Dear Mr. Carney,
In your open letter in the Financial Times of Saturday, October 30, you declared that the world of finance would be judged on the $100 Trillion climate challenge.
Your COP private finance strategy has devised 24 significant initiatives to build a financial system in which every decision made takes climate change into account. To supercharge these reforms, the U.N. and the COP26 presidency have created the Glasgow Financial Alliance for Net Zero (GFANZ.) This alliance garners the most ambitious firms in every sector of finance from every continent. GFANZ also calls explicitly to an end of fossil fuel subsidies.
Your leadership in this space needs to be praised. There should be more leaders like you.
Yet, I would kindly challenge the ambition level of the Net-Zero Banking Alliance (NZBA), a group consisting of 44 of the world’s leading banks, and submit, in all humility, a set of guiding best practice principles.
There is concern about credibility (absence of greenwashing), accountability, transparency, and the apprehension that leadership and members walk the talk with every initiative.
These broader concerns take a grimmer character in the wake of the banking industry’s carbon footprint and the recent International Energy Agency (IEA) annual World Energy Outlook. IEA stated that achieving net-zero emissions by 2050 and keeping within 1.5 degrees Celsius of warming implies that expansion of fossil fuel development needs to be halted with immediate effect.
Additionally, the Financial Stability Oversight Committee (FSOC) in the U.S. has identified that climate change is an emerging and increasing threat to U.S. financial stability, which by extension represents one for global financial integrity.
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Earlier this week, you fully endorsed the Good Transition Plan, a best practice guide released by the Climate Safe Lending Network on how financial institutions can best navigate their financial institution towards net-zero commitment lending.
To address the accountability and transparency concerns regarding NZBA, I herewith submit the following ten best practice guiding directives for your review:
- $100 Trillion climate challenge
It would be helpful to document annually the member banks’ respective and aggregate financing ambition of the overall $100 Trillion climate challenge, now elevated apparently to $130 Trillion.
Of that determined amount, by when (2030, 2050) and how much respectively will flow into transition financing and decarbonization initiatives? Recommending bifurcated valuation and earnings disclosure for respectively transition and decarbonization efforts would shed tremendous clarity on opaque financial institutions’ balance sheets and profit & loss accounts.
As to transition financing, why not use the $4 trillion advanced by the banking industry to the oil and gas industry, per the Rainforest Network Alliance (RNA) disclosure, as the base for assessing progress in scaling down that sector exposure. Coming forward with precise detail would contain the critique that RNA is not pristine in singling out the decarbonization effort.
Concurrently, it would be advisable to offer a full look-through report given the industry’s evolving exposure to the non-regulated sector, especially the private equity and prime brokerage (hedge fund) industry players. The shadow banking sector is now actively and frequently procuring offset capacity to the banking industry.
Capital restructurings result from crystalized risk exposure to climate calamity triggered physical damage (at counterparty level) and client-centric transition exposure risk. By some estimates, $22 trillion is a crucial variable in the stranded asset equation.
What magnitude of the $100 Trillion climate challenge will be needed to bolster the bank’s capital restructurings? This question may warrant an iterative conversation with the investment managers and asset owners represented in your broader GFANZ coalition.
The timing of the aggregate flows is crucial concerning the set ambition to half greenhouse gas emissions by 2030 and be carbon neutral by 2050.
Detail of these commitments is fundamental to discern and potentially accelerate the stated level of ambition, given the climate change imperatives.
- Price Differentiation for Carbon Intensity
The overall capital and bank lending allocation process still takes place in a fully carbon agnostic mode. Fairness opinions are still signed off, totally oblivious of potential value erosion triggered by trend reversal in carbon asset pricing.
Should the principle of carbon agnostic banking pricing not be revisited and removed in 2021? How could NZBA incite its alliance members to initiate pricing differentials per the carbon intensity footprint of its clients?
This could happen at a minimum capital adequacy requirement (CAR) of 10.5% (Basel III) for nimble carbon exposure and building up from there for more carbon-intensive customers. To be fully aligned with the IEA, the risk weight for new oil and gas exploration should be calibrated at 1250%, equivalent to pure equity financing. Such notion has also been initiated in the one-for-one-rule proposal articulated by Benoit Lallemand.
The recommendation would be visionary to trigger decarbonization momentum, build up reserves for a future stranded asset base, and anticipate prudential regulatory guidance.
- Climate change disclosure
There is still extensive dissonance between banks’ Net Zero Commitment announcements and their respective own climate change disclosure compliance.
It is fair to state that the challenge is steep: TCFD, CDP, Science-Based Targets, imminent SEC Climate disclosure standard….
Your leadership could shepherd NZBA to disclose each member bank’s climate change disclosure record.
