A new framework by the Climate Safe Lending Network doesn’t sugarcoat the challenges facing banks when it comes to developing net zero transition plans
There’s a crude adage popular with the military known as ‘The 7Ps’ : “Proper Prior Planning Prevents Piss Poor Performance”. It conveys an important truth which banks are being forced to recognise when it comes to their net-zero goals: that they cannot be achieved if the path leading to them isn’t mapped out right.
A transition plan acts as the bridge between where a bank stands today and the decarbonised version it wants to be 10, 20, or 30 years down the line. Plenty of lenders have unveiled such plans in recent months, including the emerging markets-focused Standard Chartered Bank, which published its pathway to net zero today.
However, agreed-on standards for these plans — on their integrity, scientific rigour, and positive externalities — have been lacking. The result? Transition plans that strain credulity and leave stakeholders unsatisfied. Indeed, it took the responsible investment charity ShareAction the work of just a few hours to poke holes in Standard Chartered’s effort.
In an attempt to bring quality and clarity to these documents, on Tuesday the Climate Safe Lending Network (CSLN) published ‘The Good Transition Plan’, a step-by-step guide on how banks can turn their long-term climate goals into practical actions — and ensure these actions are the best they can be for the planet, too.
Its release is timely. In the not-too-distant future, the composition of banks’ transition plans could have important operational, regulatory, and even legal ramifications. Just last week, Frank Elderson, Vice-Chair of the Supervisory Board of the European Central Bank, said that banks’ transition plans should be legally binding, and align with the European Union’s own efforts to operationalise the Paris Agreement.
Bank investors are also more likely to press for meaningful transition plans going forward thanks to the evolving recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). Earlier this month, the group published new and updated guidance, including a section on what makes for an effective transition plan and best practices from across the business world. Though the TCFD shied away from including detailed recommendations on the disclosure of transition plans in its revised implementation guidance, it did say that most organisations “should describe their plans for transitioning to a low-carbon economy”. Investors and other external stakeholders that have pressured banks in the past on TCFD-aligned disclosures are likely to use this guidance to insist they produce detailed transition plans as well. Initiatives like ‘Say on Climate’ offer new, binding mechanisms through which shareholders can initiate and enforce transition plans, too.
Still, demand for quality transition plans is one thing. Determining what ‘quality’ means in this context is another. This is what ‘The Good Transition Plan’ sets out to achieve. Here’s how James Vaccaro, the Executive Director of the CSLN, explained it in an interview with Climate Risk Review:
“How do you assess ‘good’? If you try to make it uniform, and you say: “here is what ‘good’ is”, and it’s a global standard, then everybody just lobbies for that single bar to be as low as possible. Whereas if you ask: “what are the most relevant questions, and the sensible set of contextual points for assessing good” that’s going to really positively drive the whole sector forwards. That was the starting point for the provocations we’ve got in ‘The Good Transition Plan’”
And there are plenty of provocations to be had. The report explains that a ‘good’ transition plan is much more than a jumble of targets and policies couched in climate-friendly language. ‘Good’ entails a plan that ultimately transforms a bank’s products, services, relationships, and staff incentives. Even more than that, ‘good’ demands a bank considers the “outward impacts” of its activities on the climate. In other words, it has to adhere to the principle of ‘double materiality’.
“The TCFD seems fixed on a narrow framing of single materiality in terms of risks and opportunities. It’s about keeping finance safe from the world, rather than the world safe from finance. In reality, you can manage your transition risks in ways which are good for the planet, or bad for the planet. You could say: ‘we’ve got a lot of short-term lending to expand fracking, so we can get out of this stuff quickly when needed’, and that could be structured to tick the box for TCFD — but you’re still cooking the world. These actions will come back to hit the financial system, because the risks will eventually be socialized — to other banks and ultimately via governments to everyone, just like in the financial crisis of 2008. It’s time for something which is specifically looking at the broader, systemic and double materiality factors. That’s the angle TCFD misses”
In practice, this double materiality principle requires banks to completely overhaul how they operate, changing the way they approach clients, policymakers, and their own internal risk management. ‘The Good Transition Plan’ sets out how.
First, clients. The report recommends banks work to maximise “real economy ‘delta’” when decarbonising their investments. This means finding ways to reduce the carbon in their portfolios that lower real world carbon emissions too. Under a “climate-safe” approach, this makes perfect sense: after all, the goal of climate action should be to limit the release of greenhouse gases. But it goes against a more narrow interpretation of portfolio decarbonisation practiced by some lenders, one focused on simply getting rid of the ‘carbon hogs’ on their balance sheet any way possible. As ‘The Good Transition Plan’ argues, this isn’t the best approach for the planet:
“Banks can easily reduce their portfolio carbon by avoiding or exiting high carbon assets. While this is the quickest route to a Paris-aligned portfolio it has some drawbacks: it can mean giving up profitable business, it has only a limited impact on reducing real world carbon emissions, and it could perversely make higher carbon assets more profitable for banks that are willing to take them on”
Another potential downside is that the carbon-intensive assets purged by lenders could end up on the balance sheets of ‘shadow banks’ like hedge funds and family offices, which are less well-regulated and likely to have far fewer climate-conscious stakeholders — bad news for financial stability and global climate change goals alike.
Instead of a stampede-to-the-exits approach, ‘The Good Transition Plan’ makes the case for banks to “work with clients to reduce the emissions from their assets”. This makes it sound like the report is taking sides on the perennial “engagement versus divestment” debate, but it isn’t as simple as that.
