The Financial Services challenge: achieving net zero while funding the real economy

Global investment needs to double from today’s levels to secure Paris Agreement Targets, and triple to protect against a >1.5° rise. Finance is already stepping up to the challenge: 2021 has witnessed the Global Financial Alliance for net zero bringing together 300 firms with an estimated $90 trillion in assets under the banner of a shared net zero commitment.^[1]

Meanwhile almost 85-90% of global energy supply is still met by fossil fuels. The Climate Policy Initiative’s (CPI) Net Zero Finance Tracker shows that most firms do not yet have clear strategies in place to deliver on their net zero commitments.^[2] Fossil fuel financing from the world’s 60 largest banks was higher in 2020 than it was in 2016, the year of Paris. We are currently still on track for the worst. The International Energy Agency’s (IEA) latest World Energy Outlook shows that existing policies globally still put us on a pathway to a 2.6 ° rise.^[3]

Three key questions for financial institutions to answer in their net zero journeys

The financial system has a critical role to play in securing our success in the race towards net zero, but it must do so in a balanced way to protect social and economic stability in the real economy.

1. What is your strategic ambition and the role you will play in getting to net zero?
2. Which actions will you take to support the right kind of transition?
3. Which opportunities will deliver the greatest impact and the right kind of growth?

Setting a net zero ambition

• Ambition has to come from the CEO and Management Team and should be woven into your broader business strategy. It must be supported by credible commitments and targets, with the right people “on the hook” for delivery
• Net zero looks different for every organisation. You need a rich understanding of what it means for every sector, region and division within your business to enable you to build a credible view of your own roadmap to zero
• Setting targets should be underpinned by robust analysis of your loans and investments, determining your baseline financed emissions, as well as your projected financed emissions in the short to long term
  • This will require understanding methodologies for measurement based on industry best practice, establishing the right metrics and obtaining the right data both internally and externally
  • You will need to determine appropriate scenario-based pathways by sector and region, engage with your clients to determine their transition plans, and understand the financial implications of proposed targets.

Translating ambition into action

• Translating your commitments and targets into action will involve education and engagement across a range of internal, client and policy stakeholders to make the case for change. There are very real trade-offs and decisions to be made with the balance of growth, profit and the path to net zero provoking hard discussions. You may need to assess which sector, regions and clients to potentially exit or actively support in transition, or even create new market opportunities
• One size does not fit all. The strategies available to an asset manager are different to that of a retail bank – and the right incentives for agriculture are different to oil and gas. You must deploy the right blend of direct and indirect actions and incentives on a business and product line basis. Sensitive analysis of the actions is critical towards ensuring a balanced and orderly transition that avoids negative social and economic impacts, while allowing capital to flow to where it matters most
• The goal of net zero is not to simply off-load all your “brown” assets; far from it in fact. It will require huge investment to convert brown assets to green. This is at the heart of transition finance and can range from large scale infrastructure investment to repurpose gas networks to support transmission of hydrogen power, to a £5,000 loan to help a homeowner with insulation. The key to this is building robust frameworks to evaluate and monitor customer’s transition actions that you facilitate, so that you can have the right level of visibility and assurance over the results

Accelerating growth through collaboration and products

• Sustainable growth is essential for net zero. Being a first mover reveals significant commercial opportunities, if you place the right bets aligned to your business strategy. Transition involves a lot of complex changes involving new technologies that are rapidly evolving. This can make it difficult to make the case internally to invest or take on the perceived risk. Undertaking rich analysis of the relevant policies, technologies and supply chains around key sectors can help you to more confidently forecast future costs and risks around key investment opportunities and products
• These opportunities are broader than simply investing in wind farms. We also need to solve for tougher transition challenges in other areas, including agriculture, manufacturing, small and medium-sized enterprises (SME) and the residential mortgage market where the business case does not yet stack up for customers and clients. This requires a new form of collaboration to innovate and develop new forms of circular models, finance products and customer propositions

Baringa are the leading advisors on net zero globally. We understand that charting the right course requires some tough decisions, but also raises huge opportunities for firms with the right strategy. We are here to help you seize them.