In the wake of the climate change Conference of Parties 26 (COP26) in Glasgow, the role of the financial industry in combating climate change is a significant focus for those committed to a net zero economy. One of the ways in which the industry is a central figure in the transition to a net zero economy is net zero investing. Overcoming obstacles to greater investment in a green transition is a primary focus of the Biden administration’s recent Roadmap to Build a Climate-Resilient Economy.
As public awareness of the adverse impact of climate change grows, so does the number of institutions committing to funding a net zero transition. On October 26, 2021, former US Vice President Al Gore announced the launch of Just Climate, a net zero emissions investment fund with backers including Microsoft, Goldman Sachs, and Harvard University, one of many recent high-profile commitments to net zero investing. On the same day, the largest pension fund in the Netherlands announced that it would divest from all fossil fuel investments—including Royal Dutch Shell—with a target date of Q1 2023.
Despite the rapid growth in net zero commitments and sustainable investment, challenges remain. The challenge is not necessarily in finding funding—Generation Investment Management, the parent of the Just Climate fund, has $36 billion in assets under management. Rather, the challenges lie in the disconnect between government policies and financial incentives, and the impact that the disconnect has on meeting climate change goals. As outlined in the White House’s roadmap, these challenges include: (1) a lack of policies that sufficiently discourage greenhouse gas-emitting activities and encourage climate solutions; (2) high project preparation, permitting, and other transaction costs for climate solutions; and (3) a lack of clarity and consistency in reporting on an investment’s sustainability.
This last point is particularly salient for financial industry players. Some investment decisions are clear. Investing in a new coal-fired power plant is not likely to help an investor meet a net zero emissions target. Many of these decisions, however, are more complex. For example, while replacing fossil fuel-powered vehicles with electric ones is important to net zero goals, an investor considering an electric vehicle startup may also want to consider the environmental impact of the vehicle’s manufacturing process and whether the metals used to make the vehicle, particularly its battery, were extracted in an environmentally friendly fashion.
Questions like these can make net zero investment difficult, particularly as there are not yet government-mandated or universally accepted standards for measuring and reporting on corporate sustainability. While advocacy groups can issue recommendations on how to conduct net zero investment strategies, most agree that regulatory standards will go a long way to producing decision-useful information for investors.
Indeed, the US government has already moved to resolve some of the issues outlined in the Roadmap in the Financial Sustainability Oversight Council (FSOC) October Report on Climate-Related Financial Risk. To address the issue of clarity and consistency in corporate reporting on sustainability, the FSOC report cites the importance of climate-related financial disclosures and specifically notes the need to standardize and fill gaps in climate-related data. This new guidance could not come at a more opportune time. With more and more investment funds setting net zero targets, regulations that help clarify climate risks, sustainability targets, and other climate-related reporting will give investors the information necessary to make well-informed choices to contribute to their net zero investment goals.
The challenges of net zero investing are just one of the several topics addressed by the Biden administration’s Roadmap to Build a Climate-Resilient Economy. In a series of posts, Guidehouse will discuss all aspects of the report, ranging from regulations to safeguard the financial system to how to use policy to protect vulnerable, disadvantaged communities.
Our next post in the series dives into climate-related financial regulations and what financial institutions and other regulated companies should start thinking about.