Members of the Finance Sector Expert Group for Race to Zero and Race to Resilience (FSEG) are seeking feedback on a suggestion that financial players use metrics that “better distinguish real world impact from virtual emissions reductions as a result of portfolio reallocation”.
In a discussion paper, the authors also floated the idea of a framework based on the Task Force on Climate-related Financial Disclosures (TCFD) to help investors and others drive positive climate-related change.
According to the authors, who are four members of the FSEG, market participants and others are highlighting that some actions to decarbonise portfolios, such as rebalancing away from fossil fuel companies into technology companies in listed equity portfolios, may not necessarily be aligned with actions required to decarbonise the economy.
The authors also point to growing literature on what it means to have impact through finance and investment, saying that, while deploying different terminologies and concepts, the literature focuses on the key distinction between the concept of ‘impact-alignment’ and ‘impact-generation’.
The former, they said, does not necessarily create impact, especially in the case of secondary market transactions in large public markets. At the same time, they said “we are not claiming that impact-alignment cannot create impact, merely that impact-alignment is not necessarily sufficient to create impact”.
They also emphasised that the topic of net-zero finance and impact is nascent and evolving, and “therefore this paper is merely designed to inform discussion and invite wider contribution rather than set out any definitive framework”.
On the path to allocating impact causality, responsibility
On the topic of metrics for “real economy impact”, the authors acknowledged that allocating causality or responsibility of impacts and outcomes to specific actions is complex and that this makes it difficult for financial institutions to disclose their impact in a way that is consistent with the academic literature definition of “impact-generation”.
However, they said there were a number of approaches being pioneered in the market or developed in academia “that can represent meaningful intermediate steps”.
- Rebaselining of emissions/alignment disclosures to distinguish ‘virtual’ changes from real world outcomes;
- Disclosure of primary versus secondary market transactions to better understand the extent to which direct financing is provided;
- Full disclosures of the universe of climate actions and impact case studies to better understand actions taken by the financial institution to realise impact outcomes and to inform academic research on the topic.
The first approach is one that the authors cite Sweden’s AP2 as having adopted in its 2020 climate report, in which it broke down the causes of the reduction in its carbon footprint, highlighting what was attributable to changes in company holdings (the bulk of the reduction) and what was attributable to changes at the companies.
The authors are looking for feedback on whether the overview of metrics they presented capture all relevant market practices, and whether people think certain approaches are more or less relevant than others.
They also posed the more overarching question of whether stakeholders think there is a need for financial firms to provide further information on how they will generate impact to support Paris alignment in the real economy.
As concerns their idea of a TCFD-based framework for impact generation, meanwhile, the authors said this could be one way greater focus could be placed on real-economy impact. It would involve retaining three of the TCFD’s four disclosure categories but replacing the ‘risk’ category with a ‘delivery’ category.
Feedback is being welcomed until 30 June.
The authors of the discussion paper are Ben Caldecott, from University of Oxford and chair of the FSEG, James Mitchell of the Rocky Mountain Institute, Matthew Scott of WTW, and Jakob Thomae of think tank 2° Investing Initiative.
The FSEG was set up in 2021 to advise on “consistent, fair, and rigorous” interpretation guidelines of the Race to Zero and Race to Resilience criteria for the finance sector. The UN-backed Race to Zero campaign was launched in 2020 and is stewarded by Nigel Topping and Gonzalo Muñoz, the UN High Level Champions for the UK and Chile.
The discussion paper can be found here.