Uniquely among industries, the role of financial services is to enable other parts of the economy to function well. Lending, borrowing, investing and paying all grease the wheel of the modern economy, and financial institutions are the channel for making these activities happen. It is clear, then, that these organizations must also be at the heart of the massive economic transformation needed to move away from fossil fuels and achieve a net-zero world.
The Paris Agreement itself makes this clear, stating that environmental sustainability requires “making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.”
Currently, however, the greenhouse gas emissions associated with global financial institutions’ investments are estimated to be 700 times greater than those associated directly with these companies’ largely office-based activities, according to global disclosure not-for-profit CDP.
Additionally, only 45% of banks, 48% of asset owners and 46% of asset managers report taking steps to bring their investments in line with the objective of keeping global warming well below the threshold of 2.0 degrees Celsius above pre-industrial levels, according to CDP. (This is itself less ambitious than the safer goal of 1.5 degrees Celsius).
It’s time for the penny to drop, and it already has for forward-looking institutions; initiatives throughout the industry point to a growing awareness of both the urgency to change and the opportunities that can be realized by this transformation.
(For a full description of the net zero era and a field guide to navigating it, see our report “The Future of Us.”)
Coinciding with the growing sense of urgency around environmental sustainability are the increasingly mature technologies that can help businesses address this challenge, such as artificial intelligence, 5G and Internet of Things (IoT). The financial sector’s job is to finance this kind of innovation.
For example, Octopus—a UK sustainable energy provider that counts the Canada Pension Plan Investment Board and Generation Investment Management among its investors— enables electric vehicle owners to simply determine when they need their vehicle to be charged, and leave the system to automatically do it in a way that minimizes fluctuations in the grid. Such fluctuations have long made network managers wary of relying on renewables, so these types of capabilities broaden the appeal of clean energy in their eyes.
The pandemic increased what was already mounting pressure on financial companies to act. In the EU, UK and Singapore, for example, regulators are preparing sustainability disclosure rules for the sector. Access to talent is also on the line; in the UK, for example, 65% of office workers are more likely to work for a company with a strong environmental policy.
Clients and new competitors are also ratcheting up pressure—67% of consumers globally would like their financial institution to become more sustainable, and fintech companies are offering them the alternatives they crave. One example is Germany’s Tomorrow Bank, which promises that customers’ bank accounts will be used exclusively to finance sustainable industries.
Finally, the business case for sustainable finance is now clearer than ever. On the whole, there appears to be little clash between climate-friendliness and profit-maximization. A study by the Global Alliance for Banking on Values—an independent network of banks—found that, on average, a list of 55 values-based banks had annual returns on equity (ROE) of 8.4% between 2016 and 2020, compared with 7.4% of 31 global systemically important banks.
What to look for
Forward-looking financial institutions are beginning to respond to such pressures and opportunities. A key area of action centers on sustainable financial products, such as green credit cards, green loans and green deposits that promise carbon footprint and emission reduction. Barclays and ABN AMRO, for example, offer better mortgage rates to customers building environmentally friendly houses.
And while financial companies’ direct operations account for only a small fraction of their overall environmental impact, some are leveraging digital technologies to make smarter decisions that support a low-carbon economy. For example, Italian incumbent Banca Mediolanum has launched Flowe, a cloud-enabled digital bank built on green principles. Goldman Sachs has recently signed up for the Green Software Foundation, launched by organizations including Microsoft and GitHub with the goal of creating a freely accessible ecosystem of people, standards, tools and practices for the accurate measurement of emissions and the construction of “green” software.
Things are also moving fast on the investment side. Investors representing more than $45 trillion in assets under management have already agreed to drive climate action across their portfolios. BlackRock, the world’s large asset manager, announced it would concentrate its investments on securities focused on sustainability. Globally, sustainable investment has reached $4 trillion.
Asset owners and managers are also increasingly leveraging their status as large shareholders to exert pressure on polluting companies to accelerate their transition to net zero. So far, 700 of these organizations, managing a total $68 trillion in assets, have formed the Climate Action 100+ group to influence companies to go green.
Many individual investors, however, are not waiting for asset managers to take action; rather, they are turning to platforms such as Tumelo, which enables investors and pension holders to have a say in how their money is invested.
How to prepare
Financial services companies can take several steps to thrive in the net-zero era. The first of these will be to identify the risks associated with their portfolio emissions. Few have been doing a good job here—CDP has found that only 41% identify climate-related risks they classify as operational risks, 35% identify those seen as credit risks, and a mere 26% identify those classified as market risks. However, just credit and market risks have, together, a potential impact of up to $1.04 trillion on investments, according to CDP. In short, financial companies must step up their game to fulfill their fiduciary duties to investors and shareholders.
A corollary will be the need to use climate-based assessment as part of the criteria used to direct investments or make lending decisions. For asset managers and owners, a good place to start is Climetrics, a climate rating service by CDP, which provides monthly updates for 18,000 funds covering over €15 trillion.
Banks can also nudge their customers to adopt greener products via incentives such as discounted lending rates. Open banking can help. By opening up their financial data, banks can unlock insights into customer behavior, consumption patterns and preferences, helping them change their behavior or rewarding them for their contributions toward sustainability.
Smart financial services firms will link carbon footprint analysis to current and future spending patterns; some, such as Swedbank and BBVA, have built in-house proprietary calculation tools, while others, such as NatWest and Mastercard, have partnered with third-party providers to calculate their customers’ emissions.
The effectiveness of sustainability efforts can be fortified through partnerships. Nowhere can this be more effective than in the use of digital finance, lending and investment. Virgin Money, for example, collaborated with fintech data expert company Life Moments to develop the sustainability elements of its business banking customers.
Accountability is also of the essence. It’s pointless to fight the growing power of consumers; rather, they must be seen as the powerful allies they can be for financial companies willing to embark on a deep sustainability transformation. It is essential to fully disclose both direct and portfolio emissions on a regular basis. Financial companies have a long way to go here—according to CDP, half of them do not conduct any analysis of how their portfolio impacts the climate, let alone disclose it.
Businesses in the industry may be tempted to exaggerate their achievements, especially when times are hard or goals prove elusive. That would be a serious mistake; customers are increasingly able to identify “greenwashing” and quicker than ever to vote with their feet. A far better solution is to have an environment ombudsman that can both be available for external stakeholders with particular concerns and act as a powerful force for change internally.
Bank of the future
The bank of the future will create not only a human-centric digital banking experience but also one that leverages digital technologies to drive positive consumer behavior change. Banks that use digital technologies sustainably (and smartly) will gain consumer trust and loyalty in a world where climate change is fast becoming key to creating new business value.
For our full report, read “The Future of Us.”
This article was written by Euan Davis and Eduardo Plastino, from Cognizant Research, with valuable input from Gaurav Bose and Andrew Warren, Chief Architect and Head respectively, in the UK & Ireland (UKI) Banking and Financial Services practice at Cognizant.