A guide to COP26 for the private finance sector — Investors, Banks and Insurers commit to net-zero

When development charities, ecologists and a splattering of diplomats met in Rio de Janeiro nearly three decades ago at the landmark Earth Summit, there was barely a suit in sight. As for bankers, not a whiff!

In Glasgow, by comparison, leaders from the finance world, including the CEOs of the largest private finance organisations, are lining up besides heads of state to discuss how to fund — and profit from — the race to limit global warming.

This isn’t about asset managers, asset owners, bankers or insurers suddenly becoming tree-huggers, it is about reducing climate-related risks and taking advantage of business opportunities.

It is also about the survival of these companies — take for example the case of the insurance sector — As catastrophic weather events continue to become more common and more severe due to climate change, the insurance industry will be sorely tested. Homes razed by forest fires. Seafronts washed away by floods. Foundations shifting with subsidence. The damage from climate change means that insured property catastrophe losses in key markets like China, France, Germany and the UK are predicted to rise by as much as 120% over the next 20 years. More frequent catastrophic events, in combination with the need to meet evolving regulatory requirements, can threaten company business models — and make insuring some risk unaffordable for customers or unfeasible for insurers — So, climate change could be the end of the insurance industry.

The impact of climate change and nature loss can no longer be ignored by the finance industry. But it’s not just the insurance industry that is in jeopardy, it’s also every other company in the financial sector.

Climate is not only a risk, but also an opportunity. There is a growing recognition in the financial industry and in academia that ESG factors influence investor returns. An analysis of over 2,000 academic studies on how ESG factors affect corporate financial performance found “an overwhelming share of positive results,” with just one in 10 showing a negative relationship.

Increasing demands from beneficiaries and clients calling for greater transparency about how and where their money is invested is another reason why there is so much interest in climate these days. This is driven by growing awareness that ESG factors influence company value, returns and reputation, and by an increasing focus on the environmental and social impacts of the companies they are invested in.

It is undeniable that the financial sector is an enormously powerful and effective force, and it can certainly be a force for good.

The road to COP26

A lot of people think that the negotiations and decisions happen during the few days of the conference, but the reality is that all the work is done for months and even years before the big announcement is done.

On the road to COP26, multiple stakeholders from the private finance sector have worked on various fronts to “green” the industry by working towards integrating ESG issues and considerations across 4 areas: reporting, risk-management, returns and mobilisation of capital.

Some of the achievements leading up to COP in each one of these areas are highlighted below:

1. Reporting: improving the quantity, quality and comparability of climate-related disclosures by implementing a common framework built on the Taskforce for Climate-related Financial Disclosures (TCFD) recommendations.

Achievements leading up to COP:

• Central banks, regulators and governments are now issuing guidance on climate-related reporting and implementing the TCFD, including the G7.
• The IFRS Foundation is working towards comprehensive global baseline sustainability reporting standards — built from the TCFD and backed by the G20 and others.
• Auditors are considering climate-related risks and assumptions during assurance of company reports and accounts.
• Stock exchanges are now developing TCFD-compliant listing guidance thanks in part to the UN’s Sustainable Stock Exchanges Initiative.
• Critically, the TCFD has become the go-to framework for climate-related disclosures and over 2,300 companies in 88 countries representing a market capitalization of $17+ trillion are now committing to voluntary TCFD disclosures.

2. Risk management: ensuring that the financial sector can measure and manage climate-related financial risks.

Achievements leading up to COP:

• Central banks and supervisors have conducted climate stress tests of banks and insurers, and issued guidance on climate risk management.
• Financial firms and credit rating agencies are beginning to use scenario analysis with the Network for Greening the Financial System NGFS reference scenarios.
• Companies are now developing sector-specific scenarios and guidance, and finance ministries and central banks are starting to capture risks in their mandates.
• Central banks in turn are making disclosures in line with the FSB Task Force on Climate-related Financial Disclosures (TCFD) on the alignment of their investment portfolios.
• The NGFS has established a training centre for central banks and supervisors to build capacity around climate risk practices. Climate risks are now integrated into International Monetary Fund financial sector assessment programs and Article IV reviews.
• The Financial Stability Board (FSB), Bank for International Settlements — BIS and IAIS — International Association of Insurance Supervisors now use international standards to review approach to climate risk measurement and management.
• The insurance sector, for its part, is developing products to de-risk the transition and improve physical risk modelling to increase coverage.

3. Returns: helping investors identify the opportunities in the transition to net-zero and report how their own portfolios are aligned for the transition.

