NZAOA Toughens Decarbonization Targets, SEC Official Warns Against ESG Ratings Abuse, and More

February 3, 2023

The top five climate risk stories this week.

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Net-zero asset owners toughen decarbonization targets

The Net Zero Asset Owners Alliance (NZAOA) has barred members from using carbon removals to hit their 2030 portfolio decarbonization targets.

In a Tuesday update to its target-setting protocol, the group said it wants asset owners to encourage investee companies to cut their real-world emissions first, instead of relying on schemes that absorb carbon from the atmosphere. Members of the USD$11trn alliance include insurance giants Aviva, Allianz, and Munich Re.

“With carbon removal technologies yet to impact at scale, the Alliance guides members to encourage investee companies to prioritize emission reductions and disallows the use of carbon removals to achieve intermediary emission targets that detract from these efforts,” the NZAOA said. 

However, the protocol says investee companies’ use of carbon removals with “long-lived storage” still counts as long as they’re used to offset “residual emissions” that can’t be reduced otherwise. The NZAOA also encourages members to “contribute to a liquid and well-regulated carbon removal certificate market before 2030” since this is seen as important to meeting global decarbonization goals.

Other updates to the protocol require asset owners to consider whether their investment decisions fairly spread the benefits of the low-carbon transition. This “Just Transition” provision intends to ensure the social risks to workers and communities are properly accounted for. 

“A transition which would put livelihoods and living standards at risk is unlikely to succeed: as such, a just transition is an important aspect of achieving global net-zero GHG emissions,” the protocol says.

More action needed on physical risks — UK Climate Committee

Financial regulators should ensure banks, insurers, and other firms incorporate physical climate risks into their risk management practices, the UK Climate Change Committee (CCC) has said.

In a report on how the UK can invest to build climate resilience, the CCC said the country’s financial stability may be threatened if institutions don’t properly account for physical climate risks. Effective climate adaptation projects could also fail if these risks are neglected.

The report recommends that regulators provide financial institutions with guidance on measuring physical risks and their portfolios’ climate adaptation outcomes. It also suggests scenario analysis and stress testing exercises consider the linkages between physical, transition, and liability risks. 

In addition, the UK should define common standards for the design of high-quality climate adaptation plans that can be used by financial institutions and real-economy companies. This could build on the work of the Transition Plan Taskforce, which established a self-proclaimed “gold standard” for corporate net-zero plans.

The CCC also calls on the UK Infrastructure Bank, UK Export Finance, and other public financial institutions to draft adaptation finance strategies and to introduce “sustainability-linked instruments” that promote climate resilience.

The CCC is an independent body that was formed in 2008 to advise the UK government on emissions targets and climate adaptation.

SEC official warns against ESG ratings abuse

Environmental, social, and governance (ESG) standards may increase rating agencies’ power to dictate companies’ business practices, a US Securities and Exchange Commission (SEC) official has said.

In a January 27 speech, Mark Uyeda, one of two Republican SEC commissioners, said he has “significant concerns” that proposed rating standards “may be intended as a means for asset managers to engage with company management in a broader effort to drive companies to satisfy the criteria of a specific ESG rating service.” This could lead to companies having to comply with certain ESG rating firms’ agendas to access investment.

The International Organization of Securities Commissions (IOSCO), which the SEC is a member of, has called on voluntary standard-setters and industry associations to promote good practices for ESG rating and data providers. These would cover their methodologies, policies, information gathering approaches, and management of conflicts of interests.

Uyeda does not want any ESG rating standards that come out of this process to drive assets to certain companies based on their social or political stances. “The emerging system has more in common with a George Orwell novel than what anyone would consider an accepted financial analysis tool,” he said.

The Commissioner also questioned the purpose of the SEC’s climate risk disclosure and ESG fund names rules. “Are these unique, highly-prescriptive disclosure requirements specifically targeted at ESG investment strategies needed? The current rules provide the Commission with sufficient authority to bring enforcement actions against advisers and funds that engage in ‘greenwashing.’ Additionally, some of the proposed disclosure requirements for investment advisers and funds would be tied to yet-to-be-adopted proposed disclosures from corporate issuers,” he said.

US banks’ climate plans should be held to account — think tank

US regulators should inspect banks’ climate efforts and make sure they align with their net-zero commitments, a new report says.

Published by the Roosevelt Institute, a left-leaning think tank, the paper argues that federal banking agencies have the authority and responsibility to supervise firms’ climate plans as part of their risk management oversight duties. This is because climate plans that don’t align with net zero could expose banks to heightened transition risks. For instance, allowing the continued financing of fossil fuel projects could result in “stranded” assets as the global economy decarbonizes. 

“Given the uncertainty and complexity inherent in both climate change and the energy transition, net-zero transition plans are a strong risk management and financial stability tool available to large banks and their regulators,” the report says. “To protect the banking system, regulators should encourage or even require large banks to adopt commitments to reach net-zero emissions by 2050 and credible transition plans to achieve that goal.”

Regulators could start by issuing detailed guidance on what it means for banks to align their internal strategies with a net-zero commitment and by explaining how they will go about checking whether managers are implementing climate plans effectively, the report adds. 

The Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and Federal Reserve have all issued climate risk management principles for banks in recent months. However, the report says these “fall far short” of what’s needed to ensure net-zero promises are kept.

“By embracing their role as supervisors of voluntary transition plans, regulators can reinforce the value of those plans as risk management tools. But they should also follow this insight to its logical conclusion and encourage or require banks to adopt transition plans to protect the safety and soundness of both individual banks and the larger financial system,” the report says.

California lawmakers introduce climate risk disclosure bill

Businesses in California would be required to prepare and disclose annual climate-related financial risk reports under a bill introduced in the state senate on Tuesday.

Senate Bill (SB) 261 covers any entity formed in the Golden State and any entity formed in another state that does business in California with annual revenues over USD$500mn. The mandatory filings would have to detail businesses’ climate risks in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), the world’s premier climate reporting framework. 

Businesses would have to submit their climate risk reports to California’s Secretary of State and make them available to the public on their own websites. If the bill passes, the first round of disclosures will have to be made by December 31, 2024.

“Failure of economic actors to adequately plan for and adapt to climate-related risks to their businesses and to the economy will result in significant harm to California, residents, and investors,” the bill reads. “California has an opportunity to set mandatory and comprehensive risk disclosure requirements for public and private entities to ensure a sustainable, resilient, and prosperous future for our state.”

SB 261 was introduced by Democratic Senators Henry Stern, Josh Becker, Lena Gonzalez, and Scott Wiener. The bill now goes to a policy committee for scrutiny. A similar bill was introduced during last year’s legislative session but failed to gain traction in the senate.