Green finance: Europe gets serious

Recently published for Pensions for Purpose. Richard Folland and Shuen Chan reflect on the implications of two recent major reports for green finance.

The low-carbon transition is underway and – judging by the way that clean energy costs continue to fall and becoming increasingly competitive against fossil fuels – it is accelerating. However, this transition has to be funded. The scale of investment needed to meet the national emission reductions targets submitted to the Paris Climate Agreement (the Nationally Determined Contributions – NDCs) is estimated to be more than $3.5 trillion, and that doesn’t take into account developments in other areas such as infrastructure and agriculture.Ultimately, major flows of finance and investment will need to move from fossil fuels (“brown”) to low-carbon sources of energy (“green). Policymakers and markets have done much to disincentivise investing in brown (from regulating to phase out coal, to establishing carbon pricing schemes), although much more remains to be done. But since the Paris Agreement was signed in December 2015, there has been a growing recognition of the need to incentivise investing in the green. And Europe in particular has been getting serious.Since the start of 2018, two major reports have been published: one from the European Commission-appointed High Level Expert Group on Sustainable Finance (HLEG); the other, more recently, by the UK Government-appointed Green Finance Taskforce (GFT). The Commission has already responded to the HLEG; the UK Government may not reply substantively until much later in the year. But what both initiatives demonstrate is the recognition that, if the transition is to be funded in the narrow window that the climate science tells us it must, green finance can no longer be niche but must go mainstream.To take the HLEG report first, its recommendation on a green taxonomy – in effect an EU-wide classification for sustainable activities – is key, in order to set benchmark standards for green bonds and potentially other forms of low-carbon financing. The Commission in its sustainable finance action plan has acknowledged the importance of putting a taxonomy in place. The Commission also recognises that (as highlighted by Governor of the Bank of England Mark Carney in his landmark “Breaking the Tragedy of the Horizons” speech in 2015) the establishment of a long-term approach towards responsible investing will help influence attitudes and behaviour change in respect of climate change and the green economy. This is why the Commission has made it a priority – reflecting a thread that ran right through the HLEG –  to address the role of institutional investors through fiduciary duty and the disclosure of non-financial and material information (picking up on where the Taskforce on Climate-Related Disclosures (TCFD) left off).The UK GFT report similarly emphasizes the importance of mainstreaming the TCFD recommendations (which were endorsed in the Government’s Green Growth Strategy last autumn) and maintains that existing UK law and practice makes the disclosure of material climate-related risks mandatory. There is also a host of recommendations covering green finance: from highlighting the symbolic importance of the UK issuing a sovereign green bond to driving a market in green lending products. There is even, as has been mooted in European Commission circles, a suggestion that the Government should examine whether it is feasible to consider a regime for banks and insurers where there is a better reflection of the different financial risks associated with brown and green assets – the so-called “green supporting factor”.Of course Europe is not the only place where the action is. China has been commended for its international leadership on the development of green finance; domestically, it has established guidelines for “establishing a green financial system”. However, what marks out the EU, including the UK, on green finance is its ambition to make it a core part of the financial ecosystem – from both an opportunity and a risk perspective.2018 is an important year for action on climate change. In Poland in December, the international community will for the first time since Paris take stock of their collective progress against the NDC targets. Calls for greater ambition will probably accompany that stock take and be an important part of the story. Another key international meeting will take place in September this year, when Governor Jerry Brown will convene a meeting on global climate action where business and finance will play a central role. No doubt we will hear time and again from these meetings how the transition has to be financed if we are to stave off a world of 2 degrees-plus. It will therefore be essential to create a global green economy – right now, Europe (as London and Paris battle it out to be a global green finance hub) has given itself a good chance of showing the way.

The low-carbon transition and the disconnect between companies and their pension funds

May 2018 – Sustineri writes for The Aldersgate Group about the disconnect between corporates and their pension funds in the way they are approaching the low-carbon transition

There is growing evidence that business is serious about addressing the low-carbon transition. Over 100 companies now have approved science-based targets, i.e. they have set an emissions reduction target in line with accepted climate science. Even major fossil fuel companies are being more pro-active: witness Shell’s recent energy transition report, and Exxon’s 2 degrees C scenario analysis report (even if there remain major question marks about the assumptions the sector continues to make).

Action by corporates on climate change is of course vital. However, the institutional investor sector is equally important: mobilising their immense pools of capital will be fundamental to securing a low-carbon future for us all.

Action by pension funds – incorporating and mainstreaming the transition and its implications into the DNA of their investment practices – is something that we should all welcome. Public pension funds are in overall terms taking a greater interest in sustainable investment; but the same perhaps (although there will always be exceptions) can’t be said about corporate pension funds.

