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What COP26 means for financial services in the near-term

December 9, 2021

What COP26 means for financial services in the near-term

Wayne, you have been following the Glasgow COP26 UN Climate Conference closely. If you would need to take stock of what was achieved, what would you highlight?

Dr. Wayne Visser
Dr. Wayne Visse

Many sustainability advocates and activities are taking a position that COP26 has failed to deliver the expected results. I look at it from a different stand-point, in my view what COP26 achieved is getting a consensus around the key areas of work for the 196 countries who were represented.

World leaders agreed for the very first time to include in an international agreement to phase down fossil fuel to keep the 1.5°C target alive, making it an official global commitment. It sends clear signals to countries, to businesses, to cities that transition is inevitable and the speed of change will only accelerate.

Look for example at one of the biggest emitters, India, which committed that it will source 50% of its energy from renewables by 2030. This is wildly ambitious for a country with over a billion people.

Additionally, the COP really acknowledged the issue of climate justice. Developed countries who are proportionally more responsible for the climate change need to step up not only to release the yearly 100billion USD fund to help countries adapt that are on the front-line of climate change, but they may extend to compensate the loss and damage they suffer and will suffer in the future.

I think that the pressure from the market including pricing of commodities, policy pressure coming out of bilateral and multilateral agreements following the COP, social pressure from society and activist groups as well as technological breakthroughs will speed up the change and will make it accelerate faster than expected.

COP26 just turned decarbonisation from an elite sport into a global movement.

When you look at the agreements that were announced on reducing coal, methane, stopping deforestation, phasing down fossil fuels and on finance, they send very powerful signals that cross-sector partnerships, philanthropists, businesses and industry associations are committed to change. When you see it coming from all these different parties, it creates a change in the system.

If you look at how complex systems change, they need these positive feedback loops or reinforcing effects and that is what COP26 has done.

There are different estimations, but some say that 130 trillion USD capital needed to transition the economy into a low-carbon future. Where do you see the biggest challenges for the financial sector to act as a catalyst for change?

The Glasgow financial alliance is a collective of 450+ financial organizations that represent about 130 trillion USD assets under management (AuM), which is 40% of AuM globally. These 450+ organizations committed to fund the transition, so they can be held accountable. People will start to look at their portfolio more closely and start criticizing and keeping the pressure up. What it means practically for those banks, is that they have to go to their clients and ask them for their science-based net-zero plan.

Think about the ripple effects of all these big financial institutions going to their big corporate clients and effectively demanding this plan from them, and checking whether it is really science-based and credible. On the basis of what financial institutions will get back from those companies, they will have to make some difficult decisions to stop lending to those companies who do not have a credible plan to limit exposure. This will create a huge impact.

Barriers to transition

These companies, many of them are publicly listed, have shareholders that find it perfectly possible to make a lot of money invested in the fossil fuel industry. Those who are set in their ways and have expectations only for certain levels of financial performance and returns, will probably be reluctant to shift into new business models.

Some developing countries who are fossil fuel dependent are not wanting to move that fast and want to continue to exploit. They represent of course big lobby power that governments and financial institutions need to face. Governance of the countries or sectors can be a barrier if they do not have a strong law and framework.

On the other hand, financial institutions haven't yet skilled up in people who can understand science-based targets and ESG performance and translate them into risks and opportunities from an investment perspective.

Another barrier and at the same time an opportunity, now financial institutions need to find projects and companies to fund to make real on their promises. There is a lack of projects today that bring the solutions, because suddenly the demand will outstrip the supply. The standards are still a bit inconsistent; the Paris rule book is trying to sort this out to get common ways to measure sustainable impact, but there are still a lot of risks.

What makes things sustainable is going local e.g. micro-grids, but sometimes it makes it harder to scale. Especially big financial companies prefer big projects, e.g. where you build a mega solar farm that will give energy for the whole country, but from the sustainability point of view what we need is lot of little projects.

Brigitta Gyoerfi
Brigitta Gyoerf

We have spoken about the challenges for the financial sector in the light of the transition, let's talk now about opportunities as a first mover. Where do you think financial services companies should focus on to deliver more value and how they can overcome some of the challenges?

Financial institutions also have to invest to improve governance in the countries where they plan to invest. What came out of COP26 is how financial institutions might work together with multilateral development agencies and development banks, as well as with philanthropists to de-risk investments.

Recognizing that some of the countries are too risky and some of the technologies are in a too early stage, you can partner let's say with “Bill Gates Foundation”, which can put down X million USD for the first few years. Your bank needs to invest the rest, but you will receive a guarantee if it goes south that at least you get your money back as a commercial investor. It might unlock private sector capital.

There are real benefits if companies take a leadership now. Banks that take those sorts of decisions maybe getting completely out of fossil fuels, and they will be the ones who get the reputational benefits.

Finance can be the real engine of innovation. Look at the Glasgow Breakthrough Agenda, that commits to innovate in 5 sectors which are hard to decarbonize like steel, transport or agriculture. This is hugely significant.

“Convergence of enabling factors that will give more and more space for the financial institutions to make the bold changes that they need to.”

Fields of innovation

1. Fintech type innovation / Climate Fintech: bring solutions through financial technology that make it easier for people to access finance and to track risk and return based on sustainability impact using the full set of technology from big data and AI to blockchain.

2. Innovation around data: making it easier to get to the data and make the data accessible. We had a problem for many decades now that even though companies were reporting on sustainability for more than 30 years, it is not in a comparable and accessible way. We need to get the data in a format that the financial institutions can also use to assess risks and the sustainability performance of companies.

3. Innovation to scale solutions to reduce the impact: banks need to find those innovators and help them to scale. They can de-risk the investment by working with other financial players, or even working with coalitions of entrepreneurs like the Clean Energy Alliance. There is a lot of learning that can happen in between all of those innovators and startups. If the financial institutions can support these groups, in a way they can de-risk it for themselves.

4. Circular economy innovation: a lot of financial institutions haven't figured out how to move towards the sharing economy and lease type of models. They used to make their money by investing upfront, but what do you do when there is an ongoing service and some of the benefits may come later, there is still a lot of figuring out going on.

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Photo credit: Photo by Karsten Würth (➡️ @karsten.wuerth) on Unsplash