Innovative analytical models & technology will do the heavy lifting before a net-zero standard for financial institutions is adopted

• The Science Based Targets initiative has released its widely anticipated ‘foundations’ paper for a Net Zero alignment standard for financial institutions
• SBTi outlined its Guiding Principles and a conceptual framework that will link together ongoing efforts to tackle the thorny issue of what should qualify as ‘net-zero aligned’
• Net-zero ambitions often far outstrip the data required to fully validate the efforts being undertaken, but innovative analytic approaches and technology are helping fill the gaps

The Science Based Targets Initiative (SBTi) has released the foundations paper for its future standard on net-zero targets for financial institutions. The standard will expand upon the science-based targets standard for emissions reductions targets in line with the Paris Agreement. This standard was recently strengthened to require targets to be aligned with limiting the global temperature rise to 1.5° C rather than the original 2° C target.

The interim targets — required to cover between a 5- and 15-year time-frame — will remain “one essential element of [a financial institution’s] overall net-zero target”. However, it remains an open question for the Expert Advisory Group to decide whether to keep the SBT standard focused on decarbonization and only add investment in ‘climate solutions’ into the net zero standard, or to harmonize both standards to include a role for decarbonization and ‘climate solutions’.

Apart from the elements described above, the net-zero target will cover Scope 1–3 of financial institutions and their customers, while limiting strategies such as portfolio emissions reductions that don’t have real economy impact and the use of carbon credits to achieve net-zero targets. To summarize, the four Guiding Principles articulated by SBTi are:

1. Cover Scope 1–3 emissions for financial institutions and their customers (broadening customers’ emissions coverage beyond the GHG protocol’s financed emissions standard, which only incorporates customers’ Scope 1 & 2 emissions) but not consider avoided (Scope 4) emissions, which carry significant challenges of methodology;
2. Limit warming to 1.5° C with little or no overshoot, and achievement of the SDGs;
3. Financial institutions should use their influence towards decarbonization of the real economy rather than limit efforts to portfolio decarbonization (e.g., through sectoral reallocation or exclusions other than of companies unable or unwilling to decarbonize); and,
4. Mitigation strategies should involve both financing decarbonization efforts along established sector pathways as well as investment in ‘climate solutions’ such as nature-based solutions or direct carbon removal.

There are several issues that raise questions about how to operationalize these types of net-zero standards, but the major issues are more practical. The net-zero standard itself will likely be a year more in the making, and the data inputs required to align a financial institution’s entire exposure to net-zero will take longer to achieve.

This doesn’t reduce the need for standards that still provide important common language for efforts to mitigate climate change through the financial sector. However, it does require a different form of standard development and implementation than is common for other topics. Typically, standards emerge out of an evolving harmonization of ‘best practices’ and the standard marks one approach as being the default option going forward.

Climate-related standards, especially relating to ecosystems as complex as those in which financial institutions operate, still have significant divergences in practices across institutions, countries and market segments within finance. The movement towards standards is an effort to order the disorder that risks market-wide credibility because the opportunities for greenwashing are so prevalent and so lucrative.

What the foundation document does — in addition to laying the groundwork for an eventual standard — is provide a source of understanding for how different analytical frameworks working on the same issue relate to one another, even if they are not entirely compatible with each other, or looking at the same thing.

To take an example, the RFI Foundation’s research on the financed emissions of financial sectors in Islamic markets presents a static, top-down estimate of total emissions and emissions intensity per dollar of financing & investment. It presents an analysis of how efforts by one type of financial institutions’ efforts in a particular sector might impact the effectiveness of other financial sector stakeholders’ efforts in a different sector.

That’s a different type of metric that may be more useful as a starting point for one financial institution’s efforts to develop a strategy towards Paris Agreement alignment or efforts needed to reach long-term net-zero. It may support the efforts by one financial institution or investors, while a production-oriented metric such as PACTA may be more relevant to another financial institution that has a more concentrated financing portfolio in high-carbon sectors where measuring near-term alignment or misalignment is more relevant.

These and other approaches to bridge data availability gaps will be critical for financial institutions developing strategies, showing progress and calibrating their approaches in response to new climate, financial and economic data. The most successful financial institutions at navigating the transition to aligning with global and national net-zero targets will combine strong and adaptable governance structures internally to allow continual refinement of strategy along with the ability to use technology to avoid data overload that is all but assured based on the trajectory of responsible finance.

That’s part of the reason that, in addition to conducting research to show the ‘lay of the land’ for investors and financial institutions in Islamic markets, we are also working with HSBC Middle East on the Net Zero Challenge. We believe a top-down perspective is helpful to see where financed emissions are connected, but this model alone won’t generate the bottoms-up insights needed within each financial institution to find the most achievable and impactful ways for them to mitigate their direct and indirect sources of operational, financed and facilitated emissions. So we are trying to provide a catalyst for the creators and users of the technology to make a connection with a focus on financial institutions in the Middle East, North Africa and Turkey.

Find out more about the Net Zero Challenge here — applications are open through 21 April for interested ClimateTech and FinTech entrepreneurs, startups and established companies

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