The climate metrics zoo is getting wilder. Increasing numbers of banks and other financial institutions are disclosing climate indicators and quantifying how their activities support net-zero goals. But the rapid spread of financed emissions data, portfolio alignment tools, and other climate gauges has yet to significantly change the financial system’s approach to the low-carbon transition. This begs the question: do these climate metrics have any meaning?
Not yet, according to the Rocky Mountain Institute (RMI), a nonprofit working toward a zero-carbon global energy system. In a recent paper, the group argues that most climate data and metrics “will not necessarily help financial institutions assess both the feasibility and the credibility of a counterparty’s role in the net-zero transition.” It further claims that “transition-relevant metrics” (TRMs), those that “most effectively enable day-to-day decision-making toward the highest impact on the real-economy transition to net zero,” don’t factor into financial firms’ decision-making. In other words, climate metrics aren’t up to scratch when it comes to measuring or incentivizing the financial industry’s contribution to the low-carbon transition.
The paper serves as a timely reminder that higher rates of climate disclosure do not necessarily mean financial institutions are taking higher quality climate actions. In its latest status report, the Task Force on Climate-related Financial Disclosures (TCFD) shows that 42% of the 248 banks it reviewed disclosed climate metrics in 2021, up from 34% two years prior. A survey by the task force also found that 53% of asset managers and 71% of asset owners produce metrics disclosures. However, the initial findings of an investor-led framework for assessing banks’ net-zero progress show that big lenders need to “substantially accelerate” their decarbonization plans if they want to align with a 1.5°C climate change pathway. Elsewhere, research by nonprofit Universal Ownership Initiatives suggests that so-called net zero asset managers are failing to link their actions with real-world emissions reductions. Clearly, there’s a disconnect between metric use and meaningful climate action.
What may explain the discrepancy is that financial institutions aren’t getting the raw data they need to create useful TRMs. After all, the quality of banks’ and investors’ own climate metrics largely depends on the input data they get from investees and borrowers, or from the data vendors that provide it on their behalf. The RMI says that financial institutions find it challenging to identify transition-relevant data among the mass of climate risk, finance, and opportunity information that’s currently provided through companies’ disclosures. Another difficulty is accessing this kind of data. As the RMI paper states: “[W]hile client-sourced data is widely used, accessing it on a large scale can be time-consuming, the data is not always comparable, and the process can add friction to client relationships and transactions.”
There are two other deeper issues with respect to how the financial sector is engaging with the climate transition that may also be stymying progress on TRMs. One is how industry-led initiatives herd firms toward specific metrics. The second is the preoccupation with emissions data over financially relevant transition indicators.
Popular climate metrics and their shortcomings
A handful of climate transition metrics have entered the mainstream in recent years, propelled partly by financial industry groups. Two stand out in particular: financed emissions and portfolio alignment metrics (PAMs).
Financed emissions metrics, which show the emissions linked to a firm’s lending and investing portfolios, have built up a following thanks to the Partnership for Carbon Accounting Financials (PCAF), a coalition of over 300 financial institutions committed to standardizing these metrics’ calculation and disclosure. Financed emissions metrics have also been adopted by members of the Glasgow Financial Alliance for Net Zero (GFANZ), the world’s largest climate finance alliance. To sign up to most of the alliances’ sub-groups, institutions have to commit to report their progress against absolute emissions and/or emissions intensity targets, a requirement that many have fulfilled with financed emissions disclosures.
In recent months, financed emissions have come under fire because institutions are able to lower their portfolio emissions without necessarily driving real-economy emissions reductions or supporting the net-zero transition. Moreover, the RMI paper notes that the metric can give rise to perverse incentives. For example, a bank may be encouraged to cut ties with a high-emitting counterparty to improve its financed emissions metric, even though it could better influence its transition if it maintained a financing relationship. Another issue is that much of the emissions data that financial institutions get from companies is backward-looking and therefore only offers a picture of their past carbon performance, rather than their future emissions pathways.
Portfolio alignment metrics may also induce unwanted behaviors. These metrics have been embraced by GFANZ members because they purport to show how in sync financial institutions’ portfolios are with global climate goals. The alliance also released a report on how firms can design and implement effective PAMs, underlining how central they’ve become to many institutions’ climate planning and disclosure activities.
