Banks, financial risk and our changing climate Opinion Article

Jun 07, 2016 - 9:00am

This article first appeared in ANZ BlueNotes on 7 June, 2016.

Kate Mackenzie
Manager, Investment and Governance

Climate change is now widely recognised as presenting potential financial risk. Investors and other financial agents must decide exactly how they respond and take advantage of the opportunities which might arise.
In contrast to some of the other broad changes under way, such as technological disruption and geopolitical shifts, there is a reasonable amount of empirical information about how climate change might affect investors and other financial agents.

However, taking a position is not possible if you don’t know what the exposure is. For this reason, financial institutions are increasingly being asked by shareholders to measure and disclose their exposure to carbon risk.

ANZ’S carbon risk

ANZ commissioned my organisation, The Climate Institute, to comment on its new carbon risk disclosures, released with its interim results on May 3.

We applaud the acknowledgement that climate risk should be measured and disclosed. But what do these disclosures tell us?

With respect to ANZ’s financed emissions disclosure, counting up the amount of greenhouse gas emissions ‘financed’ by a bank or other financial institution is a fraught and complex exercise. There have been attempts by industry-backed initiatives, third-party analysts and NGOs. Banks are complex.

However the big Australian banks are relatively simple creatures. Mortgages make up the majority of their loan books, along with the usual asset management, retail financial advice, insurance and superannuation.

Yet it’s clearly not straightforward to measure the financed emissions arising from being the lead arranger of a syndicated loan or underwriting a debt issue for a diversified company.

Principles of disclosure

Some basic principles for disclosure would start with a robust and transparent methodology. They would also require metrics that can be compared - both to industry peers and to one’s own previous and future performance. This both recognises shortcomings and potentially provides an incentive to continually improve

However, companies and institutions should be wary of being exclusively focused on relative performance or improvement. Ultimately it is the absolute amount of emissions that matter.

Mapping out scope 1 and 2 emissions from each sector, as ANZ does in its announcement, is a reminder some sectors are much bigger emitters than we might think. The total emissions from the commercial services sector, for example, are much larger than from mining or construction.

However, none of this data on emissions intensity by sector is specific to ANZ. It is derived from NGER (National Greenhouse Energy Reporting Act 2007) data - that is, it uses average scope 1 and 2 emissions from the sector, rather than the amount specifically financed by ANZ. This means there is no scope for ANZ to demonstrate it has improved in future years.

The emissions intensity data is not specific to ANZ, making the data points of limited use. How would it spur ANZ to reduce its carbon exposure? For example, “Commercial Services” lending appears to comprise ANZ’s biggest single sector of carbon exposure but clearly it would be self-defeating to curtail lending to this entire sector.

More useful would be to have emissions by sector specific to ANZ’s own loan book. That would allow the bank to measure any tangible progress in reducing the emissions it directly finances. This could include requiring emissions disclosure when new lending or refinancing is being sought.

Next, the emissions intensity data is of limited usefulness when comparing with other banks. Comparability to peers is important.

Essence of de-carbonisation
TCI doesn’t believe fossil fuel extraction is the beginning and end of decarbonising the financial chain. Demand factors (emissions prices, energy efficiency, transport) matter, as does substitutability (for example, it is particularly difficult to decarbonise air travel in the short-term).

Metallurgical coal will be necessary to build new energy and transport infrastructure. However the fossil fuel industry is ‘special’ in that extraction and production investments are generally large and long-term – and therefore can lock in future consumption. That consumption results in emissions accumulating in the atmosphere, regardless of how cheaply or expensively it is combusted.

It’s true like-for-like comparisons are not necessarily fair and in the complicated realm of financed emissions and climate risk, perfectly comparable data is not always even possible.

The big four Australian banks specifically disclose financing of the resources sector’ including breaking down the sector into coal, oil and gas, iron ore, and other categories. This is potentially quite a useful means for comparison.

