In the first two blogs in this series, I wrote about the UN Principles for Responsible Banking (PRB) and the ongoing dance between the private and public sector that is ratcheting up sustainability ambitions. Today, I finish up this pre-COP series by considering how significant the net-zero objective has become for the finance industry, and what’s needed to make this a credible game changer going forward. Of course, I’ll also opine a bit more on the criticism that the net zero alliances have been receiving, some certainly deserved and some maybe less so.
Let’s be clear; net zero is not a financial objective, in and of itself. It’s an environmental objective, an externality in conventional interpretations of business value. But convention is changing, quickly. As I wrote earlier, the real significance of the PRB framework is the focus on aligning a bank’s business with societal goals such as financing the climate transition. But let me focus on the investment sector, which has made the first move here.
The day after the PRB was launched in 2019, also in New York, the CEO of Allianz, Oliver Baete, announced that his organization and 11 other insurers and pension funds were establishing a Net-Zero Asset Owner Alliance. This coalition of the willing, now 60 strong and managing USD 10 trillion in assets, became in April a founding part of the Glasgow Financial Alliance for Net Zero (GFANZ) led by Mark Carney and COP Champions Nigel Topping and Gonzalo Muñoz. GFANZ now includes many other coalitions from across the finance industry working voluntarily to fully decarbonize their investment portfolios by 2050 along a 1.5C pathway.
Looking back on the eve of COP26, the launches in 2019 of the PRB and AOA may have marked a turning point in how sustainability would henceforth be addressed by the finance industry. Sustainability is no longer about just managing risks, but also about portfolio alignment. Alignment and enterprise value inextricably linked.
Ever since the launch of the Freshfields report and the subsequent launch of the Principles for Responsible Investment in 2005/6, responsible investors have come to see environmental, social and governance (ESG) factors as financially material to investment decision making. The legal interpretation of an investors’ fiduciary duty to factor ESG issues in has evolved from ‘can, to should, to must’ with the EU and increasingly other jurisdictions now moving towards mandatory inclusion and disclosure requirements.
However, the notion and legal interpretation of what is, or isn’t, material has also been evolving with the push towards double-materiality that includes both the risks of environmental and social externalities on business value, but also the impact of the business on people and planet. The World Economic Forum have posited the idea of dynamic materiality, whereby ‘inside out’ impacts like carbon emissions will eventually come back around ‘outside in’ to affect enterprise value and therefore are material and need to be considered in company accounts. This new focus on impact has led the International Financial Reporting Standards (IFRS) foundation to consider establishing an International Sustainability Standards Board (ISSB) to sit alongside their International Accounting Standards Board that currently sets financial reporting standards for most jurisdictions.
Whether you’re in the double, or the dynamic camp, the increasing mobilization towards the race to zero is showing that sustainability objectives are becoming core aspects of enterprise value. So let me fold these developments back into the net zero discussion.
After two years of work, the Asset Owner Alliance launched last week their progress report which details the interim 2025 targets that have been set and the work being done to achieve them. They reported that 27 of the first 29 members in the Alliance have now issued their individual 2025 targets for listed equity, corporate bonds and real estate holdings. Based on the AOA 2025 Target Setting Protocol, all targets had to be within the 16% to 29% reduction range that the IPCC scenarios (P1-P3) say are needed to stay with the 1.5C trajectory. Most of the signatories’ 2025 targets have been set at the upper end of that range, as the progress report explains. In total, these targets aim to decarbonize USD1.5trillion of assets under management and as methods for additional asset classes are finalized, the AUMs in motion will increase accordingly. There’s a lot of devil in the detail but overall this is progress and the transparency of approach they are showing keeps them at the front of the pack in terms of ambition, but also in actually walking the talk. Of the many, many net zero coalitions formed to date, only the Asset Owner Alliance has issued 2025 targets that align with the science and where their actual performance will be measurable in years rather than decades. We need others in the finance industry to follow their lead, even if setting targets for 2025 becomes increasingly difficult and the focus starts to shift to 2030.
Earlier this week UNEP FI released its G20 Sustainable Finance Working Group Input Paper proposing a set a recommendations for credible net zero commitments. The Net Zero Asset Owner Alliance, and the Banking and Insurance Alliances that UNEP FI is also supporting, have implemented many but not all of the recommendations therefore there’s still work to be done. And most importantly, now it’s all about implementation which won’t be easy considering the pace and scale of decarbonization that’s required.
Coming back to the ideas shared in my second blog in this series, the public – private dance will be critical for success in the net zero transition. Financiers have a lot of influence but it’s wishful thinking that they will be able to realise the race to zero on their own. Companies need to partner with financiers in driving forward the decarbonization and their voluntary leadership will only succeed if governments themselves ratchet ambition and create the enabling conditions that all know are needed, in time and at scale.
Okay, we’re ready for the curtain to rise in Glasgow…