A science-based net-zero target for financial institutions

A growing number of financial institutions have committed to, and set, net-zero targets. At COP26, the Glasgow Financial Alliance for Net Zero (GFANZ) announced pledges that were set to transform the financial system, including commitments from firms with more than US$130 trillion in assets under management to reach net-zero before 2050.  Yet there is seemingly no clear, common understanding of what net-zero actually means for these firms.  The Science-Based Targets Initiative (SBTi) Net-Zero Standard for Financial Institutions (FIs) – published earlier this month - represents the first step in closing this important gap. 

Alignment with the Net-Zero Standard for FIs will be predicated on net-zero targets for 2050 at the latest, underpinned with 1.5C-aligned interim targets covering all emissions scopes.  It follows the SBTi's criteria and guidance for FIs setting near term science-based targets covering investment and lending portfolios (published 2020) and the Corporate Net-Zero Standard (published 2021). The Standard may well dispel some of the doubts raised over GFANZ's ability to meet the net-zero goal, by providing clarity on what is expected from FIs' decarbonisation pathways.  It also marks the beginning of the end of self claiming net-zero commitments without credible methods and metrics.  

The initial foundations set out in this new paper will, it is envisaged, generate specific criteria for the formulation of targets, a validation protocol and detailed guidance for credible net-zero claims. The goal, in short, is “to build a growing group of FIs that transparently, quantitively, and robustly support the emissions reductions in the real economy needed for climate stabililization”.  As it stands there are 19 financial institutions with approved science-based targets that are verified in line with 1.5C. As more firms seek to measure and disclose their climate risks and emissions in the light of a growing body of mandatory climate-related disclosure requirements, the setting of science-based milestones would be a logical next step.  

The current assortment of net-zero targets – in terms of scope, timeframes and strategies - is in some ways explained by the differing services offered by various types of FIs, as the paper notes.  A range of existing approaches is presented in an overview (section 2.2) (this usually includes engagement with portfolio companies; the re-allocation of capital from high-carbon to low-carbon sectors; divestment; and financing climate solutions, among others); there is also an assessment of the effectiveness of five hypothetical mitigation strategies (section 5.1) and a list of metrics currently being used to track progress (section 5.2). 

Some points emerging from the paper:

• The role of fossil fuels in financing activities needs to be addressed and engagement is the priority.  The paper proposes a “disclosure, transition and phase-out” approach (actual phase-out of financing for fossil fuel companies are for those unable or unwilling to transition).  
• Being consistent with the global net-zero goal means a state where all of an FI's financing activities (including arranging, underwriting and syndication) are aligned with reaching that goal, not just specific portfolios. It will require “real world cuts in GHG emissions from companies’ value chains, and not simply a reduction in exposure to emissions within portfolios”.
• The purchase of carbon credits is not a replacement for reducing value-chain emissions in line with near and long-term science based targets.  FIs should prioritise “opportunities within their core business through direct financing of climate solutions” when addressing scope 3 category 15 financed emissions.
• FIs have an important role to play in scaling up investments in new and existing climate solutions such as renewable energy, sustainable mobility, infrastructure, nature-based solutions for the conservation and enhancement of natural sink capacities and carbon removal technologies. Questions around if and how climate solutions financing can be addressed with net-zero targets will be examined as part of the framework development. 

Firms are not, as it stands, actually required to set verified, science-based goals to reduce emissions in their operations and supply chains, and the Standard is entirely voluntary.  But without it, it won’t be possible to evaluate whether the action being taken is sufficient to achieve the goals of the Paris agreement.  

The final Net-Zero Standard for Financial Institutions will be launched in early 2023, following multi-stakeholder consultations, road-testing of methodologies and a technical review.  But already this framework indicates the trajectory for best practice and will add to the growing momentum for increased delivery against targets.

The Standard represents a real opportunity for FIs wanting to have a clearer sense of what is required to achieve net-zero and head off growing concerns around “greenwashing” and the litigation to which it can lead. It also reinforces the importance of tackling – through disclosure and engagement, initially at least - the impact of fossil-fuel related financing activities (from investments, direct project financing, through to arranged financing and lending). SBTi will follow up with a detailed oil and gas sector target-setting method in due course.

Issuers and borrowers, who ultimately bear the follow through of the decarbonisation of FI portfolios, should also take note as the Standard paves the way for increasing scrutiny by FIs of the sustainability credentials of companies they invest in and lend to.

The SBTi is also working with the Net Zero Insurance Alliance to develop a target-setting protocol for insurance underwriting portfolios, to be published by January 2023.

(See also Five things you should know about setting science-based targets - Slaughter and May Insights).