Transparency and corporate pension funds

Some fairly cursory research would indicate that there is a lack of transparency about how corporate pension funds approach climate and sustainability and general integration of Environmental, Social and Governance (ESG) factors into their investment process. Do they accept the scientific case? Would they agree, as Mark Carney argues, that climate change will have major implications for financial stability? Do they have the governance and risk frameworks – and the integrated expertise – to address this agenda? Are they selecting their investment managers based on specific criteria that address these risks? Where do they stand on initiatives such as the Climate Action100+, the global investor-led initiative to engage with the largest greenhouse gas emitters?

Overall, the most important question worth asking of pension funds is whether they have a policy on the transition. Enough guidance has now been published – from The Pensions Regulator to the industry-backed Taskforce on Climate-Related Financial Disclosures, which makes major recommendations on how institutional investors should address strategic, governance, risk management and targets considerations  – that, respectively, pension funds and the broader range of companies and investors should be taking climate risk seriously. So it ought to be a subject that is hard to ignore.

The other key question should probably be directed more at the corporate sector. They may well be taking action (including serious structural changes to their business model) on the transition; but are they in a dialogue with their pension fund, who may well be exacerbating the problem (eg by investing in more carbon-intensive stocks) that their parent corporate is trying to mitigate?

Food for thought

All this should give food for thought to the corporate sector and to the pension funds sector. But there are two other dimensions that they might care to consider.

First, the direction of travel on policy. In its response last month to its High-Level Group on Sustainable Finance (HLEG), the European Commission acknowledged the theme of fiduciary duty picked out by the HLEG. In its action plan, the Commission has therefore said that it plans to bring forward a proposal shortly to clarify investor duties – set within the context of fiduciary duty – and how they should consider sustainable finance within their asset allocation. The Green Finance Taskforce, which reported to the UK Government just before Easter, has been thinking along similar lines, recommending that regulations on fiduciary duty should clearly incorporate ESG issues.

But perhaps more importantly than that, corporates might reflect on whether their pension fund is adopting the types of values that their employees and beneficiaries would like to see. In its latest Global Shapers Survey (covering more than 30,000 individuals under 30 from 186 countries), the World Economic Forum says that, for young people, climate change and the destruction of nature is their number one global issue. The view of millennials is one reason why public sector pension funds are coming under increasing pressure from external groups and stakeholders – perhaps the time is approaching when corporate pension funds will also start to come under this spotlight too, and they can no longer hide behind the CSR practices of their corporate business.


From COP21 to COP23: What are the signals that investors should be looking for from the COP in Bonn?

And so the circus returns. The climate COP in December 2015 was such a landmark, but it’s not easy to dismiss the reflex thought that these big international gatherings on the climate change negotiations (or, to give the annual meeting its proper designation, the Conference of the Parties (COP) UN Framework Convention on Climate Change (UNFCCC)) have invariably failed to deliver. But the Paris Agreement– where, crucially, every country agreed that they are obliged (though not legally bound) to make their own individual contribution towards tackling climate change – really did change the game.

Two years on from that historic meeting, delegates meet from 6 November at COP 23 in Bonn in a somewhat ambivalent mood. On the one hand, the momentum continues, driven by policy makers, investors, corporations, cities and municipalities. There is a prevailing consensus that: not only is the transition to the low-carbon economy underway; but that a combination of domestic policy measures around the world and the spiralling fall in the costs of wind and solar technologies means that this transition is accelerating.

On the other, the worst fears of 12 months ago, when COP 22 in Marrakesh was greeted by the surprise election of Donald Trump to the US Presidency, have been realized. In May, Trump announced that he will withdraw America from the Paris Agreement because “it’s a bad deal for the US”. In procedural terms this withdrawal will take four years to complete, but one of the sub-plots in Bonn will be how the US delegation behaves: passive bystander or disruptive participant?

Bonn will make no major decisions. But it still matters for investors who want to better understand the scale, pace and implications of the low-carbon transition. At the high level, the most important takeaway will be whether this international climate show stays on the road. 2018 will be a more significant year: it will be the first occasion for the parties to come together to assess their progress against the national emissions reductions goals they submitted to the Paris Agreement. So COP 23 will be about finalizing the rulebook for this 2018 stocktake (known as the “Facilitative Dialogue”), and making sure the building blocks are in place.

On the geo-politics, the investment community should be reassured that no other industrialized country is following the US through the Paris exit door. On the contrary, although there remain tensions between developed and developing countries about how ambitious their national climate polices should be, the indications are that Trump’s climate stance has if anything stiffened the resolution of the rest of the international community to stick firmly with Paris.

