The Big Smoke
The finance sector will play a vital role in determining whether the world will successfully transition towards a low-carbon, sustainable economy. As an important stakeholder to the world’s economic actors, the finance industry can exert enormous influence by aligning investment and lending activities with the goals of the Paris Agreement and engaging their clients and investee companies to do the same. While the UK financial sector’s national importance and its international reach is championed by the government and regulators, its ongoing role in financing the climate and nature emergency is not a matter of corresponding regulatory focus.
To date, neither the government nor relevant regulators have taken adequate action to address the global emissions financed and enabled by UK private financial institutions (FIs) and to ensure that they align their activities with the country’s climate ambitions and the goals of the Paris Agreement.
This report provides an indicative, up-to date assessment of the size of the global carbon footprint that is financed by some of the largest and most systemically important entities in the UK’s financial sector, in other words, the UK’s ‘financed emissions’. The analysis was undertaken using the market leading carbon accounting methodology from the Partnership for Carbon Accounting Financials (PCAF) which is underpinned by the greenhouse gas (GHG) protocol. This approach calculates the indirect (Scope 3) emissions of the reporting FI, currently covering the borrowers’ and investees’ total (absolute) Scope 1 and Scope 2 emissions (e.g. operations and offices) across a range of economic sectors.
The analysis was based on a sample of selected FIs to give an indicative representation of the UK financial sector, focusing on banks and asset managers. The fifteen banks were selected based on the Bank of England’s domestically significant systemic institution list from 2019, that evaluated banks based on core determining criteria (e.g. size, connectedness, economic importance). The asset managers are the ten which have the largest assets under management (AUM), are headquartered in the UK and made public disclosures enabling analysis. It is the first time we are aware of that such a holistic analysis has been completed based on data publicly disclosed by FIs using this approach.
Financed emissions are extensive
Our results show estimated carbon emissions associated with the FIs analysed amounted to 805 million tonnes CO2e (Banks: 415 million tonnes CO2e, Asset Managers: 390 million tonnes CO2e), based on year-end disclosures from 2019.
This is almost 1.8 times the UK’s domestically produced emissions. If the FIs in this study were a country, they would have the 9th largest emissions in the world– larger than Germany’s (776 million tonnes CO2e) and Canada’s domestic emissions (763 million tonnes CO2e).
The results demonstrate that the UK’s financed emissions are extensive, likely representing one of the UK’s most significant contributions to climate change. Yet, the indicative figures generated by this analysis should not be seen as conclusive or final and are likely a significant underestimate of the total UK financed emissions.
Legislation is needed
PCAF’s methodology does not currently include the emissions associated with insurance underwriting, the securities underwriting and advisory services of banks, or those in asset management assets classes other than fixed income and equity. This meant that while the asset managers included in this analysis together manage 86% of total UK AUM, only 39% was included in the indicative calculation.
Insurers were excluded due to the lack of public disclosure and external methodology to calculate their carbon emissions. Given the London market for (re) insurance is the largest globally by some margin, the carbon emissions enabled by insurance underwriting are anticipated to be substantial.
PCAF’s methodology also does not yet enable the incorporation of Scope 3 emissions of any underlying loan or investment in part due to substantial variation in the comparability, coverage and reliability of data. The exclusion of Scope 3 likely results in the overall indicative figure for this assessment being an underestimate and will result in a significant underestimate of the financed emissions in individual industrial sectors. This is particularly the case for those industries where Scope 3 dominates overall carbon footprint, for example, according to MSCI the Scope 3 emissions of the integrated oil and gas industry are more than six times the level of its Scope 1 and 2 emissions.
The exclusions of key financing activities and Scope 3 from even the leading carbon accounting methodologies present FIs, regulators and governments with a misleadingly positive assessment of their financed emissions and climate impact. Unless such gaps are closed when assessing financed emissions, the true extent of FIs exposure to carbon, and corresponding climate risk, will continue to be misjudged and underestimated.
These findings show that the government and regulators must not assume that a combination of voluntary high level ‘net zero’ pledges and increasing disclosure of climate risk by FIs will drive capital allocation at the scale and pace required to meet the climate emergency, without further regulatory intervention. Mandatory climate risk disclosure must be accompanied by mandatory transition plans to align financing activities with the goals of the Paris Agreement including the aim of limiting global temperature increase to 1.5°C above pre-industrial levels (the Paris Goals).
While disclosure is an important first step, elevating it to the status of regulatory ‘silver bullet’ is a flawed approach to climate change mitigation. It limits the consideration of climate change to the risks posed to the finance sector while ignoring the significant negative climate impacts enabled and financed by the industry. Fundamentally, it mistakes corporate climate risk management with alignment with climate outcomes, and overlooks larger macroeconomic systemic risks created by climate change against which investors cannot ultimately hedge.
Government has a clear role in setting a legislative requirement that all regulated UK FIs adopt and implement a transition plan that aligns with the Paris Goals. Regulators can then set out “a clear framework for what alignment with Paris means in practice for FIs, and set out the consequences for failing to meet the requirements”. In doing so they can ensure that commitments to Paris Goals are sufficiently ambitious and robust while providing an essential evaluation and enforcement mechanism.
They can also address gaps in data availability and accelerate the development of key methodologies, supporting FIs through the implementation process to meet their current high-level commitments. COP26 provides a unique opportunity for the UK to accelerate the adoption of financial practices that actively support the paradigm shift towards net zero and Paris alignment and begin to tackle globally financed emissions. Prior to the summit, we recommend that the UK government commit to the following measures:
• Legislation to require all UK regulated FIs to adopt and implement a transition plan that aligns with the 1.5°C goal of the Paris Agreement, the provisions of which should be guided by regulation, that is both flexible to evolving best practices for assessing alignment and in line with latest science.
• The development of specific requirements to be included within those transition plans and their supervision should be undertaken by the relevant regulatory and supervisory bodies.
• The transition plan would apply to all financing activities (lending, underwriting, investing, advisory services, and insurance underwriting).
• The transition plan would include interim emissions reductions targets that are in line with 1.5°C pathways with low or no temperature overshoot and not reliant on carbon dioxide removal and to be reported on an annual basis.
• The UK government should use its G7 and COP 26 Presidencies to encourage other countries to adopt this approach, by spearheading leadership towards the alignment of private finance sector with Paris Goals and creating international venues and mechanisms to take this commitment forward.
• The UK government should support the harmonisation and consistent implementation of an industrial classification across all reporting under Pillar 3 of the Basel Framework to increase transparency, comparability and granularity of disclosed data.
• The Treasury should report to parliament each year on whether financed carbon emissions for the UK regulated FIs has increased or decreased and whether this poses any systemic financial risks for the UK financial system.
In line with its updated mandate on climate change, we also recommend that the Bank of England:
• Ensure that climate-related risks and impacts are integrated into asset purchase schemes and the collateral framework; and
• Adjust the macroprudential regulatory framework so that climate-related risks and impacts are more accurately reflected in capital liquidity rules.