“Engagement” at its most basic may be limited to banks bringing up or supporting shareholder resolutions on climate strategy, or making continued financing conditional on clients’ achievement of climate KPIs. ‘The Good Transition Plan’, in contrast, supports a broader understanding of engagement, one that recognises how banks are well-placed to teach their clients about climate science, climate-related risk management, and decarbonisation.
Though the report says that banks cannot lead their clients’ climate strategies, it does say that climate-competent lenders “can be a trusted source of feedback and be influential in shaping a client’s decision”. This suggests a far more proactive approach to engagement, one in which banks take steps to steer their clients in a climate-friendly direction, for example by sharing what best practice looks like in their sector, connecting them with helpful resources, and conveying pricing signals through their financial products.
Source: ‘The Good Transition Plan’
Still, when it comes to the fossil fuel sector, ‘The Good Transition Plan’ appears to take the side of divestment. The report states that “leading practice” is for banks to end all financing for fossil fuel expansion and exploration, which means both direct lending with this specific purpose and general lending to companies engaged in these activities. It’s a bar that Standard Chartered failed to clear with its latest transition plan, according to ShareAction, but one that all banks need to hurdle to be truly aligned with net zero, CSLN implies.
As for banks’ legacy fossil fuel assets, the report says these should be phased out over time, and that the related financing relationships should be tightly controlled in the interim. For example, it recommends the use of covenants and conditions that specifically require fossil fuel companies to keep to their transition plans and climate targets. It further suggests that the breaching of these covenants be treated as an event of default, giving a bank the power to exit a relationship where a fossil fuel client falls short of its promised goals. In recent years, banks have used sustainability-linked loans, bonds, and derivatives to try and encourage clients to hit climate-related KPIs. However, the ‘stick’ with these products is merely a slightly higher repayment rate. A climate-related default condition could act as a far stronger disincentive for clients to welch on their transition promises.
‘The Good Transition Plan’ does not pretend a tough approach to fossil fuel clients will be cost-free. In fact, it freely admits that the steps it recommends could lead to lost business and sundered relationships, and in turn angry investors “who may resist temporary negative impacts on return on equity”. Instead of minimising this risk, the report explains that bank leaders should face it head-on by holding frank discussions to “manage the fear of transition”.
Such an approach is at odds with the current strategies taken by bank executives. Standard Chartered’s CEO — Bill Winters — told Bloomberg earlier this month that “it’s just not practical” to expect banks to stop fossil fuel financing. Goldman Sachs’ David Solomon struck a similar note on October 19. ‘The Good Transition Plan’ approach would presumably have these executives say the exact opposite — that it’s not practical for them to continue to finance fossil fuel companies.
In terms of banks’ interactions with policymakers, ‘The Good Transition Plan’ also suggests a fresh approach. Specifically, it says that banks should “end lobby practices that undermine the net zero transition” and ensure that transition leaders have sign-off on their positions on public affairs. This would mean a significant expansion of power and influence for banks’ sustainability professionals, and their involvement in areas they may be new to.
Such an approach would also inflate the role of banks as agents in the policymaking process beyond that envisioned by current climate-related financial initiatives. For example, while the Net Zero Banking Alliance (NZBA) commitment calls on signatories to engage in corporate and industry action “as well as public policies” to support a net-zero transition, it does not tell them to end political, policy, or regulatory associations that work against this objective. ‘The Good Transition Plan’ tries to close this loophole by emphasising the importance of consistency in lobbying. The report also underlines how banks can and should be active participants in climate-related policymaking by working directly with clients, governments and competitor banks to achieve change, instead of issuing meager ‘calls to action’ from the sidelines.
Perhaps the most controversial recommendations made in ‘The Good Transition Plan’, however, concern risk management. In a section on financing innovation, the report says that banks may “adopt a higher risk appetite for climate innovation”, for example by ramping up their investments in carbon capture, utilisation and storage (CCUS). Doing so would demonstrate that a bank is operating in harmony with its transition plan, especially if this is based on an emissions pathway that necessitates the use of CCUS technologies. However, as the report itself admits, these investments could be highly speculative and vulnerable to losses.
Though it does not call for banks to abandon a prudent approach to risk management, the report does say they have to “find ways to lean into uncertainty and stray from their proven business-as-usual approaches”, something that has “major implications for risk appetite policies”. This may rankle with bank risk purists, who prefer capital allocation decisions to be based on tried-and-true methods, like credit risk modelling and financial analysis. But it makes sense in the context of the double materiality principle. After all, traditional risk analysis does not explicitly factor in negative externalities — like climate change — to reach its conclusions.
Vacarro describes ‘The Good Transition Plan’ approach as changing the distribution of banks’ existing risk appetites, rather than a call for banks to take on more absolute risk. Still, for certain lenders making this kind of change will be tough. Not only could it offend their own internal risk functions, it could alienate the shareholders whose equity they put at risk and even regulators concerned about ‘green investment bubbles’.
This recommendation, like many made by ‘The Good Transition Plan’, asks banks to overturn established orthodoxies in the pursuit of meaningful climate action. Too many industry-led initiatives — past and present — aspire to the transformational goal of a Paris Agreement-aligned world while holding onto conventional processes and practices. ‘The Good Transition Plan’, in contrast, doesn’t sugarcoat things. The journey to net zero for a bank may be tough and uncomfortable at times, it says, and challenges are to be expected. Maybe a bank will lose customers. Maybe it will lose employees. But this is the price of progress.
As Vaccaro puts it:
“‘The Good Transition Plan’ asks the questions that go deeper into the purpose and value creation model of banking. It’s about seeing climate as a lens for corporate strategy and thinking root and branch about every function as to what they need to do”