The financial industry’s commitments to achieving net-zero emissions are critical to the financing of the greening of utilities and other industries in a way that was unthinkable just a couple of years ago. Last week, big banks, institutional investors, insurance companies, and regulators announced that the amount of capital controlled by institutions committed to net zero initiatives now tops $130 trillion (£96 trillion), up from $5 trillion in 2020, according to the Glasgow Financial Alliance for Net Zero.
That is about equal to the $100 trillion to $150 trillion amount required to transform the economy to net zero by 2050, the group claims. Banks, insurers, pension funds, asset managers, export-credit agencies, stock exchanges, credit rating agencies, index providers, and audit firms have committed to achieving net-zero emissions by 2050 at the latest and plan to report progress and financed emissions annually. (The signatories include Morningstar.)
“It’s only in the last couple of COPs where the finance community is recognised as not just a key but absolutely necessary player, because without the capital, transition simply can’t happen,” says Michael Jantzi, founder of Sustainalytics. “These initiatives are important not just because of what they tell us about the state of play today, but when CEOs make a public commitment to achieve net-zero, they’re committing to infuse all relevant products and services from a net-zero angle. Large financial institutions are committed to use the force of their assets in a more meaningful and comprehensive way than they have been. It’s a transition of our economy, and many of the business models that underpin it.”
The Weight of Industry
That will affect heavy emitters like utilities, oil and gas, steel, cement and other materials, transportation, mining, and commercial and residential real estate.
Utilities will play the essential role of eliminating as much as 75% of the energy sector’s carbon emissions by decarbonising electric power and electrifying transportation, real estate, and small manufacturing. To fulfill President Joe Biden's goal of decarbonising the power sector by 2035, for example, the United States must triple its current carbon-free generation, according to Morningstar analyst Travis Miller. That will require substantial amounts of capital investment, including wind and solar projects, and electric grid reliability and substantial investment along the energy value chain, from manufacturers to utilities to renewable energy developers.
Most of the early financing has come from utilities issuing green bonds and monetising tax credits, observes Adam Fleck, Morningstar director of equity research, ESG. The financial industry’s new commitments to net zero would probably lower the cost of capital for investments made by utilities. “Most of that benefit would flow back to customers, but utilities shareholders would get some benefits from faster earnings growth and slight increase in earned returns on equity,” Fleck says.
For now, the impact on the finance industry itself isn’t clear. Lenders will still be looking for a good return and are already funding projects “that provide an appropriate return,” says Michael Wong, Morningstar's director of equity research, financial services. Wong believes funding for clean energy is already likely to surge, even without lenders committing to net-zero goals, because more clean-energy companies are starting up.
The moves are “broadly positive” for banks, says Dan Dorman, senior ESG analyst at Calvert Research & Management and a financials expert. They are part “of a narrative in sustainable investing that’s been evolving since the financial crisis, when a lot of institutions were blamed for the hardship associated with the crash.” Instead, today, banks are being viewed as partners in solutions to systemic crises such as the pandemic.
Investment Opportunities
There is certainly plenty for banks and other financial institutions to invest in. The emissions cuts that are required before 2030 to stay on the net-zero pathway can be achieved by existing technologies such as solar, says Svenja Telle, PitchBook’s climate and clean technology analyst. After 2030, emissions reductions will depend on innovations such as expanded energy efficiency, hydrogen, and carbon technologies. These need to be at commercial scale. For such innovations, climate tech venture capital will be critical.
To be sure, there are plenty of challenges. For example, forecasting how different portfolio companies will reduce emissions can be fraught, as they are struggling with their own net-zero plans. Dorman of Calvert notes, for example, that while many of the largest banks had already committed to decarbonising their portfolios, including JPMorgan Chase (JPM), Bank of America (BAC), Morgan Stanley (MS), Citigroup (C), Goldman Sachs (GS), and Wells Fargo (WFC), his conversations with executives suggest “they really don’t have details [yet] about how to land this plane.” (There is also some debate about whether the group is double-counting the money that it claims is available, according to the FT.)
In the near term, Dorman sees banks, asset managers, and other institutions getting prepared to hold “tough conversations” on how decarbonisation will work in their sector. Expect a greater use of incentives built into debt covenants and other financial instruments that push company executives to decarbonise.
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