Beyond net zero: People, nature and climate

3 December 2021 - Nick Villiers, Director of CISL’s Centre for Sustainable Finance, reflects on the role of the finance industry in taking a more active and assertive role in supporting, enabling and accelerating the transition to a more regenerative economy. 

Embracing a ‘beyond net zero’ strategy means we have an opportunity to protect not only climate but people and the natural world. The collapse of our ecosystems, climate change and growing social inequity are interconnected challenges and that is why a safe future will involve us working now to protect and restabilize the global climate while conserving and regenerating nature so resources can be shared sustainably and fairly.

A ‘beyond net zero’ strategy requires the finance industry to look beyond net zero emissions taking an active and assertive role in supporting, enabling and accelerating the transition to a more regenerative economy — one that puts nature and society centre stage. While leading financial institutions will follow their clients in unlocking and accelerating action, without a widespread and proactive approach, both the sector and its customers will suffer.

Net zero: From commitments to action

The Intergovernmental Panel on Climate Change (IPCC)’s Sixth Assessment Report warned that some changes to the climate are now inevitable and irreversible, stating that even the most ambitious scenario sees us peaking at 1.6°C mid-century.

CISL welcomes the recent pledge at COP26 made by more than 450 finance firms, jointly managing US$130 trillion, to align their financing activities to achieve net-zero emissions by 2050. These commitments will need to be backed up by individual net-zero commitments and transition plans. Viable delivery mechanisms, including blended finance, and guarantees, will be required to ensure finance reaches emerging markets where it is most needed.

While global frameworks and pledges to tackle climate change are in place and ambition is increasing, there remains a stark lack of progress. Significant work is now required on implementation, including building transition pathways, measurement tools and development of new financial products, as well as widening the focus to areas such as net zero insurance underwriting and support for small and medium-sized enterprises globally.

Critical to a successful transition and to deliver against their commitments, the financial sector must also engage its clients, alongside its staff and industry peers. Financial institutions must recognize that some clients will require support and incentives to embed sustainability through their organizations. Building new forms of relationships with clients is necessary to create a transition pathway that co-creates sustainable products and services. Without broader collaboration across finance, net zero will be harder to achieve.

To drive the necessary change, staff at all levels of financial institutions need to build their understanding of what the transition to a sustainable economy means for their clients, as well as their own business.

Arguably even those who have made commitments or are currently demonstrating leading practice are in a zone of transition — no one is near institutionalization. The financial sector is trying to understand the current position and exposures before they start to map transition journeys for sectors and geographies. Critically, such action will require firms to move beyond viewing sustainability as an overlay or silo but embed it into financial decisions. Nor can they rely on small teams od sustainability experts but need o grow capacity across their business operations.

CISL works to address this need through a number of channels, including helping boards to understand the changing context and delivering a range of education programs for financial practitioners, including customized programs for senior staff in financial institutions. CISL’s Banking Environment Initiative also recently published a guide, Let’s Discuss Climate, to help client-facing bankers engage with their corporate clients around transition plans.

Beyond net zero: Adaptation and resilience

The IPCC report showed that net zero is an important milestone, but cannot be the final destination. We will be living in a warmer world, even with the most ambitious actions, meaning that investing in adaptation and resilience must be an urgent focus for the finance industry. In particular, that requires a focus on financing the adaptation of emerging markets, and learning lessons from action already taken in those markets.

At COP26, an agreement was made to double adaptation finance – this acknowledgment of the lack of progress on delivering the US$100 billion needs to be underpinned with swift implementation to enable vulnerable countries still to plan and deliver their adaptation and mitigation programs in earnest.

