Make it Count: Structuring Climate Finance to Meet COP26 Objectives

By Christina Schwantes and Colin Powell

One of the most pressing goals of COP26 is mobilizing climate finance, but we need the right structures in place to make sure investments get us to net zero.

The headlines are clear: there is a lot of stake at COP26, the UN Climate Change Conference. The Intergovernmental Panel on Climate Change’s Sixth Assessment Report has told us the world is on a trajectory towards more than 3°C of warming (well over the Paris Agreement stretch goal of 1.5°C), unless we collectively reach net zero emissions before 2050, with the most drastic changes needed in the next decade.

One of the four overarching goals of COP26 is mobilizing climate finance. In 2010, developed countries pledged US$100 billion annually to support developing countries in reducing emissions and adapting to climate change. However, a new report to be jointly drafted by Canada and Germany shows that we have fallen short. The Organization for Economic Co-operation and Development (OECD) estimates have shown that climate finance provided by developed countries was US$21 billion short in 2019. It is now expected that countries will have to re-double their efforts, like Canada just did, to climate finance in order to meet the US$100 billion goal. But as always, the devil is in the details.

Here are some of the main challenges and opportunities for Canada as nations come together to mobilize climate finance at COP26:

1. While sustainable investment portfolios are growing in size, millions of Canadian investment dollars continue to pour into fossil fuels today. Capital should be redirected from investments that are not aligned with the Paris Climate Agreement. Doing so is one of the most impactful ways to invest in the low carbon economy – but quick divestment may cause disruption to employment and regional economies. Thus, divestment strategies must not be sudden. Transition plans need to be just, incorporating a vision and process shared by workers, industry and governments – and grounded in the geographical, political and social context. Transition plans should provide support to the employees and economies most affected, minimizing negative impacts and maximizing the positive opportunities of the low carbon transition.
2. Many popular sustainable investing products are not actually funding new investments, are not aligned with net zero targets, or do not require their emissions impact to be calculated — making it impossible to know if impact is being achieved. Green bonds, for example, are lauded as a tool to invest in environmentally sustainable projects, helping investors and issuers label projects as “green.” However, project requirements are often loosely and individually defined, and some may only represent avoided emissions, such as an investment in a new LEED-certified building as opposed to a deep retrofit of an existing building. Furthermore, the proceeds of existing green bonds may be going towards projects that would have been funded regardless of how “green” they are. Simply tagging loans as “green” does not represent net new emissions reductions, nor does it does allow for new projects that would not have happened without the green bond proceeds. Wherever possible, sustainable investment products should support projects that are aligned with the path to net zero by 2050, such as by funding net zero (or net zero ready) buildings or carbon removal technologies. They should also incorporate additionality as a criterion. That is, provide dedicated net new capital to these projects and not merely tag old investments as “green.” Calculating the impact of investments, such as green bonds, and categorizing them as avoided or reduced emissions is also essential to ensure a meaningful investment in the low carbon economy.
3. At the organizational level, Canadian companies and banks must undergo deep organizational transformation to manage climate risks across their operations, investments, and business strategies. Companies are strongly encouraged to measure and disclose climate related risks through frameworks like the Task Force on Climate Related Financial Disclosure (TCFD). However, many investors and stakeholders do not find current disclosures useful in making climate-informed investment decisions. There is often a lack of consistency and sufficient detail between the disclosures, making comparisons challenging (see more from WSP’s White Paper on Meaningful TCFD Disclosures, here). The Canadian Securities Administrator recently proposed requirements to standardize climate-related disclosure by companies, which would help with the challenge of consistent, meaningful disclosures across companies.
4. As the need to disclose climate financial risk becomes essential and potentially mandatory, there is mounting global pressure on banks and asset managers to quantify the climate impact of investment portfolios. These “investment emissions” are the emissions from investment portfolios and loans — calculated using data from each company in the portfolio or from the activity of the loans, while also accounting for the size of the holding. Investment emissions tend to be significantly higher than operational emissions for financial institutions, but to date have been rarely reported (this is changing, though). One reason is that calculating investment emissions is challenging, and requires granular details on each company and loan. Methodologies such as that from the Partnership for Carbon Accounting Financials (PCAF) have been developed for different asset classes, but need to be expanded to other asset classes to allow more comprehensive and consistent disclosure of financed emissions. Canadian financial institutions must quantify investment emissions to ensure investments have a meaningful, trackable impact on climate change. Canadian financial institutions should also publish their investment emissions methodologies in order to ensure consistency in disclosures.

Canada has recently taken a significant step towards measuring investment emissions. In October 2021, Canada’s big six banks signed onto the Net Zero Banking Alliance (NZBA), an initiative led by Mark Carney, the former Governor of the Bank of Canada. The banks committed to aligning their lending and investment plans with the 1.5°C target while also achieving net zero emissions in their operations by 2050. This includes net zero financed emissions, meaning the banks will need to implement a system to quantify their investment and loan portfolios. Once again, the devil will be in the details about how these banks’ strategies are implemented, and the announcement included promises for near term action plans.

Whether we successfully mobilize climate finance will depend on the ability of both public and private sectors to create a system in which the low carbon economy can thrive, while achieving the emissions reductions needed to get to net zero. This means climate change must part of all financial decisions: where finance comes from (or where it is redirected from); the projects that are funded; and transparency about their impact. Further, we need investors, asset managers and banks to manage and disclose climate risks and be accountable for the emissions associated with their loans and investments.

The following takeaways are paramount as we monitor the outcomes of COP26 and beyond:

• Capital should be redirected from investments that are not aligned with the Paris Climate Agreement.
• Transition plans must be just, providing support for employees and economies most affected.
• Sustainable investment products should support projects that are aligned with the path to net zero by 2050 and incorporate additionality as a criterion.
• The GHG emissions avoided or reduced because of sustainable investment products, such as green bonds, should be measured and disclosed.
• Canadian financial institutions must quantify investment emissions to ensure investments have a meaningful, measurable impact on climate change and targets are tracked and met.

WSP is deeply committed to helping Canada realize the opportunities of the transition to the low carbon economy. Our team supports companies, banks, and investors to quantify emissions of their operations and portfolios. We can help clients measure, manage, and report on emissions and implement just low carbon transition plans. We also support companies in understanding and managing climate risks and disclosing climate information through TCFD and other reporting frameworks.

Click here to learn more about WSP Canada’s Climate Change and ESG services.

Christina Schwantes is a Climate Change, Resilience and Sustainability Specialist with WSP Canada. Colin Powell is an ESG Advisor for Climate Change, Resilience and Sustainability at WSP Canada.

Note: This sponsored story originally appeared as a WSP Canada Insight.
For more WSP Canada Insights, visit: https://www.wsp.com/en-CA/insights