Critically, this includes China; and all stakeholders will want to be reassured that China’s behaviour on the international stage is in line with the stream of domestic policy announcements and measures on decarbonization to have emerged in recent months.

Signals from financial policymakers and regulators are also key for investors. COP 23 may not have much to deliver on that front – although it’s worth recalling that the Taskforce on Climate-Related Financial Disclosures (TCFD) was launched by Mark Carney and Michael Bloomberg at the Paris COP two years ago – but it will be followed hotfoot by the international climate summit that President Macron is convening in Paris in December, to mark the two-year anniversary of the Paris Agreement. The French have determined to make climate finance the focus of this summit, and they are pushing for a number of announcements. It will be interesting therefore to hear what that summit says about the TCFD, perhaps the European Commission’s High-Level Expert Group on Sustainable Finance – and on bringing the Sustainable Development Goals into investor and finance planning, where there is something of a push. The summit will also help showcase the policy framework, symbolized by the Energy Transition Law, the French are adopting on climate and transition risk disclosure.

COP 23 isn’t all about policymakers, of course. A developing theme in recent years has been how investor coalitions have used the COP to launch initiatives. We may for example hear from the PRI and UNFCCC and their work and engagement on ESG in credit ratings; from the UN, World Bank and investors on developing blended finance vehicles and tools to contribute towards the sustainable development Agenda 2030; and from the Sustainable Stock Exchanges (SSE) Initiative on their new “Guidance on Green Finance”. Green and sustainability bonds will remain high on the COP agenda; as well as the financing of sustainable infrastructure, including at cities and municipality level. Individual corporates may wish to use the meeting in Bonn to highlight the progress they are making with TCFD and SDG commitments in relation to strategy, disclosure, governance, targets and metrics.

Which is a long way of saying there’s a lot going on. Investors should stay firmly tuned over the next few weeks. See you in Bonn – or Paris.


(This article was also published in RI news on the 6th of October 2017)


How policymakers can drive the TCFD agenda, with Europe in the driving seat

As published on Responsible on the 12th of September 2017

The EU’s HLEG recommendations can dovetail with other regulatory changes to back up the climate reporting shift.

There has been extensive commentary on the work of the Taskforce on Climate-Related Financial Disclosures (TCFD), first on its formation and then on its recommendations, which were presented in final form to the G20 in Hamburg in July 2017.

In short, the TCFD is a big deal; and the reaction has served to emphasise that following the watershed Paris Climate Agreement in December 2015 change is underway in the financial community, as it is for other parts of the economy affected by the climate and energy transition. Less considered is how policymakers and regulators can help drive this key agenda relating to disclosure and climate risk.

The first point to make is that the TCFD’s genesis is policy-based. It was the G20 who first pulled the trigger in 2014 when its finance ministers met. Following their initiative, Mark Carney, as FSB Chairman, and fresh from his own high-level interventions on climate change and the “tragedy of the horizon”, approached Michael Bloomberg about establishing the Taskforce.

It has therefore come full circle for the TCFD to present their report to the G20. But there’s a problem. Although taskforce members themselves have indicated that their recommendations are aimed as much at policymakers and regulators as they are at the business and finance community, the G20 now doesn’t know exactly what to do with the report.

The G20’s July communique carried only a reference to the TCFD report, and made no attempt beyond that to take it forward, either directly or indirectly. The primary reason for this is quite simple: the depressing reality of US federal climate policy in 2017, and how that has spun on its axis since 2014 when a rather different US administration was in office.

To be clear, even if Obama (or Hillary Clinton) had been in office, there would have been limitations on the G20’s mandate to direct action on the TCFD report. But with US international climate policy under Trump playing unwilling participant or blocker, the G20’s political will in this area is fractured. Those who advocate making the taskforce recommendations bite therefore need to look elsewhere if policymakers and regulators are going to act.

The EU – or European countries – have for some time looked the most likely candidates to carry the TCFD torch. This is not only because of the leadership shown by senior figures such as Carney. The last 12 months have demonstrated that even if they were initially late to the game on the implications of climate risk for finance and investment, the European Commission now really seems to have grasped it. The catalyst was Financial Services Commissioner, Valdis Dombrovkis, the former Prime Minister of Latvia, fresh from his appointment in the summer of 2016, and his decision to add substance to the deliberations about climate finance in the Capital Markets Union (the Commission’s flagship finance initiative under President Juncker) by appointing a “High-Level Expert Group” (HLEG) on sustainable finance.

