The world’s attention was recently focused on COP26, as global leaders took aim to tackle climate issues and work towards limiting global warming to 1.5 degrees. The goals and commitments carved out during the international summit will have implications across all industries and will transform the financial sector, too.
by Jennifer Geary, General Manager, nCino
However, not only are societal and regulatory pressures driving environmental, social and corporate governance (ESG) trends, there is also a clear business imperative; research finds that companies using the combination of sustainability and technology-lead strategies are 2.5x more likely to be among tomorrow’s strongest-performing businesses.
What makes ESG so fundamental for banking is that it will alter the very way in which financing decisions are made. Capital and investment decisions have been driven according to pretty much the same set of financial metrics in banks for decades. The revised capital adequacy requirements of the last ten years changed them somewhat, but that pales in comparison to the changes that will need to take place for ESG. Having a broader-based dashboard with which to assess lending, which takes into account a range of non-financial factors, including climate, the environment, sustainability and social good is something that will some adjusting to in credit risk departments around the world.
This is not without pitfalls – done cynically, this can lead to greenwashing and gaming the system, which is why having access to reliable frameworks and independent sources of data will be so important. This will need to be strengthened in turn with rigorous, informed governance by those charged with overseeing these decisions.
With support from trusted partners, it’s possible for financial institutions to start addressing how they can put sustainable finance at the core of their decision-making. However, before delving into the details of this, let’s look back at some of the key goals established at COP26 that will help shape the sustainability agenda of the financial industry moving forward.
Highlights from COP26
Aligning private finance to net zero – A major step was taken by private financial institutions to ensure that existing and future investments align to the global goal of net zero. Thirty-six countries agreed to compulsory actions to make sure investors have access to reliable information regarding climate risk so they can guide investments into greener areas. What’s more, over $130 trillion of private finance is now dedicated to science-based net zero targets and near-term milestones through the Glasgow Financial Alliance for Net Zero (GFANZ). Additionally, the UK Chancellor set out proposals to make the UK’s financial centre aligned to net-zero. Under the plans, UK financial institutions and listed companies will have new requirements to publish net-zero transition schemes that detail how they will adapt and decarbonise as the UK moves towards to a net zero economy by 2050.
Mobilising private finance – Amongst discussions, finance ministers agreed that the billions invested in public finance must be utilised to maximise on the trillions available in private finance needed for a climate resilient, net zero future, and how to support developing countries to access that finance. In addition, the UK, European Commission, and the US all committed to work in cooperation with developing countries to support a green and resilient recovery from COVID-19 as well as to boost investment for green, clean infrastructure in developing countries. The UK also pledged £576 million at COP26 for an initiatives package to mobilise finance into developing economies and emerging markets. This included £66 million to expand the UK’s MOBILIST programme, which supports the developments of new investment products which can be listed on public markets and attract different types of investors.
Meeting the $100 billion commitment and financing adaptation – Several countries made new commitments to increase finance in support of developing countries to cope with the impact of climate change. This included a commitment from Japan and Australia to double their adaptation finance; a commitment from Norway to triple its adaptation finance; and commitments from Switzerland, Canada, and the US for the Adaptation Fund. The US finance adaptation commitment included some of its largest commitments to date – to reduce climate impacts on those most vulnerable worldwide. At the same time, Canada has committed to allocate 40% of its climate finance to adaptation. The UK, Spain, Japan, Australia, Norway, Ireland and Luxembourg also pledged commitments for climate financing that build on the plan put in place ahead of COP26 to deliver the $100 billion per year to developing countries.
Turning to data and technology
Taking the goals set out at COP26 as just one example, it’s clear that moving in a direction towards sustainability and tackling climate change is top of the agenda for the financial services. However, whilst the intention to drive sustainable finance is key, the real question is ‘how financial institutions can successfully achieve this transition?’. The answer, we believe, lies in data and technology.
Whilst some financial institutions that have moved to the cloud have reaped the rewards with access to integrated data, those that haven’t face a challenge of disparate and siloed data. Now, following years of never having to consider it, financial institutions need to bring in a whole new data set centred around climate and sustainability. Ensuring access to this data is going to be fundamental to facilitating sustainable investments and evidencing that what has been done has had a positive outcome on the climate. This is where embracing new and flexible technology platforms that drive ESG initiatives is crucial.
The role of partnerships
According to recent research from nCino, nearly half (44%) of financial organisations are adopting technology to better respond to ESG trends. With the right technology in place, banks and other financial institutions can easily add additional data points for the finance they are evaluating and issuing. Non-financial covenants – such as the amount of CO2 emissions avoided or clean energy megawatts hours generated – can be tracked against a particular piece of finance. For example, if a bank is financing a wind farm, technology platforms can help make sense of the metrics and external data integrations can track commitments relating to that finance.
In the past, credit losses were the primary constraint on what FIs financed and what they put in their portfolios. Now, there is a whole new set of criteria including the most recent goals and targets from COP26. For FIs to successfully track their finance against climate goals and place limits on portfolios to ensure they are sustainable, it all comes down to having the right data. And it’s here that new, flexible technology can help to generate this and track it to make sure banks are living up to their commitments.
A future of sustainable finance
Looking back over the highlights from COP26 and the commitments being made, finance has a clear role to play in moving businesses, societies and countries towards a more sustainable future. It’s time for financial institutions to turn the tables and ensure that making sustainable investments is a priority. With the support of agile technology to help gather and report on the right data, there’s no reason for financial performance and sustainability to be mutually exclusive anymore.