Banks are uniquely positioned to act as catalyst for system-wide change, through shifting capital from high to low carbon investments. ShareAction’s Sonia Hierzig outlines the key areas for investor engagement with banks on the severe risks posed by climate change.
The systemic risks associated with climate change will have severe economic implications. Recent economic modelling suggests that under a 4°C scenario, investors might face a value at risk equivalent to a permanent reduction of between 5% and 20% in portfolio value in just under a decade. ShareAction’s new report, ‘Banking on a Low-Carbon Future’, highlights why the banking sector is key for climate-related investor engagement and provides guidelines on the main issues investors might want to focus on to ensure that banks support the low-carbon transition.
While investors can protect their portfolios from risks associated with low-carbon scenarios by tilting away from sectors unlikely to be successful in adapting for a low-carbon world, they will still be exposed to the portfolio-wide physical risks associated with high-carbon scenarios. The only way in which these potential losses can be avoided is through an economy-wide decarbonisation. Due to the central role banks play in the global economy, they are uniquely positioned to help facilitate this transition to a more sustainable economy by shifting capital away from high-carbon processes and into low-carbon, sustainable activities.
In the report, there are four key areas investors are encouraged to discuss with investee banks:
Climate risk assessments and management: Investors can encourage banks to measure climate risks using various existing frameworks, including the recommendations of the FSB Task Force on Climate-related Financial Disclosures. The risks identified can then be managed, for instance by ceasing to finance high-carbon activities inconsistent with a <2°C world or engaging with high-carbon clients on how they can transition.
Low-carbon products and services: It is estimated that US$359 trillion will be needed by 2050 to avoid catastrophic climate change. Banks can be prompted to harness this business opportunity and help satisfy this need for funding by systematically offering low-carbon products and services across all their business lines.
Policy engagement and collaboration with other actors: Investors can suggest that banks use their lobbying power to engage with policymakers and promote policies facilitating the low-carbon transition. Collaboration with other actors, including other companies, academics, think tanks and NGOs can also be supported.
Implementation and monitoring: Investors can encourage banks to develop company-wide and forward-looking climate strategies, aligned with the <2°C target of the Paris Agreement. To ensure this is implemented, investors can request related disclosures and ask whether there is board-level oversight and whether the bank offers employee incentives and training.
An obstacle for achieving this is that climate change is often understood as a long-term risk, and many assets only remain on banks’ balance sheets for a short period of time. Despite this, there is a strong case for incorporating climate risk assessments into short-term activities:
Short-term loans to high-carbon projects and companies that do not have low-carbon transition plans in place will contribute to increased temperature rises and the risk of carbon lock-in. Once upfront investments have been made in hydrocarbon projects and related infrastructure, there is a considerable incentive to continue operating them for their entire lifespan, which can be over 40 years. This will intensify the effects of climate change on the economy as a whole.
In many regions the physical impacts of climate change are already being felt. According to the V20 group of developing countries, losses linked to the effects of climate change were estimated at nearly US$50 billion a year since 2010. The physical impacts of climate change have economic implications outside of the regions directly affected, given the globalised nature of trade, communications and supply chains.
Low-carbon advances are taking place at a much faster pace than many had previously predicted. Countries like China and India are rapidly picking up the pace on climate action, and low-carbon technologies are penetrating markets much more quickly than many traditional industries are planning for. Transitional risks can play out very quickly – for example the market share of the Big Four utility companies in Germany fell by around 50% in three years due to energy transition legislation.
Many investors recognise the relevance of climate risks in the short-term and are already taking action. For example, Boston Common Asset Management runs a coalition of investors with more than US$500 billion of assets under management engaging with banks on climate change. Another example is the call recently issued by more than 120 investors for banks funding the controversial Dakota Access Pipeline to get it rerouted.These are positive developments that should be very much welcomed. In future, these initiatives need to be expanded and deepened for investors to ensure that the banks they are invested in stop enabling high-carbon activities inconsistent with <2°C scenarios and instead facilitate the low-carbon transition.
ShareAction’s new report, ‘Banking on a Low-Carbon Future’ can be accessed here. Sonia Hierzig is a Research Officer at ShareAction and co-authored the report with Juliet Philips, Campaigns Manager at ShareAction.
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