However, similar to financed emissions, a portfolio alignment metric can be ‘improved’ by a firm divesting from misaligned companies — actions which may not result in real-world emissions reductions. Furthermore, while they’re useful for keeping track of companies that are already aligned with — or coming into alignment with — selected warming pathways, portfolio alignment metrics are not set up to inform stakeholders on the breadth and quality of financial institutions’ climate financing or efforts to phase out high-emitting assets over time. Both these activities are crucial to the low-carbon transition’s success.
Structural challenges remain
Lots of climate data products offer financial institutions various ways to identify their counterparties’ climate risks, opportunities, and emissions profiles, which they can then use to inform their own metrics. However, some practitioners argue that the market has yet to yield TRMs that could genuinely help them drive real-economy decarbonization.
One gripe is the lack of metrics that link companies’ climate progress — or lack thereof — to their financial activities. Much of the focus of climate data vendors, financial authorities, and firms themselves has been on understanding the emissions of borrowers and investees, and using this data as a proxy for institutions’ transition risks and and support of the net-zero goals. However, among the financial institutions it engaged with, the RMI found that climate financial metrics — those linked to company revenues, R&D spending, and cost of capital, for example — are favored above pure climate metrics.
Climate financial metrics would help show financial institutions how financially committed a given company is to the low-carbon transition. They would also give financial firms confidence that they are directly contributing to real-world emissions reductions through their loans or investments.
Experts discussed the lack of these metrics at a panel during New York Climate Week. “What would be really useful is if there was a common, widely-understood definition for what green capex [capital expenditure] is,” said Nazmeera Moola, chief sustainability officer at asset manager Ninety One. “You could then compare Shell’s numbers with BP’s numbers and Exxons’ numbers, and that would be really helpful.”
Another panelist, Catherine de Coninck-Lopez, global head of ESG at Invesco, touched on another problem with the current suite of tools and metrics. She said the “biggest gaps” in her company’s climate data dashboard are those around companies’ capital allocation, strategy, and targets, which she explained are “issues that may be less quantifiable but are really, really important for understanding where a company is going.”
This points to a big challenge confronting financial institutions, which is that their most effective actions driving real-economy decarbonization may be inherently difficult to report in a user-friendly climate metric. Sustained, long-term engagements by financial institutions working together are likely to yield the most impactful decarbonization outcomes at real-economy companies. But in these cases, how would firms be able to disaggregate their individual contributions from the collective effort and report this to stakeholders? Furthemore, how could firms take credit today for company engagements that may only lead to significant emissions cuts two, three, or more years down the line?
The urge to quantify financial institutions’ transition efforts may even put them off these collaborative, slow-burn activities, hindering progress on real-economy decarbonization.
A way forward
Considering these challenges, what needs to happen to develop climate transition metrics that matter?
First, corporate climate data should be disclosed in a consistent way, so that financial institutions can fairly compare one company’s transition readiness with another. This is a job for lawmakers and regulatory bodies, many of which are already on the case.
Second, standard-setters and investor groups should push companies to disclose financially relevant climate data, like the green capital expenditure metric that Ninety One’s Moola supports. Perhaps with access to this kind of information, institutions would get a clear understanding of the transition’s financial ramifications and adjust their business strategies accordingly.
Third, financial institutions should not limit themselves to popular metrics that are already in wide use, like financed emissions and PAMs. Quite the opposite — they should embrace new and novel TRMs that are most helpful to them and best tailored to their portfolios and transition strategies. For an asset owner invested in public companies for the long term, a suitable metric may be a running tally of engagement activities with high-emitting companies and a breakdown of the climate topics discussed, as well as the outcomes achieved with these firms’ leaders. For a bank underwriting the debt and equity of real-economy firms, an appropriate metric may be how much of the financing it facilitates is earmarked for green expenditures, transition-related activities, and business-as-usual operations.
Of course, the downside of this “let a thousand flowers bloom” approach is that it may be tough to compare financial institutions’ transition efforts on a level playing field. However, it is arguably more important that each bank and investor has a full understanding of how they are supporting real-economy decarbonization first. Aligning transition-relevant metrics across financial institutions can come later.
Finally, it’s important that transition-relevant metrics can be integrated into financial institutions’ decision-making processes. As the RMI explains, this is the way to ensure the signals received through transition data are converted into action. For instance, lending and investing decisions could be made contingent on how a company rates on an institution’s “scorecard” of transition-relevant metrics. Incentives within a financial institution could also be aligned toward the achievement of transition goals, if transition-relevant metrics were tied to senior executives’ compensation.
Clearly, there’s much to be done. But the value that effective transition-relevant metrics could bring to financial institutions, and the support they could give to global net-zero goals, would surely make the effort worthwhile.