Laurent Babikian, joint global director of capital markets at CDP, explores specific actions that companies, capital markets and regulators must take to accelerate the transition to a net-zero, nature-positive economy
In recent months, the world has seen many corporate boards and financial institutions increase their commitment to sustainability goals. The discourse has moved on from “why” sustainability matters to “how” it can be achieved. Organisations across all sectors globally are navigating complex issues, such as how to measure value chain carbon emissions, interpret ESG ratings and apply standards.
While this momentum is encouraging, the world is not yet on track to meet the goals of the Paris Agreement to limit warming to 1.5°C. In fact, we are quickly running out of time to prevent disastrous levels of warming.
Companies, policymakers and capital markets all have a role to play in laying the foundations for systemic change, and their response should be coordinated at the international level.
Below are four key actions which must be taken by these various actors to accelerate the transition to a net-zero, nature-positive economy:
1. Financial institutions must assess their environmental impact at the portfolio level
All financial institutions, including banks, asset managers, insurers and asset owners must calculate and report on the full extent of their emissions. This means they must account for 100% of their financed (Scope 3) emissions integrating scopes 1+2+3 emissions of their portfolio companies.
CDP analysis has revealed that the financed emissions of global financial institutions are on average over 700 times larger than their direct emissions (Scope 1 and 2), which only represent 1% of total emissions.
Through failing to disclose the full impact of their portfolios, the majority of financial institutions are severely underestimating their climate impact. If we do not know the full extent of the financial sector’s carbon footprint, we cannot reach net zero by 2050.
There is currently a significant gap between the net zero ambitions of financial institutions, and the actions and transparency needed to achieve these ambitions. All financial institutions must set science-based emissions reduction targets for 2030 and 2050 in line with 1.5°C. One way to do so is through the Science Based Targets for Financial Institutions framework.
2. Companies must set 1.5°C aligned science-based targets
In order for financial institutions to meet their targets, they need a much larger universe of 1.5°C-aligned companies to invest in and lend to.
However, companies are still lagging in this area. Despite leading on climate action, only 13% of European companies are on a path to 1.5°C, suggesting that the rate in other regions is lower still. Linking CEO and executive committee remuneration to scope 3 emissions reduction targets will be critical to supporting alignment with 1.5°C.
Financial institutions must continue to engage their portfolios to disclose their environmental impact and set science-based targets.
Through engagement campaigns such as CDP’s Science-Based Targets campaign investors can accelerate the decarbonization of their portfolios and create a positive ambition loop between capital markets and companies.
Last year, investors with $29trn (€26trn) in assets asked the CEOs of 1,600 companies to set 1.5°C targets and we know that this engagement works. Following the 2020 campaign 54 new companies with emissions equal to Germany joined the Science Based Targets initiative – 8% of all those targeted by the campaign.
3. A global political carbon price is crucial
Underpinning all of this is the urgent need for a global carbon pricing regime.
For too long our economic theory has assumed that nature is free and its resources unlimited, both of which are false assumptions. The resulting economic indicators, such as GDP, do not account for the cost of nature to produce goods and services.
We must urgently and radically shift our economic thinking so that we’re able to achieve a net-zero and nature positive economy by 2050. We could start by taking into account the cost of negative externalities, such as a political price on carbon agreed by all.
The International Energy Agency’s 2021 World Energy Outlook found that in order to reach net zero by 2050, a carbon price of $250 per tonne must be applied for developed countries.
CDP analysis of corporate carbon pricing in 2020 found that the median internal carbon price disclosed by companies in 2020 was as low as $25 per metric ton of CO2e. This week, the carbon price on the EU Emissions Trading System market reached €93.
Raising the cost of carbon so that it more accurately reflects impact on the environment will send the right pricing signals, which will likely lead to a stock market correction. Analysis from Dutch asset manager Kempen Capital Management found that a global carbon price of $150 per tonne applied to scopes 1+2+3 of all listed equities is expected to cause as much as a 41% fall in global equity valuations.
While many sectors and companies driving net zero will prosper, the economy on average will be impacted by the cost of negative externalities. The adjustment variable on markets will most likely be a lower Return on Equity (ROE) than the current 12-15%. But if ESG is well integrated into investment strategies, without greenwashing, the Return on Impact (ROI) will increase and, in time, the Return on Investment calculated as ROE+ROI could be greater than 12-15%.
4. Global harmonisation of ESG reporting standards
2021 was a milestone moment for global ESG reporting standards, with the development of a global baseline for comparable reporting through the International Sustainability Standards Board (ISSB) and the European Financial Reporting Advisory Group (EFRAG).
This progress must continue. It is important that there is a global harmonisation of ESG reporting standards in line with the most ambitious approach in order to level the playing field across jurisdictions and markets.
Critically, ESG reporting standards must embrace double materiality. In other words, a company should report simultaneously on sustainability matters that are financially material, but also material to the environment, and people at large.
The bottom line is that unless markets re-allocate huge volumes of capital, the Paris Agreement is at risk. Now is the time for regulators, companies and financial institutions to make good on their commitments, disclose 100% of their financed emissions, and align their portfolios with a 1.5°C world. Time is running out to avert a climate catastrophe.