SUSTAINABLE BANKING
WHY COAL IS STILL THE OLD GOLD
The role of financial institutions in net zero – Kiran Dhanapala
At the recent World Economic Forum (WEF) meeting in Davos, CEOs assured that sustainability remains a business imperative. Navigating the ‘net zero economy’ became more complex over the past year but proactive businesses that fast track value creation can reposition themselves ahead of their competitors.
Uncertainty is the new normal in what is a globally interconnected economy. Despite current geopolitical tensions however, there is global interconnectedness. Banks and other financial institutions are central to these links, and arguably the first to detect challenges and patterns for value creation.
Therefore, key decisions or events that can help prepare and shape the future of businesses are increasingly demanding the time and attention of chief executive officers. A range of potential risks and scenarios will need to be identified by them, and more time spent on strategic spotting rather than execution.
CEOs of financial institutions must be vigilant and proactive in the wake of rapidly imposed regulations.
Banking on sustainability to deliver a better outcome means they must take consistent action towards decarbonisation as part of board approved sustainable finance strategies. This requires investment as part of a global transition to a low carbon economy.
Decarbonisation by 2050, if not sooner, is a goal that requires substantial investments by all stakeholders.
And yet, banks in Asia are still financing coal – as highlighted in a recent BankTrack report. Most of the Asian banks surveyed had weak or nonexistent exclusions of coal in their investment portfolios.
The report highlights how banks are moving away from project financing to corporate financing and underwriting of coal. Several loopholes enable continued coal financing including for ‘captive coal projects’ (coal-fired off-grid plants used for heavy emission industries such as smelting).
Coal project developers are looking more to domestic and regional banks, and private equity investors, to finance them. However, there’s increased vigilance of banks on financing coal with reputational and litigation risks.
This transition has significant business opportunities for financial institutions in providing sustainable climate solutions, according to a recent Ceres report. It notes that in 2022, banks earned an estimated US$ 2.3 billion in fees on 580 billion dollars of green financing – in excess of fees for financing fossil fuel company debt.
It estimates that reaching net zero by 2050 requires an investment of US$ 275 trillion for low emissions infrastructure, which represents an unprecedented boom in climate financing for financial institutions.
The International Energy Agency (IEA) estimates that four trillion dollars in clean energy investment is required annually, between now and 2030, to reach net zero by 2050.
Transition finance is now a top theme after a commitment of US$ 30 billion was announced at the 2023 UN Climate Change Conference of the Parties (COP28), five billion dollars of which is for projects in the Global South.
The UAE will cap its returns for the fund at five percent and any returns above this will be redistributed to other investors as part of derisking to incentivise private capital to co-invest in projects. It is hoped that this fund will grow to US$ 250 billion by 2050 but remain short of the requirement for a global transition.
Transition finance involves the investment required to decarbonise high emitting and hard to abate industries – such as steel, shipping and aviation. It’s a huge opportunity for investors because of attractive risk adjusted returns. And it also focusses on the environmental and social impacts of decarbonisation, such as job losses and low tax revenue.
Scaling transition finance is challenged by a lack of standard frameworks and the use of taxonomy with multiple definitions. Transition funds are being launched by private equity players for clean energy, green technologies and decarbonisation of existing infrastructure.
Banks such as Barclays and Citibank are creating groups to advise clients on their strategies, and will facilitate transition financing for this purpose. For greater effectiveness and scale, the pooling of finances by governments and investors is also needed.
The EU’s Corporate Sustainability Due Diligence Directive (CSDDD) has a mixed record. It was criticised for not including the financial sector in due diligence on human rights and environmental requirements that are demanded of other industries.
However, Article 15 requires financial institutions (and all businesses) to adopt Paris aligned transition plans with clear reduction targets for financed emissions. Some view this as being stronger than the voluntary net zero pledges that banks make.
Nevertheless, financial institutions are exempt from civil liability and can’t be taken to court for noncompliance with climate goals. The world needs to see greater due diligence obligations by financial institutions to facilitate a decarbonised future.