutions to mobilise finance toward sustainable activities relies on the disclosure and transparency of the firms they invest in or lend capital to. To this end, bodies such as the SEC, the recently formed International Sustainability Standards Board (ISSB), Global Reporting Initiative (GRI) and the European Financial Reporting Advisory Group (EFRAG) are all working on climate and general sustainability disclosure prototypes to improve transparency. While each approach overlaps in certain areas and is helping to shape the transition, only EFRAG’s approach currently considers disclosure through a more detailed double materiality lens that assesses the impact on the planet, people, and financials. As discussions progress, prototypes will emerge to provide coherency and consistency in disclosure standards across multiple jurisdictions.
Reviewing the roadblocks
Dedicated sessions on finance are due to be held at COP27 to review the work achieved and ways to remove roadblocks that impede future progress. A current roadblock is the lack of formally agreed upon recognition of green assets, making financial players reluctant to invest when unsure of the green credentials presented. While many frameworks have been developed, no framework has emerged as comprehensive and robust enough to give financial players the confidence to adopt. Another roadblock is the level of risk associated with the financial performance of green finance and how to remove uncertainty and grow trust and financial reliability in green projects. The intervention of regulators is now seen as key to underpinning confidence and incentivising financial players to mobilise capital by applying the same regulatory rigour to green projects as is currently applied to traditional investments.
It’s clear that the finance sector has made progress over the past 12 months, particularly in collaborating to provide solutions and input on steps forward. This has involved each player assessing their own transition to a sustainable future and areas where they can improve. For financial players who have reached a certain level of sustainable maturity, such reflection has provided a format to act as role models, give encouragement and highlight clear pathways to clients looking to improve their own sustainability transition.
As witnessed by progress to date, it’s only by collaborating and learning together that sustainability challenges can become opportunities. Hopefully, COP27 will provide further nourishment the finance sector needs to transform its sustainability ambitions into credible actions.