Shifting Climate Scenarios Muddy the Picture for Investors

(Bloomberg) -- For investors struggling to get a clear read on how banks are delivering on their net-zero pledges, changes to climate scenarios made necessary by shifting realities may further complicate the picture.

Most major banks in Europe and North America have followed the same playbook for net zero: make an overarching commitment to eliminate net-financed emissions by 2050; then determine which are the most carbon-intensive parts of the loan book and set shorter-term targets (typically for 2030) to reduce emissions when lending to those sectors; and third, add more sectoral targets covering an ever-increasing share of the balance sheet.

A fourth stage may be adjusting those targets as the path toward net zero changes. Chief among those changes are forecasts that include unexpected increases in coal and oil use over the coming years.

Just last month, HSBC Holdings Plc spelled out what these adjustments might look like. The London-based bank said its sectoral targets, which cover its financing for cement, real estate, oil and gas companies and more, “will need to be refreshed periodically to reflect updated 1.5C-aligned scenarios for achieving net zero by 2050.” Those targets must “keep pace with science and real economy developments,” the company said.Each scenario that envisions a path to net-zero emissions by 2050 comes with a variety of assumptions. They include the rate of deployment of new emissions-cutting technologies, policy and regulatory developments, changes in consumer behavior and the quantum of carbon removals.

HSBC chose the International Energy Agency’s Net Zero by 2050 scenario as the foundation of its interim targets. The scenario was first released in 2021 and then updated last year to reflect the impact of the global energy crisis caused by Vladimir Putin’s war on Ukraine.

The IEA’s revised scenario aims to take into account both record energy-related carbon dioxide emissions as well as the rapid development of clean energy production. The revisions have numerous implications for the companies that HSBC finances.

For example, the forecast for coal demand in 2030 was increased by 32% in the 2023 scenario from where it was in 2021, while demand for oil was predicted to be 8% higher at the end of the decade than previously estimated. Additionally, the updated scenario resulted in expectations for emissions reduction from the aviation industry to be lowered due to the short supply of sustainable fuels.

“We can’t stay in the 2021 view of the world,” said Celine Herweijer, HSBC’s chief sustainability officer. “We can’t choose a pathway that is several years out of date and just stick to it. We will need to keep looking at how the net zero-aligned scenarios are evolving.”

In some good news, IEA credited electric vehicles with “an even more prominent role” in its 2023 scenario, given the increase in sales and manufacturing.

HSBC said in its recently published transition plan that the bank expects to update its targets “following the release of new 1.5C-aligned scenarios” from the likes of the IEA and the Energy Transitions Commission, though no targets have been changed to date. 

Climate activists and advocacy groups pay particular attention to banks’ interim targets because they are the clearest indicators of how financial institutions are following through on their climate promises. Any changes are therefore closely scrutinized for any hint of greenwashing.

“Banks should ensure that their targets and disclosures remain consistent with the best available science, but it’s critical that they transparently communicate on any adjustments,” said Xavier Lerin, senior research manager at ShareAction, a UK-based nonprofit known for pushing climate-change resolutions at banks, including HSBC and Barclays Plc. “Failing that, banks could be seen as cherry-picking methodologies or making misleading claims about their net-zero alignment.”

Activists are on high alert for any indication that banks aren’t meeting their commitments. A recent report that said Bank of America Corp. was changing its pledge as it relates to financing coal mines was met with indignation in the climate community. 

More broadly, there’s also concern in some corners that climate scenarios used by finance firms are out of step with current climate science and downplay the level of risk brought on by rising temperatures.

Still, for Anna Moss, senior sustainability analyst at Abrdn Plc in Edinburgh, the fact that net-zero scenarios are being updated reflects an increasingly grim landscape.

“We have a shorter time period in which to achieve the same objective,” said Moss, who oversees the asset manager’s climate scenario analysis. “And that means emissions declines across sectors necessarily become steeper.” 

While some sectors, like road transportation, may decarbonize faster than expected, others will do so more slowly. And to make matters worse, Moss notes that “the technology needed to decarbonize industry isn’t proven at scale or has barely made it off the drawing board.” 

“An orderly net-zero pathway is looking very unlikely,” she said.

Sustainable finance in brief

The European Union’s most stringent ESG rule to date may be thwarted by eleventh-hour German opposition to the plan. The EU was on track to move forward with the Corporate Sustainability Due Diligence Directive after December, when lawmakers and representatives of member states ended months of negotiations with a provisional agreement. Under the directive, companies would face civil liability for failing to address environmental and human rights breaches in their value chains. It also mandates climate transition plans. But Europe’s largest economy is likely to abstain from the final vote among member states, currently scheduled for Feb. 9, according to a person familiar with the matter. An abstention by Germany could prompt others to follow suit, eroding support for and potentially burying the legislation.

• The investment unit of Deutsche Bank AG will have to divest more than 5% of holdings in some ESG funds in response to new EU rules aimed at making sure such funds live up to their billing.
• Catastrophe bonds, which last year formed the basis for  the best-performing hedge fund strategy, have been delivering gains that trounce those of other high-risk fixed-income products. Now others want in.
• Banks including  JPMorgan Chase & Co., Lloyds Banking Group Plc,  NatWest Group Plc and  Standard Chartered Plc are adding new roles aimed at monetizing biodiversity through financial innovation.

More stories like this are available on bloomberg.com

©2024 Bloomberg L.P.