NGFS does not do justice to the climate transition

July 4, 2024|Written by and |Network for Greening the Financial System
A woman standing in a field of small bushes, holding several green seed pods in her hands. Behind stand two solar panels.
Solar panels in Saptari, Nepal. Transition plans should recognise historical and current contributions towards emissions responsible for global heating. © Nabin Baral / IWMI

The Network for Greening the Financial System (NGFS) recently dropped a new package of reports on financial institutions’ climate transition planning. The attention paid to the credibility of plans is commendable as are the few references to a just transition

However, the NGFS doesn’t substantially engage with climate justice, the notion that historical and current differences in responsibility for greenhouse gas emissions between and within societies should be taken into account in efforts to mitigate climate change. Nor does the NGFS provide guidance on actual emissions reduction targets in this context.  

We argue that the credibility of financial institutions’ transition plans can only be ensured by including emissions reduction targets that can be described as ‘climate just’, in that at the very least they reflect the common-but-differentiated-responsibilities principle.

The climate transition planning package

The NGFS has conducted a number of deep dives into topics related to financial institutions’ transition plans. One of the reports in the package deals with the relation between transition plans of financial and non-financial firms. Banks can play a unique role in furthering the transition across the real economy by demanding adequate transition plans from their corporate clients. 

As a result, this relationship is key to developing a business strategy by banks which is aligned with the Paris climate agreement, as well as for achieving the necessary emissions reductions. However, the transition plans of both financial institutions and their corporate clients need to be credible and sufficiently ambitious if this aim is to be achieved.

Transition plan credibility is the subject of another deep dive in which the NGFS rightly notes that “transition planning information of financial institutions can provide important insights to microprudential authorities on the institution’s strategic approach to addressing climate change”.  

Yet the NGFS takes a mostly procedural approach to transition plans. It indicates that credible transition plans should discuss the governance of the transition, engagement of clients, climate risk analysis, viable actions taken to implement the plan and the process of monitoring and review. 

Remarkably, despite identifying target setting as the top common credibility element in a review of existing frameworks and literature, this is absent from the proposed list of credibility elements for transition plans of financial institutions. The NGFS argues that assessing financial institutions’ emission reduction targets is generally outside microprudential mandates, although (fortunately) it recognises engagement of microprudential authorities with target setting as an area of further exploration.

Credibility and target setting

The procedural approach of the NGFS, and in particular its shunning of target setting, sits somewhat uneasily with its proclaimed purpose to “help meet the goals of the Paris Agreement”. It is also strikingly odd in light of its own observation that transition plans need more international guidance. 

A key step in achieving prudential goals such as effective management of climate-related financial risks is to ensure the credibility of financial institutions’ transition plans. Misalignment of a bank’s transition targets with the Paris Agreement could be seen as a proxy for climate-related risks, which the European Central Bank has shown might already materialise in the medium-term. 

Moreover, widespread misalignment within the banking system could create systemic risks. Ambitious and credible transition plans are therefore a key tool for micro- and macroprudential supervision, as well as to achieve emissions reductions in line with the Paris Agreement. This warrants detailed guidance through prudential expectations.

In its initial stocktake of climate transition plans in May 2023, the NGFS noted that credible transition plans need an “absolute cap on total emissions over the life of the transition plan”. Although not repeated in the current package, the need for absolute emissions targets has been echoed by ECB staff in their recommendations for improved disclosures and was emphasised earlier by the UN’s High Level Expert Group on the Net Zero Emissions Commitments of Non-State Entities. While emission intensity metrics can be useful for comparing clients or portfolios, absolute reduction of emissions is what matters in avoiding dangerous climate change.    

Large international banks are systemic actors that provide financial services to activities across the whole economy. Their targets should therefore, at a minimum, in accordance with absolute emissions reductions needed to limit global warming to 1.5ºC. According to the latest scientific insights of the Intergovernmental Panel on Climate Change, this means banks must reduce their absolute CO2 emissions across their portfolio by 48% by 2030 compared to 2019.

Since financial institutions also finance activities that emit greenhouse gases other than CO2, such as methane from cattle farming, it makes sense to use the relevant overall target for CO2 equivalents, which means an absolute reduction of 43% by 2030.

However, such an overall absolute reduction target based on the global average does not do justice to another key Paris-aligment principle: common-but-differentiated-responsibilities. 

In its stocktake of the transition plans of Dutch financial institutions, Der Nederlandsche Bank notes that with respect to fossil fuel transition pathways (our translation) “the net zero scenarios of the International Energy Agency (IEA) offer a basis for the reduction of fossil fuels, but these are determined at the global level. Because it is expected from developing countries that they transition at a higher pace than other countries, this could lead to a required transition in the Netherlands which is faster than according to the global net-zero scenarios of the IEA.” 

The implication seems to be that Dutch financial institutions should use transition pathways that are steeper than the global average. We concur that climate justice requires financial institutions historically based in or focused on the western world to reduce their emission by more than 48% by 2030, reflecting the outsized responsibility of these countries for causing dangerous climate change.

In practice, the common-but-differentiated-responsibilities principle would apply to most of the largest international financial institutions. Take for example ING Group, one of the 40 banks designated as global systemically important by the Basel Committee. According to the group’s 2023 annual report, over 80% of its shareholders are based in the US and western Europe. Similarly, over 80% of its corporate clients are based in Europe and Australia. Its board members are mostly from countries with a higher responsibility for climate change and its corporate headquarters is based in one of those countries, the Netherlands. 

The global average of a 48% absolute reduction by 2030 should thus be an absolute minimum for a bank like ING Group, if it is to make a credible contribution towards achieving the goals of the Paris Agreement.

Climate-just targets

In summary, credible transition plans require climate-just absolute emissions reduction targets that reflect differences in (historical) responsibilities for emissions. 

Friends of the Earth Netherlands has served a legal notice of liability to ING Group that applies these principles, with a demand for an emissions reduction of at least 48% by 2030 compared to 2019 across its portfolio, based on the bank’s civil law duty of care.  We will not shy away from following through with this climate court case, but it would be prudent if financial supervisors are able to demand climate-just targets from financial institutions too in the exercise of their prudential oversight. 

In our view, including this requirement in its guidance for transition plans would be a logical and necessary extension of further exploration by the NGFS of the credibility of financial institutions’ transition planning.

This page was last updated July 4, 2024

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