However these are calculated in one method (Exposure at Default) by some banks and another (Total Committed Exposure) by others. The two methodologies reflect group-wide reporting practices, so are difficult to correct.

ANZ notes it is responding to the work of the global Financial Stability Board which set up a taskforce in December to produce a framework for comparable climate-related financial risk disclosure.

The taskforce has identified its scope and established disclosure principles but the framework won’t be finalised before late 2016.

Where next for disclosure?

In the absence of a universally agreed and standardised methodology, what should and could banks be doing? It’s worth noting the banks themselves have committed to working on a standardised and comparable approach.

Commitments were made in late 2014 to deliver financed emissions reporting and to construct an Australian pilot project to develop a methodology as part of a global initiative on financed emissions.

Last November, the big four banks quietly announced the Australian Portfolio Carbon Group, an informal working group recognised by the UN’s Environmental Programme Finance Initiative (UNEP-FI), to enable measurement and disclosure of climate performance and demonstrate how they will support the transition to a lower-carbon economy.

The rationale is “financed emissions” is not a sufficiently useful metric, either in terms of pure risk or in terms of contributing to meeting the 1.5-2C goals.

This makes sense and we look forward to hearing more about their work; so far the pace of work towards a disclosure framework for Australian banks has been disappointingly slow.

We recognise it can be difficult to be a ‘first mover’ if that means foregoing business to competitors but that is why industry initiatives are so important - as is actively advocating for industry rules and guidelines that support all participants to reduce their climate risk while allowing flexibility in how to achieve that.

What could ANZ do?

There is an opportunity for leadership. ANZ could:

  • Adopt the most stringent policies possible for future financing. Several US and European banks (including Credit Agricole, Goldman Sachs, and JP Morgan) have declared they will not finance new coal-fired power capacity in developed countries unless carbon capture and storage is deployed.

  • Australian banks could at least make this gesture, as in Australia even electricity generators acknowledge the future trajectory for coal-fired power is to close existing plants. A more meaningful approach would be to rule out re-financing existing conventional coal-fired plants. 

  • Encourage and support innovative ways to reduce emissions throughout the economy. For example, banks, as the biggest providers of residential development finance, could incentivise the construction of more energy efficient buildings - thus helping reduce one of the biggest sources of emissions.

ANZ’s 2016 Corporate Sustainability Update mentions agricultural sector emissions will remain high until more sustainable forms of farming are adopted but is it explicitly supporting this type of farming via its lending decisions?

  • Explicitly measure and disclose climate-related risk along with other risks. ANZ discloses in its Annual Report it has significant exposure to the resources sector, which could be affected if commodities prices fall (which, by the way, they have).

  • Measure and disclose risks from and exposure to the physical impacts of climate change. This is clearly in the interests of shareholders and is increasingly technologically feasible.

  • Tally up losses which arise from high climate risk sources. ANZ in March said its write-downs would be $A100 million higher than forecast just a few weeks earlier, due to losses arising from the resources sector. Peabody Energy was identified as one source of losses by Bloomberg News.

Informing investors of how much of that came from thermal coal and other high-emissions sources would illustrate correlation or overlap between material risks and carbon risks, without needing to prove the extent to which climate was a factor.

  • Comprehensively report against previous commitments. ANZ pledged last year to “fund and facilitate at least $A10 billion by 2020 to support our customers to transition to a low carbon economy, including increased energy efficiency in industry, low emissions transport”. Granular reporting against this commendable goal will encourage peers to do the same.

Kate Mackenzie

Kate is Investment & Governance Manager at The Climate Institute. Prior to joining the Institute in 2014, she worked primarily as a financial journalist, winning awards for her work at the Financial Times and the Australian. Earlier, she was a technology and business reporter for the Australian, and online editor of Australian IT. Kate is a veteran of new media, and was one of the first online journalists to be hired by the ABC in the late 1990s.

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