Climate change: banking on a greener future?

“Climate-related risks are clearly among the long-term risks to which financial institutions are exposed: monitoring these risks is not a ‘nice to have’… but a ‘must have’.” This statement came from France's central bank governor, François Villeroy de Galhau,¹ on 24 April 2023, effectively throwing down the gauntlet to the financial sector to address arguably the greatest challenge of our time – life in a higher temperature world.

Discussions around greenhouse gas (GHG) emissions reduction often focus on high-emitting sectors such as energy, utilities or industrials. The operations of companies in these sectors account for the majority of global GHG emissions, as can be seen in Exhibit 1. Therefore, these sectors have been primary targets for engagement by asset managers, as highlighted in our paper “Oil & gas majors: active stewardship rather than divestment.”

The operational emissions of banks are comparatively much smaller. This perhaps explains and justifies why they have historically been a lower priority when developing some of the commonly used engagement and analysis frameworks.²

Exhibit 1: Financed emissions reveal the significant relevance of climate change for banks

Source: MSCI, as at 12 October 2023. GHG emissions aggregated by sectors for MSCI ACWI Index constituents, based on companies' most recently reported or estimated Green House Gas (GHG) emissions modelled by MSCI depending on data availability and quality.

Combining our sustainability research and stewardship engagement experience, in 2022 we developed a framework to guide voting in management resolutions on Say on Climate in the UK and shareholder resolutions in the US. We evolved this framework in 2023 by adding several new criteria, extending certain thresholds, and expanding its use to drive more targeted engagement.

As an example, this year we engaged with a large US listed bank, forming a positive view of its climate transition performance that included progress against climate intensity targets. As an outcome, we did not support a shareholder proposal that called for absolute GHG reduction goals.

Our framework comprises five pillars with 23 criteria (expanded from 16 in 2022). We need this number of criteria to capture the complexity of banks’ climate strategies. Each criterion is assessed against a pre-determined scale of performance for which we referenced commonly used available frameworks. For 2023 we recalibrated some of the performance scales to reflect evolving market practice. For example, in assessing one of the 23 criteria – around commitment to align financing and investment with the Paris Agreement – we stepped-up the level of expectation by adding mortgage and capital markets, because the methodology for assessing these areas is becoming available.

Our framework enhances our engagement activity, giving us better conviction on a bank’s progress versus both peers and our expectations. Ahead of selected annual general meeting votes and in preparation for engagement meetings, we analyse reported material and complete the assessment per framework. Although reported material can run into hundreds of pages, more is not necessarily better. By distilling our analysis into key indicators benchmarked against pre-set scales, we obtain a clearer picture of the banks we have analysed.

Through engagement meetings, often with specialised teams of sustainability and climate experts fielded by the company, we gain additional insight to supplement the reported information. For example, these meetings may help clarify the background of decisions reported. Beyond gaining better clarity on the company’s climate strategy, engagements can be helpful to gain a first-hand impression of the internal resources that have been committed to implement these strategies. Finally, these meetings allow us to convey our specific expectations for issues we have raised.

Exhibit 3: AllianzGI proprietary framework shows banks’ climate progress

Source: Allianz Global Investors, August 2023

This process, and our enhanced engagement framework, provided key learnings. First, collaboration matters. Combining both our thematic research and our stewardship activity increases our effectiveness. The analysis described in this paper was the product of collaborative work between our dedicated Sustainability Research and Stewardship teams. Engagement quality is boosted by the depth of research, and engagement output contributes to further honing of the research.

Second, less is more. For some banks we looked at, climate reporting spanned several lengthy documents. No doubt the intention was to address a broader set of interested stakeholders and more detailed set of regulatory expectations. Yet at times we found it difficult to extract necessary, quantified pieces of information that we saw as relevant from our own point of view. For example, use of climate-related metrics does not always align with an investor’s perspective. Some banks report financed emissions as raw numbers but fail to specify the limited coverage in terms of asset class, activities or geographies. In other words, we know the magnitude of their financed emissions for part of the business, but we are not able to contextualise it within a complete picture of their entire activities. It means that we are limited in our ability to assess the extent of associated investment risk and mitigation measures relative to the whole institution.

In a year when climate progress in the energy sector has been tested, it was encouraging to see that so far, the leading banks have maintained momentum by delivering on long term climate commitments, and notably by broadening sector coverage of mid-term emissions reductions. At the same time, many gaps remain, with some banks falling short of our expectations.

The 2030 deadline for achieving intermediary milestones of the Paris Agreement temperature goal is very much in sight. Rightly, the emphasis for climate strategies has now shifted decisively to the implementation of commitments made in the past year or two. The more we build up our understanding of this implementation across financial institutions over time, we will be able to assess the effectiveness of chosen strategies. For example, it would become increasingly difficult to explain a bank’s persistent underperformance versus initially anticipated emissions reduction trajectories.

We believe this approach to engaging with banks will aid investors in making better-informed decisions and put clear distance between the laggards and the leaders across the banking sector.