Financial institutions are underestimating their climate-related risks and are also underreporting portfolio emissions, according to the CDP report The Time to Green Finance.
It found the sector is underestimating climate risk as most only identify direct operational climate-related risks, such as physical damage to their operations (41%). The vast majority are not yet reporting credit risks (65%), such as borrowers’ default on loan repayments and market risks (74%), such as stranded assets and financial asset price devaluation.
The report said these credit and market risks identified have a much higher reported potential financial impact of up to $1.05trn between credit risks and market risks, and meanwhile, some banks, asset owners, asset managers and insurance companies have not yet identified risks in their financing portfolios, which will have a more significant impact than those in their own operations.
Furthermore, less than half of banks (45%), asset owners (48%) and asset managers (46%) report taking action to align investment portfolios with a well below 2-degree Celsius goal, and just 27% of insurers are doing so for underwriting portfolios, an indicator they are underreporting portfolio emissions.
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Overall, just 25% of the 332 financial institutions disclosing in 2020 through CDP’s first financial services climate change questionnaire reported on their portfolio emissions, as it said the sector must take further actions to align portfolios with a net zero carbon economy with clear short- and mid-term science-based targets.
Emily Kreps, global director of capital markets at CDP, said: “The financial services sector is critical to achieving a net-zero carbon future. The real economy transition will require a massive amount of capital directed at decarbonizing the economy and enhancing resilience, which only the finance sector can facilitate and provide. As regulators move towards mandatory disclosure – CDP, with its 20+ years of providing comparable and TCFD-aligned environmental disclosure data to the capital markets, is ideally positioned to assess the global finance sector’s readiness to respond.”
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The CDP report suggested financial institutions can create a “feedback loop” to decarbonise portfolios and enhance resilience of the economy as a whole and engagement with companies is a key part of this. The study found 46% of asset owners and 50% of asset managers engage, most commonly as active owners, while 82% of banks and 67% of insurers engage their clients on climate related issues, most commonly to educate clients about their own climate strategies and sustainable finance products.
Time to ‘step up’
Nonetheless, finance firms “definitely see opportunities for returns”, said the report, on financing the transition to a low carbon, deforestation free, water secure future: 76% see opportunities in offering sustainable finance products and services including sustainability-linked loans, green and transition bonds, sustainable investment funds and insurance solutions. They indicated a potential financial impact up to $2.9trn. There are indications these opportunities could be realized, with potential impact outweighing the cost to pursue for most opportunities.
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The report urged the financial sector to “step up”.
“Every company, in every sector, has a part to play – such is the scale of change needed,” it said. “What is required is, yes, green finance; but also, for finance to become green. Financial institutions’ largest climate impact stems from the activities they enable through their loans, investments and insurance underwriting. It is these financing portfolios that must be aligned with 1.5 degrees Celsius world, for financial institutions to continue to thrive. With so much long-term capital still being directed at fossil fuels, and our time and carbon budget running out, the sector must act now. Financial institutions that do not align their portfolios face enormous risks, including from stranded assets.”
Banks have become under increasing pressure to phase out funding to fossil fuel companies and in January, fund groups Amundi, Man Group and Sarasin & Partners were among 15 institutional investors with combined assets under management of $2.4trn that filed a climate change resolution at HSBC, alongside 117 individual shareholders.
By March, HSBC agreed to vote on a resolution that will commit the bank to phasing out the financing of coal-fired power and thermal coal mining. More recently, however, an investor campaign calling for Barclays, the biggest financier of fossil fuels in Europe, to tighten its policies on supporting these companies expressed its disappointment after just 14% of the bank’s shareholders voted in favour at the company’s AGM in May.
CDP’s Kreps echoed the calls for finance groups to do more: “For financial institutions that do not currently measure their financed emissions the message from this flagship report is clear – they must start doing so, now, to understand their overall climate-impact and the risks they face. We urge all financial institutions to commit to decarbonise their portfolios by setting science-based emissions reduction targets, aligning all activity with the Paris Agreement and disclosing the impact of their financing activities.”