The HLEG has just published its interim report, prior to a final report that will go to the Commission at the end of 2017. The signs, in the report’s ambition and scope, are promising. The interim report carries unqualified endorsement for “clear, comprehensive and comparable” disclosure of information, and it cites the need for forward-looking analysis on how portfolios are aligned with the transition. On the latter point, proponents of a stronger disclosure regime are highly supportive of scenario analysis, where corporates (and possibly financial institutions) run publicly available assessments about how they will tackle the climate and energy transition under different policy and technology scenarios. This constituency will therefore welcome the report’s positive reference to scenario analysis (specifically giving climate-related disclosures in the energy or extractives sectors as an example).

A key point about the HLEG is that it will be reporting into a regulatory environment that offers opportunities for incorporation into existing or promised initiatives. Two such possibilities are the EU’s Prospectus Regulation and the Non-Financial Reporting Directive (NFRD), both of which deal with aspects of corporate reporting. The updated Prospectus Regulation, having entered into force very recently, has now been passed on to the relevant EU-wide body ESMA (the European Securities and Markets Authority) which will draft guidance, including possibly on what factors should be publicly disclosed as material factors in company prospectuses. The NFRD does what it says on the tin, laying down the rules on the disclosure of non-financial information by large companies. It has been criticized for its lack of specificity and that it risks placing ESG information in a silo. But it is being reviewed in 2018, and there will be pressure on the Commission to take account of HLEG proposals in the review.

That said, there will inevitably be challenges to what the HLEG recommends, and investors (corporates and financial institutions) will need to be alert to signs of push-back from opposing interests: e.g. business coalitions or national regulators who are unenthusiastic. The IHS Markit report in May which questioned the TCFD recommendations on scenario analysis – on the grounds that it could undermine efficient capital allocation – demonstrates how progress may not be straightforward.

It is also worth noting the potential for other international bodies to push forward policy and regulation on climate-related financial disclosure. IOSCO (the International Organisation of Securities Commissions) is essentially the international equivalent of ESMA and, although it may not have the regulatory mandate that ESMA has inside the EU, IOSCO wields considerable influence in setting standards for capital markets. It would therefore be surprising if this organization has not been prompted by the TCFD report to examine the climate disclosure agenda.

The other field that investors must monitor is national regulators. Again, we probably come back to Europe – and especially the French and German financial regulators (the AMF and BaFin respectively) – as those most likely to move. Still feeding off the post-Paris momentum and energized by their new President’s ambitions to do more on climate, the French have their Energy Transition Law – which inter alia strengthened carbon disclosure requirements for listed companies – to build on. The German Government would like to have done more with the TCFD report at the recent G20 summit; the question is whether they and their regulators will want to push on with the agenda once the German election is out of the way.

Franco-German interest also poses the question about how active UK policymakers and regulators will be. The UK Treasury and the Corporation of London would like the City of London to be the global green finance hub – witness the Corporation’s Green Finance Initiative. But there must be a concern that, with Brexit demanding so much time and attention, UK regulators are too preoccupied to be in the vanguard. It can’t help that the British Government is losing influence in Brussels, which is most disappointing when taking into account all that the Brits have done to drive forward the EU climate and energy agenda. Against this background in Europe, it would be no surprise to see a dynamic develop between EU-wide action and the priority accorded by the most progressive regulators. This brings us back to a core question: can government make a difference on this agenda through a pro-active approach; and do investors actually care about the policy and regulatory implications and developments?

In Conclusion

TCFD members, based on the track record of taskforces of this kind, are confident that business and finance will act on their recommendations. That seems reasonable. Peer pressure can be powerful, and a combination of action from the most forward-thinking companies and shareholder initiatives (e.g. on AGM resolutions) can help push things forward.

The HLEG’s emphasis towards a sustainable financial system through integrating ESG factors fully into financial decision making is also highly encouraging. In line with this, HLEG’s advocacy for harmonization of acceptable definitions and frameworks around ESG and sustainable finance at EU level addresses something that has plagued and hindered the scaling of the sustainable and responsible finance industry globally.

However, although there is undoubtedly rising interest in climate risk among the investor community, caution and a view that climate change is tomorrow’s problem rather than today’s (in effect, reinforcing Carney’s fears about the tragedy of the horizon) can still be strong restraining factors. Likewise, regulators can be cautious beasts. There are therefore risks that investors and regulators will hold each other back, which could undermine an orderly climate and energy transition. In short, more national regulators will probably need to stick their necks out and show some leadership; and investors – who are advised to stay fully on top of the policy agenda, above all in the EU (think for example about responding to the HLEG consultation in train) – would be advised to engage with governments: it’s always more productive to try to influence change than be a passive bystander.