Headspring Insight: COP26 & Sustainability with Silvia Pavoni
It is over five months since the 2021 United Nations Climate Change Conference, COP26, was held in Glasgow. Setting the global agenda for the next decade, world leaders made pledges to keep global temperature rises within 1.5oC, among other commitments on future actions around climate change and sustainability.
What was achieved at COP26, and whether it can be regarded positively or negatively, is highly contested, with many people looking at it as a missed opportunity, says Silvia Pavoni.
“Some of the announcements and thinking about deforestation, for example, were positive. But some of the targets set by governments fell short of having a real impact. However, it’s fair to say that for the first time the financial services sector was very much present, often driving the discussion and putting down commitments.”
“You can look at these with a cynical eye and think it’s easy to make big announcements surrounded by important government representatives and your peers. The real test is whether these companies and their finance chiefs are prepared to follow through on their commitments.”
“But it was interesting to hear the announcement in Glasgow about the creation of the so-called GFANZ.”
The Glasgow Financial Alliance for Net Zero is a global coalition of leading financial institutions in the UN’s Race to Zero that is committed to accelerating and mainstreaming the decarbonisation of the world economy and reaching net-zero emissions by 2050.
“We had many companies, many asset managers, asset owners, and banks putting their weight behind reaching net zero. In total those companies represent $130 trillion worth of assets. They say they are ready to come into action to reach those net-zero targets, although it’s still very early to see where we’re going with it. But it was an interesting sign of the discussion moving from governments to the private sector and now to financial services.”
Looking at the private sector in general, what are the main issues for companies? According to Silvia, transparency is a big topic, making sure that companies are held accountable and know what happens throughout their supply chains.
“European legislators tend to take a more monetary approach,” she says. “For example, the EU has put together a proposal that will hold companies accountable for human rights breaches that happen throughout their supply chains. But how do you go about tracking that information and ensuring that you disclose it appropriately – and then for authorities to be able take action to ensure that any breach doesn’t go unpunished? That’s one of the many challenges companies and legislators face. And then it goes further, looking at the way products are made, the packaging that goes around the product, the distribution channels.”
Europe is being prolific in introducing legislation. The EU taxonomy for sustainable activities (i.e. ‘green taxonomy’) is a classification system established to clarify which investments are environmentally sustainable, in the context of the European Green Deal. The aim of the taxonomy is to prevent greenwashing and to help investors make greener choices.
“That’s a big, big project,” says Silvia. “That taxonomy also comes with a disclosure element, so not only does it define what is green, it also tells you how to disclose it. And it’s important to look at other jurisdictions, not just the EU, that are starting to catch up. There is work happening in China around the green taxonomy. Clearly it is the biggest polluter in the world and, equally because of its size, China is potentially able to tilt things.”
Targeting financial services
What are the obligations, targets and challenges that the financial services sector will face on meeting environmental standards?
Some of the targets are self-imposed, says Silvia. But they also come from pressures imposed by investors, by shareholders and also by the public. “It would be a struggle to find a large company in manufacturing, or even in energy and financial services, that doesn’t have a policy that relates to environmental, social and governance factors – or a policy that drives towards net-zero.”
But for a financial services company, arguably the majority of the contribution to CO2 emissions comes from the money that is either lent to companies or – in the case of an asset manager – invested.
“It is really important for them to keep an eye on what they’re doing in this respect. A lot of financial services companies will have exclusion policies against working with certain companies operating in certain sectors. But they need to start asking questions of their business clients about how they manage their supply chains, what their environmental policy looks like, all the way to questions that would fall under the ESG pilot.
“Although highly polluting companies may be cut off from raising capital from banks that have these exclusion policies, they are probably still going to find other institutions that are willing to lend money or invest in them when there is a growing movement towards climate or green bond issuances.”
Critics will say there is more talk than action, Silvia Pavoni argues. But when it comes to complying with actual requirements from the regulators, they will face, for instance, financial disclosure regulation coming out of the EU: the sustainable finance directive, SFDR, looks at the way asset managers label funds to show the details and social elements of their ESG funding. This also ensures that it is followed up by action and avoids, in theory at least, greenwashing.
“And something super-important is happening in the accounting world. The International Sustainability Standards Board established by the IFRS Foundation will look at these elements and how to incorporate ESG sustainability factors into a reporting and accounting.
“But I think we’re a long way from the point where ESG lending or green bond issuances just become regular loans. We’re getting closer, although only a small step at a time.”
Towards a greener economy
In which sectors can a bank or asset manager channel capital that ultimately has the greatest positive environmental and social impact?
Energy is the more obvious one, says Silvia. “Because there is such a big need for renewable technology, to get to the stage where we can efficiently replace fossil fuels it would be good to push capital towards new companies coming up with green technologies. But when you’re thinking about transitioning towards a greener economy, incremental changes can happen across all sectors. So essentially it’s important to include all sectors in this kind of capital investment. It’s not a matter of shifting sectors but looking at the particular issues of where you’re lending, where you’re doing transactions, and actually see what you can do in those particular sectors.
“Nevertheless, there are ‘extreme sectors’ that banks are avoiding putting their money into: for example, fossil fuels extracted through highly polluting processes – Amazon oil has been the cause of devastating pollution and terrible consequences for indigenous peoples living in the Ecuadorian side of the Amazon rainforest.”
2030 … 2040 … 2050
What sense do we get about the timeframes that companies can reduce their carbon footprint and meet global climate targets?
“There is great pressure to bring the 2015 Paris Climate Accord targets forward, and we start hearing about 2030 and 2040 targets. For some, it is good to come up with a target because it tends to focus minds,” says Silvia.
“It is very easy for a corporate CEO or a politician to commit to those targets. But when you speak to the environmentalist groups, a lot of them are saying it is ridiculous to commit to something like 2050. But there is greater public pressure, greater pressure from asset owners – or from pension funds that enjoy a much longer time horizon – to tighten the knots on corporate commitments. That’s important and points to something that can really help turn things around: whether you have ‘patient capital’, being able to potentially take a little bit of a short-term hit, versus the ones that need to meet financial returns every quarter.
“Ultimately it depends on the level of commitment and investment that you want to put towards reaching those goals – and whether reaching those goals come with the trade-off in terms of financial returns in the short term. In the end we’re talking about positive investor pressure.”