The election of President Joe Biden in the US and the fast-approaching COP26 have focused minds on the importance of taking concrete steps to tackle climate change. This week has been an important part of the build-up to Glasgow and has witnessed a number of important climate change events. The European Commission released its Draft Taxonomy Climate Delegated Act, under the Taxonomy Regulation. The US hosted the Climate Change Leaders Summit. The banking sector launched two new net zero initiatives. And the US, EU and UK have updated their emissions reductions targets.
Emissions Reduction Targets
The US used its Leaders’ Summit on Climate Change to announce a pledge to reduce its emissions by up to 52% on 2005 levels by 2030 (see blog). The EU announced that it would reduce its emissions by 55% on 1990 levels by 2030. Not to be outdone, the UK announced a plan to reach 78% reduction by 2035 (and including emissions from international aviation and shipping), building on the 68% reduction by 2030 target it will need to meet to comply with its Sixth Carbon Budget.
The ambition of the UK’s new target underlines the challenges inherent in making such drastic emissions cuts so rapidly. The UK’s new goal will require policy measures that not only completely green the UK’s power infrastructure, but will require a rapid shift in transportation and home heating: to meet its new target, the UK’s electricity production will need to be 100% zero carbon by 2035.
Carbon Border Adjustment Mechanism (CBAM)
The EU’s Climate Law (part of the regulatory framework for which is the Taxonomy Climate Delegated Act – see blog) puts it ahead of other big polluters. But the European Parliament’s resolution last month in support of the proposal to create a Carbon Border Adjustment Mechanism (CBAM) is an acknowledgement of the difficulties of being the first mover. Some EU Member States would prefer an international cap-and-trade carbon market compatible with its own system. But in the absence of such a scheme, the CBAM is a recognition of the need to protect the EU’s own carbon-heavy industry from competition from companies that may seek less regulated environments.
Recognizing that the measure would turn industry in many countries into potential targets of the EU’s trade measures, the US has urged the EU not to unilaterally take the measure, concerned that its lack of international support risked undermining efforts to persuade emerging economies to put forward new climate targets.
There is a second and potentially bigger concern – the potentially discriminatory impact of the CBAM. Without an approach which would permit positive discrimination for developing nations and grant them preferential market access, the CBAM could put those countries at a competitive trading disadvantage. Despite reticence amongst a number of Member States, the Commission seems likely to press ahead, warning that the risk of carbon leakage increases as the EU raises its climate ambition.
The Banks Step Up
The Basel Committee for Banking Supervision chose this week to step into the fray, offering to identify and plug potential gaps in the standards related to climate-related financial risks and in the data required to improve certainty. The Committee noted that this work could translate into capital surcharges for banks to better reflect the risks from climate change; accelerate the transition to a greener economy; or lead to amended supervisory guidance, scenario analysis, disclosures, or best practices for risk management.
In a sign that the US’ green relaunch is having a galvanizing effect on the international community, this week also saw the launch of the Glasgow Financial Alliance for Net Zero (GFANZ) initiative. Chaired by Mark Carney, the former Governor of the Bank of England, the Alliance includes 160 companies with a net worth of $70 trillion from 23 countries and including the 43 members of the Net Zero Banking Alliance.
GFANZ members have signed up to a number of commitments, including: setting targets to reduce the carbon content of their assets by 2030, in line with an overall goal of net zero emissions by 2050; devising “credible plans” for reducing their investment in high-carbon assets; diverting their investment towards low-carbon infrastructure and technologies; and improving data gathering. However, perhaps the most important undertaking is that – in response to concerns that some financial service companies claim to be ‘Paris compliant’ without having taken any concrete measures in that regards – the Alliance members will seek to prevent banks from “greenwashing” their commitments.
Although the formation of the GFANZ is a strong indication of the growing recognition of the central role that banks and financial services will have to play in reaching Net Zero by 2050, some Central Banks have put down warnings that there are limits to the requirements that can reasonably be placed on banks. The US Federal Reserve has so far shied away from calls to incorporate global-warming risk into stress tests that measure the capital adequacy of lenders. The Bank of England was also cautious about attempts to impose new capital safeguards on banks to protect against climate change risks, arguing instead that the focus should be on using policy to drive improved disclosure to promote progress.
The focus on disclosure was echoed by US Treasury Secretary Janet Yellen, noting that efforts to require companies to disclose their contributions to climate change was a “fundamental” step toward understanding the economic risks of global warming. Secretary Yellen called for climate reporting frameworks to be consistent across sectors and comparable across jurisdictions to help investors make informed decisions.
COP26 would seem to offer the tantalizing opportunity to agree a single, global green taxonomy standard. However, the fact that some jurisdictions are further advanced in setting their green finance policies risks a degree of tension with the potential global norms being developed by the International Financial Reporting Standards Foundation – the EU’s announcement of its own taxonomy for green investment labels this week is a case in point.
Although a common set of global green investment standards would be unlikely to become operational before in 2022, it would represent a major step forward in both encouraging companies to consider their investment profile and in avoiding the damage that allegations of ‘greenwashing’ cause to the sector. Even though the detailed negotiations to reach it are still formidable, the election of President Biden has made reaching such a goal politically imaginable.