The recent floods in Germany and the wildfires in the US, Canada and Australia echo devastating climate impacts that have already been felt across some decades. As far back as the 1990s, South Pacific islands at risk from climate-related sea-level rise attended UN climate talks to share their knowledge and ask for action to protect their very existence. We need to address such existential threats that people and nature have long been facing and learn from them as we see a rise in their frequency and the increase in temperatures. Insurance has a long track record of understanding physical risks, and is using that modeling experience to better understand the impact of climate change across the world, as exemplified by ClimateWise’s Physical Risk Framework. This understanding must be harnessed and adopted by policymakers as well as the wider finance and business communities to drive investment in adaptation and resilience measures.

Beyond net zero: People and nature

Achieving net zero can no longer be considered in isolation. The climate crisis is a catastrophic symptom of a much deeper deterioration in society’s relationship with the planet’s systems and resources, and also the relationships within society’s own structures that are compounding inequality and injustice. The activities of the poorest countries and their communities have contributed the least to the present climate crisis and it is imperative the aid needed to support their aims of reaching net zero is made available. Everyone’s health, homes and livelihoods depend on a balanced and flourishing planet.

For finance, that means taking a broader view of transition plans — looking at the real sources of risk and opportunity that become clear when we factor in the social and environmental damage being caused by some economic activities and then aligning financial flows with real long-term sustainable value.

This includes supporting the mobilization of capital toward low-income countries, to meet the trillions that emerging economies and developing countries need to decarbonize and build climate resilience. It also includes building an understanding of how finance can support a nature-positive set of changes.

Over 50% of the world’s economy depends on fresh water, clean air or productive soils. Disruption of environment and society can impact negatively on the valuation of companies, products and services. CISL’s handbook on identifying nature-related financial risks contains a framework for identifying those nature-related risks to finance. We are currently working on a number of case studies to show how this works in practice, yet more work in this area by finance is urgently needed. By examining climate disruption impacts on people and nature, firms can act to negate disruption to their own underlying business.

By addressing three elements together — people, nature, climate — we will give ourselves the best chance of avoiding any catastrophic unintended consequences of the transition to a new economy. Despite all the significant efforts to reduce carbon, we must embrace a truly regenerative economy.

Better data and transparency for resilience

To enable us to move beyond net zero, we also need improved data and transparency to understand environmental and social impact of financing decisions, to drive more robust investment choices.

Finance needs to continue collaborating to build core principles, frameworks, data points and standards to better manage the climate, people and nature transition. CISL’s Sustainable Investment Framework enables users to measure the impact of an investment portfolio, with six metrics: three on climate and three on the environment. This framework is designed for use across all funds (not just environmental, social and governance funds) to understand the impact of an investment in the round. It is based on a transparent methodology and data, essential to build confidence and avoid greenwashing.

However, we also recognize that current levels of disclosure still fall considerably short of what is required to truly understand the impact of an investment. We welcome the range of initiatives to improve disclosure and bring forward industry-wide standards that will enhance comparability and simplify the reporting process for business.

Understanding the impact

Finance has a vital role in delivering a low-carbon economy in ways that create jobs and preserve nature. The finance agenda was pivotal from the start to the end of COP26 – the pledge from 450 finance firms to align their financing activities to achieve net zero by 2050 is indicative of both the scale and ambition needed, as well as understanding from the sector on its role to achieve this goal.

As we start to think about stakeholder capitalism, just transition and the impacts of our activity on nature and society, there are lessons to be learned from different forms of finance. Some approaches to finance, such as Islamic finance, understand that every financing decision has an impact on the world, and that considerations of that impact are required to ensure fairness and transparency. The ‘notion of stewardship’, or ‘Khalifa’, can be seen in financial responsibility when prioritizing respect for employees, customers, fulfilling obligations to shareholders and caring for the environment, and feels aligned with approaches such as stakeholder capitalism.

An understanding of the wider impact of financing activity is needed to build better decisions in all forms of finance.

We are standing at a crossroads, where we need to choose between a narrow and outdated methodology or embrace a more sophisticated decision-making and integrated pathway. If we do so, a tremendous opportunity for society and finance is there for the taking.

First published in Islamic Finance News, 30 November 2021