5 Principles to Guide Financial Institution Action on Climate Change
Finance is a critical agenda item at the COP21 climate summit as country negotiators hone in on different pieces of the Paris Agreement. Meanwhile, finance is also featuring prominently outside of the formal negotiations process, and a new initiative launched on Monday demonstrates the growing recognition that action by financial institutions – both public and private – is necessary to begin shifting the trillions of dollars needed to address the climate change challenge.
Several institutions have already begun major initiatives, and some are already providing significant amounts of climate finance. For instance, the International Development Finance Club (IDFC), an association of national, bilateral and regional development banks from around the world, committed $85 billion of climate finance in 2014, according to their latest Green Finance Mapping Report.
While impressive, the current commitments aren’t reaching the scale required to keep global temperature rise below 2 degrees C (3.6 degrees F). The New Climate Economy estimates $90 trillion (about $6 trillion annually) will be invested in infrastructure between now and 2030, and the shift to low-carbon investments necessary to prevent the worst impacts of climate change requires about $4 trillion (about $270 billion per year) in additional investment.
Because dealing with climate change will not only require additional resources, but also a new way of making financial decisions, a group of financial institutions have been working since early 2015 to build consensus around a set of voluntary principles to effectively incorporate climate change considerations (both opportunities and risks) into their strategies, programs and operations. This process is often referred to as “mainstreaming climate change.”
5 Voluntary Principles for Mainstreaming Climate Action
Launched here in Paris at the start of this week, these Principles were spearheaded by several IDFC members and the multilateral development banks, but have recently been joined by other public and private financial institutions. The Principles aim to position financial institutions to capture opportunities while mitigating core business risks, and guide them through the process of mainstreaming climate change for better adaptation and promotion of climate-smart development through the following actions:
COMMIT to climate strategies: Be strategic when addressing climate change. Financial institutions must make commitments from the top with senior management leadership defining explicit strategic priorities, policy commitments and targets.
MANAGE climate risks: Be active in understanding and managing climate risk. Financial institutions should ask which climate risks are present in their portfolio, pipeline and new investments, as well as what are the most appropriate ways to help clients manage their risks. These aren’t easy questions to answer, but public resources can help the process.
PROMOTE climate-smart objectives: Promote approaches to generating instruments, tools and knowledge on how best to overcome risks and barriers to investment in low-carbon and resilient investments. This could include developing new financial instruments, vehicles and products to raise additional financing and manage risks for climate-smart activities; engaging clients and other stakeholders (including rating agencies and accounting firms) on climate change risks and resilience; and sharing lessons learned with peers and others.
IMPROVE climate performance: Set up operational tools to improve the climate performance of activities. Under this principle, financial institutions would track and monitor indicators tied to climate change priorities (see Principle 1 above), e.g. greenhouse gas emissions reporting, lending and advisory volumes supporting green investment, climate-related asset allocations, and each institution’s own climate footprint.
ACCOUNT for your climate action: Be transparent and report, wherever possible, on the climate performance of your institution. Tracking and monitoring are important steps to improving climate performance, but performance transparency and reporting on financing increases in clean energy, energy efficiency, climate resilience or other climate-related activities and investments will help ensure targets are met and empower the full range of stakeholders outside the institution (e.g. investors, clients, civil society) to make informed decisions and hold institutions accountable.
Twenty-six private and public sector financial institutions have joined the initiative as of the formal launch of the Principles on the COP21 sidelines. The hope is these principles will appeal to a wide range of financial institutions and guide them through a process that will help shift trillions of dollars towards low-emission and climate-resilient activities.
With negotiators at the UN talks currently discussing how best to signal to investors about the need to align their portfolios with a below 2 degrees C (3.6 degrees F) world, the launch of these principles is timely. However, civil society in particular has called for more leadership from financial institutions on the issue of climate change, and warned against a lack of ambition to create a fundamental change in business practice.
As a concrete next step, the Initiative will form a Planning Group in 2016 to map out future work, including sharing knowledge about processes and tools to implement the Principles. Discussions around how to take the Principles forward have already started, revealing several key questions, among them: On accountability, how will progress with implementation be measured and by whom? On reach, how can an Initiative seeking to expand and reach financial institutions worldwide attract more developing country financial institutions to join?
Answering these questions and putting these voluntary principles into actual practice across financial institutions will take time. However, the Principles have the potential to provide a useful roadmap to help guide institutions toward efficiently and transparently providing the trillions of investment needed to support the world’s low-carbon, sustainable development.