We expect six key trends to inform financial institutions’ climate strategy design, implementation, and reporting this year.
The 2020s have been termed the “decisive decade” for climate change. As we enter the fourth year, what should the climate finance space focus on in 2023?
At the Center for Climate-Aligned Finance (CCAF), we expect six key trends to inform financial institutions’ (FIs’) climate strategy design, implementation, and reporting this year.
1. The Rise of Transition Plans
Last year marked a move from long-term to short-term target setting. Of the 30 largest banks in the United States, Canada, and Europe, 26 have now published2030 emissions reductions targets. The question remaining is: what strategies will these firms follow to achieve their goals?
Recent guidance from GFANZ defines a net-zero transition plan as a “set of goals, actions, and accountability mechanisms to align an organization’s business activities with a pathway to net-zero.” We expect that many firms will publish transition plans in 2023, and that this will become a baseline for credible climate planning and reporting for both corporations and financial institutions.
In CCAF’s latest insight brief, we proposed a “portfolio-led approach” to strategy design (including transition plans), implementation, and reporting using a four-part framework to assess where — through sectors and geographies — and how — through asset classes and business units — banks can best support the real-economy net-zero transition.
2. Where “Woke” Meets Fiduciary Duty: The Debated Future of ESG
The past year saw an unprecedented backlash against ESG (environmental, social and governance) investing. This is unlikely to change in 2023, with Republican lawmakers in the United States threatening legislation and penalties for investment firms that incorporate ESG factors, including policies on climate change. While critics decry ESG as “woke capitalism,” businesses and investors increasingly recognize that climate change is having — and will continue to have — material financial implications. FIs will need to move past the political bluster and firmly demonstrate how ESG and climate-related efforts are vital to prudent investment risk and return decisions.
3. Shifting the Energy Balance: Renewables Grow as Fossil Fuels Plateau
Even with uncertainty across the global macroeconomic environment, the narrative that clean technology is good for the economy rather than costly turned mainstream in 2022. The US renewable energy sector is expected to continue growing in 2023, in part due to incentives included in the Inflation Reduction Act. Elsewhere, Indonesia committed to wean itself off fossil fuels and speed its transition to renewables with $20 billion in financing, and H2 Green Steel closed €260 million in equity financing to start building the world’s first large-scale green steel plant. Although deal pace slowed slightly in early stage venture capital last year, investors believe that climate tech is more insulated from market slowdowns than other sectors, and is expected to attract investment through economic uncertainty.
Beyond noteworthy deals, the total amount of capital deployed toward climate finance also continues to increase. Bloomberg noted that 2022 saw the “best-ever first half for renewables investment,” with an estimated $226 billion deployed into new renewable energy. We’ve also seen global demand for fossil fuels plateau. As a result, capital re-allocation toward renewables is likely to continue and accelerate in 2023.
4. Climate Learning Curve: Accelerating the Talent Transition
As FIs expand their climate products and services, they are hiring climate scientists and other experts to join their sustainability teams. However, sustainability knowledge cannot remain siloed in sustainability teams if firms are to take a holistic, portfolio-led approach to the design, implementation, and reporting on net-zero activities across sectors, geographies, asset classes, and business units. In 2023, we therefore expect to see efforts to upskill existing front-office employees. This could include promotion of external certification or in-house training. NatWest was ahead of the curve in April 2022 when it announced a £1.5 million, three-year deal with the University of Edinburgh to deliver climate education to 16,000 employees.
5. All Eyes on Greenwashing
New and refined standards and regulation, as well as client scrutiny, will raise expectations on fund-labeling, disclosure, and climate-related risk management practices in 2023.
Mislabeling funds as ESG now has serious consequences, with the US Securities and Exchange Commission (SEC) suing financial institutions, including BNY Mellon for $1.5 million, on related issues. This year will see a further tightening of the rules. For example, the Financial Conduct Authority has proposed a package of new measures including investment product sustainability labels and restrictions on how terms like ESG, green, or sustainable can be used, with final rules due by mid 2023. The SEC has consulted on similar regulation, the Fund Names Rule, that would require ESG-labeled funds to have exposures of at least 80 percent to ESG assets.
Climate and ESG-related disclosure will also see new rules and standards come into play. The SEC is expected to finalize its climate disclosure ruling in 2023, and voluntary standards will further be bolstered by the expected publication of the International Sustainability Standards Board guidance.
We will also likely see further integration of climate risk in the global financial system as international and domestic regulators continue to hone climate risk management principles and best practices that entities such as the Basel Committee, the FDIC, and the OCC published in 2022.
6. From Financed Emissions to Transition-Relevant Data
Consideration of climate risk and net-zero transition has accelerated in the past few years, but financial decisions are still largely driven by business-as-usual incentives and backward-looking data and models. As FIs move from net-zero strategy design to implementation in 2023, firms will need to look beyond setting financed emissions baselines and targets to intentionally steering portfolios in line with climate goals by supporting the transition of high-emitting companies and financing climate solutions. Identifying, accessing, and using transition-relevant data could help close this gap by directing financial flows toward the areas of the economy that need the most support to mobilize and accelerate transition solutions.
One example is the standardized data inputs and methodology agreed on as part of the Sustainable STEEL Principles (SSP), a climate-aligned finance (CAF) agreement for the steel industry. Under the SSP, participating banks assess and disclose the climate alignment of their steel portfolio via a climate alignment score for each steel producer. The methodology weighs emissions based on the company’s metallic input mix and applies a fixed boundary for emissions accounting, ensuring accuracy and comparability across both primary and secondary steel production. CCAF is developing other sector-specific methodologies to efficiently use transition-relevant data in other hard-to-abate sectors. We expect to launch an aviation CAF agreement in 2023.
What’s Ahead: Keep Calm and Carry On (to 1.5°C)
FIs — particularly in the United States — will likely have to navigate some political and economic headwinds this year. Nevertheless, they must finalize their strategy design and transition planning, scale their net-zero-aligned implementation, and enhance their climate-related reporting — or face harsher regulatory and reputational penalties for failing to do so.