Achievements leading up to COP:

• Firms, academia, and the NGO community have begun to review approaches and establish best practices on the credibility of companies’ transition plans to net-zero.
• The FSB Task Force on Climate-related Financial Disclosures (TCFD) has created a framework for measuring the alignment of investment portfolios with climate targets.
• Conduct regulators and investors will develop consumer-friendly metrics that reflect investment alignment with net-zero.
• Most importantly, the Glasgow Financial Alliance for Net Zero GFANZ brings together the most ambitious firms in every sector of finance from every continent to align portfolios and lending with net-zero, disclose progress, and publish credible transition plans.

4. Mobilisation: increasing private financial flows to emerging and developing economies, by connecting available capital with investable projects and encouraging new market structures

Achievements leading up to COP:

• The Climate Finance Leadership Initiative and numerous countries are developing a pipeline of investable projects.
• The insurance sector is developing products and tools to help close the protection gap and improve resilience in climate-vulnerable countries.
• Multilateral, new, and regional development banks, finance institutions, and governments will align investment with #climate goals and report alignment of their own lending portfolio; facilitate access to markets, de-risk investment and provide technical assistance.
• Financial market infrastructure providers, banks, and companies, are developing the infrastructure for scaling up high-quality voluntary carbon markets

What is happening on Finance Day of COP26?

On Finance Day of COP26 attendees will discuss how to mobilise public and private finance to help the world go green.

“COP26 is quite possibly our final chance to tackle climate change and the devastating effects that brings, but nothing will be possible without urgently mobilising the trillions of pounds of private finance needed to get us to net zero and beyond.”

Achieving the objective agreed in the Paris Agreement to limit global temperature increases to below 1.5°C from pre-industrial levels requires a whole economy transition — every company, bank, insurer and investor will have to adjust their business models, develop credible plans for the transition and implement them. In recognition of the scale of the task, 125 countries, including half the G20, have now committed to net zero by 2050 at the latest.

Achieving climate goals will require all forms of finance. Public and blended finance, including the important commitment made by developed countries to mobilise $100bn annually by 2020 for climate finance, have a vital part to play in the shift to a greener more resilient economy and a fair transition for society. They will contribute to critical infrastructure development, support adaptation and resilience, and help develop new markets for private finance by de-risking investment.

Mainstream private finance will help all companies realign their business models for net zero. It will fund the initiatives and innovations of the private sector and turn billions committed to climate investment through public channels into trillions of total climate investment

The objective for the private finance work for COP26 is simple: ensure that every professional financial decision takes climate change into account. This requires the right framework so that the financial sector can allocate capital to manage risks and seize opportunities in the transition to net zero.

Beyond COP26 -implications for the private finance industry

The financial industry is a critical enabler of efforts to decarbonise the global economy, supported and underpinned by strong policy action.

Every company, bank, insurer and investor will need to adjust their business models, develop credible plans for the transition to a net zero-carbon, climate resilient future, and then implement those plans. Such a radical economic overhaul will require a more-than tripling of annual clean energy investment globally by the end of the decade to $4 trillion, with over half of this in emerging markets and developing countries1. To meet this $100 trillion challenge, the core of the global financial system must align their activities with net zero.

Over $130 trillion of private capital is now committed to transforming the economy for net zero. These commitments, from over 450 firms across 45 countries, can deliver the estimated $100 trillion of finance needed for net zero over the next three decades.

Now firms across the entire financial spectrum — banks, insurers, pension funds, asset managers, export credit agencies, stock exchanges, credit rating agencies, index providers and audit firms — have committed to high ambition, science-based targets, including achieving net zero emissions by 2050 at the latest, delivering their fair share of 50% emission reductions this decade, and reviewing their targets towards this every five years. All firms will report their progress and financed emissions annually.

While much work lies ahead, there is significant momentum and credible, impactful action, with the core of the financial system now committing to decarbonise rapidly with public science-based targets and disclosure. If implemented faithfully, the upswell in commitments can deliver the investments needed to achieve net zero. Fulfilling this potential, and building confidence in it, will be a key challenge in the months and years ahead.

To make this implementation successful a key factor is the training of the work force. it is likely that only very few employees from companies such as JP Morgan, Goldman Sachs, Morgan Stanley, UBS, or AXA know that their CEOs have signed net-zero commitments. How many employees know how to integrate ESG issues in their portfolio analysis? how many know how to price underwriting policies taking into consideration climate-related risks? — Probably very few, if any at all. The thousands of employees from banks, investors and insurance companies around the world will have to acquire the skills to be able to deliver the commitments that their CEOs have proudly announced.

We are about to see a big shift for the private finance sector. But this shift didn’t start at COP26, it has been slowly happening for years and even decades. Far from being the culmination of this work, we are about to witness the beginning of a very, very long road where private finance will be key for achieving a 1.5° world.