The peer pressure could generate enhanced commitment as the sector is plagued overall by poor quartile performance. For example, regarding TCFD standards, the banking industry yields the lowest percentage of disclosure for climate-related targets across all global industries. With only 19% of firms meeting TFCD standards, the industry is an absolute laggard compared to the energy and transport sectors, where compliance stands at 44% and 35%, respectively.
- Governance processes
The financial institutions’ governance is still heavily influenced by board seat representation from the oil and gas industry.
Could NZBA consider phasing out this sector representation given the embedded conflict of interest with NZBA climate ambitions?
On the other hand, could NZBA recommend inviting climate scientists to their boards to understand better the veracious nature of the risks faced and the appropriate mitigation paths to be considered? Asset manager Wellington Management already set the tone in 2018 by announcing a collaborative effort with Woods Hole research center to integrate climate science and asset management. Financial institutions could have their pick at the Union of Concerned Scientists. Such multidisciplinary approach might be very useful when interpreting emerging daily information from Earth Hq, a situation room for the planet administered by a team around Johan Rockstrom.
- Solvency and Stress Testing
The average Capital Adequacy Rate for U.S. banks stands now at 15.3%.
Until robust climate stress testing models have been developed and reviewed, it would be cautious to aim for an average Capital Adequacy Rate of 18% for the U.S. Banking sector by 2030. This preliminary ambition should be shared with the Basel Committee and its constituents to ensure a global level playing field. This level of adequacy would substantially remove moral hazard regarding climate risk. It would also temper past and the anticipated volume of share buybacks and dividend pay-outs.
- Profitability and Carbon-Adjusted EPS
Banking business models will most definitely undergo substantial transformation. Imminent regulation, institutional investor advocacy, changing customer preferences, climate technology innovation, magnitude of distressed and stranded assets, along with, unfortunately, unintended crises conditions, will accelerate this dynamic.
To ensure bank’s capital deployment lines up with their net-zero strategies, there is a need for comprehensive and granular, third-party certified, see-through reporting of scope 1, 2, and 3 greenhouse gas (GHG) exposure.
Could NZBA propose earnings disclosure, including the cost to offset GHG?
Best practice should distinguish earnings pre- and post-carbon offsets combined with a carbon price derived from the largest regulatory carbon exchanges (ETS).
Liquidity is the ability to meet both contractual demands in a timely fashion combined with sudden, unexpected (climate change driven) demands without incurring substantial costs. It is a bank’s acumen to monetize assets seamlessly in the absence of any transaction loss.
In complete alignment with NZBA’s ambition and congruent with the IEA’s and FSOC’s risk concerns, could NZBA recommend liquidity buffer guidance?
Could NZBA endorse the best practice of selecting and retaining non-correlated (with climate change) carbon-free assets for the liquidity buffer composition to meet the Basel imposed Liquidity Coverage Ratios (LCRs)?
- Executive Compensation
C-suite compensation is all too often still primarily a function of share price developments. Could NZBA best practice be issued to make compensation explicitly function of the carbon-free revenue footprint along with progress on the net-zero financing commitments? A genuine start would be to recommend variable and long-term executive compensation due to progress in the carbon-adjusted EPS (see higher) trend line.
- Ethical code of conduct and Membership engagement
Banking leadership, akin to the medical profession, should be guided by the Hippocratic “Do no harm” and, by extension, “Leave no (carbon or waste) footprint” principles. Given NZBA’s commitment to consider climate change into every decision, how could the alliance be governed in the interest of the “common good?” How could this ambition be endorsed by protecting and regenerating a pristine environment, honoring justice and fairness, and ensuring equal opportunity for all while generating a sustainable return? The work of John Fullerton on the regenerative finance framework could be a source of inspiration.
Could these ambitions be articulated in an NZBA ethical code of conduct?
And more importantly, what would non-compliance to ambition levels and ethical standards mean in terms of NGAZ membership?
Is there a price to pay for free riding the NZBA alliance?
- NZBA annual reporting
It would be proper under your leadership to pair the announced ambition with an annual reporting update on how the members as a whole and individually perform against key performance indicators during the year and in time.
The absence of such performance benchmarking would relegate the alliance’s intent to a mere marketing stunt.
It may seem unfair to submit your leadership initiative with such demands. Yet banks need to contribute to reducing emissions by 7.6% every year throughout this decisive decade to meet the 1.5 degrees C. target.
And you offered: “… look at what your banks do, not what they say….”
There seems little alternative given your members’ money-creating capacity along with their dominant agency in markets and society.
We need your leadership and we count on you.
In full gratitude for your vision and initiative in this space.
Frank Van Gansbeke
A concerned private citizen
The author would like to thank James Vaccaro for his extensive review and comprehensive comments to the above.