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Jakob Thomae of the 2° Investing Initiative explains how 17 international banks are road-testing a new methodology to address the barriers that have prevented banks from aligning more fully with the Paris Agreement
Ahead of New York Climate Week 2019, the sustainable finance sector has made important strides toward meeting one of the Paris Agreement’s long-term goals, under Article 2.1c: "making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.”
But there’s a major caveat: while finance as a whole has concentrated on efforts to align equity portfolios with the Paris goals, or to promote green bonds, the banking sector has long remained one of the “last frontiers”. This has been due in large part to two major market gaps: the lack of data on non-listed companies, and the difficulties of processing data from unstructured databases.
Here at the 2° Investing Initiative, a non-profit thinktank working to align financial markets with climate goals, we’ve been working over the past months with a pilot group of 17 international banks in order to help address these gaps. By publicly announcing the banks that are piloting our flagship methodology for climate-scenario analysis of corporate lending portfolios, we’re hoping that the banking sector will be further empowered to contribute more fully to Article 2.1c – and to the Paris Agreement goals more broadly.
Rather than measuring backward-looking 'sins of the past', the methodology allows for a forward-looking assessment
Together, the pilot group members have been piloting one of our latest research innovations: the Paris Agreement Capital Transition Assessment (PACTA) climate scenario analysis methodology for corporate lending. The methodology builds on our earlier research on equity and corporate bonds, which resulted in the launch of version 1.0 of the PACTA methodology on TransitionMonitor.com in September 2018.
Inaugurated in partnership with the UN Principles for Responsible Investment (UNPRI) and California’s insurance commissioner, Dave Jones, the methodology helps respond to the lack of adequate information for investors to evaluate how their portfolios might be affected by climate change.
Critically, rather than measuring backward-looking “sins of the past”, it allows for a forward-looking assessment of whether their portfolio companies are adapting in line with the Paris Agreement. The methodology builds on a version that has been applied by major regulators, including EIOPA and the California Insurance Commission, and has since been used by more than 600 investors.
Given the methodology’s wide range of applications beyond the asset management sector, however, we didn’t want to stop there. After partnering with ING to extend the methodology to corporate lending portfolios, in February 2019 we began working with the pilot group members: ABN Amro; Bancolombia; Barclays; BBVA; BNP Paribas; Groupe BPCE; Citi; Credit Suisse; ING; Itaú Unibanco; KBC; Nordea; Santander; Société Générale; Standard Chartered; UBS; and UniCredit. Over the course of the coming months, they’ll be helping us to further road test and refine the methodology, before its launch in the first quarter of 2020. Given our longstanding commitment to providing open-source, IP rights-free research and tools, the methodology will be publicly available and free to use. This means that all of the pilot group members, as well as other interested banks and stakeholders, will be able to continue helping us perfect the tool even after the end of the road-testing phase.
What’s different about the methodology? For one thing, like our prototypical PACTA tool for equity and corporate bonds, the model isn’t geared towards assessing carbon footprint or physical risk. Rather, it focuses on the main seven sectors generating anthropogenic carbon emissions – oil and gas, coal mining, power generation, automotive, cement, steel and shipping. Our analysis thus draws from 1) the bank’s lending portfolio over these seven sectors in scope; 2) our databases, which store forward-looking production figures (physical asset-level data); and 3) climate scenarios, condensed to the technology pathways they prescribe.
The result is a first-of-its kind analysis that provides banks with a granular assessment of how their credit-financed activities may or may not contribute towards the global shift to a low-carbon economy. Eventually, the methodology can help measure the difference between the bank’s future portfolio profile – a picture of the most climate-relevant activities financed by the bank – and the profile towards which it should strive according to climate scenarios.
The methodology can be used to help 'steer' lending portfolios in line with specific technologies or activities
The metrics also provide a basis for enhancing disclosures, such as those included in annual reports or in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). Likewise, the methodology can be used to help “steer” lending portfolios in line with specific technologies or activities and move towards measuring the impact in the real economy of climate actions in financial markets.
Now, by releasing the pilot group members in the run-up to Climate Week, we’re hoping we can help spur further interest from banks and other stakeholders in contributing to an industry-wide climate scenario analysis approach. If adopted more widely, such an approach would help to considerably improve transparency and collective efforts to fight against climate change. After all, the banking sector has a critical role to play in this fight, above all through the capital they provide to fund their customers’ activities.
By informing discussions around these processes, the PACTA methodology for corporate lending can allow banks to eventually steer their lending towards financing the transition to a low-carbon economy – a critical way to help support Article 2.1c, and more broadly, to help avert a global climate crisis before we approach the tipping point.
Jakob Thomae is managing director of the 2° Investing Initiative. The opinions expressed in his article do not necessarily reflect the official policy or position of the 2° Investing Initiative; its funders, members, and partners; or any of the pilot group members.