Shifting to a zero-carbon economy will be a massive—and costly—endeavor. Financial firms are embracing this vision for the future and helping make it happen.
As the United States—and the world—undertakes the decades-long task of shifting to a zero-carbon economy, financial services companies are putting this transition front and center, with innovative financing; environmental, social, and governance (ESG) investments; and guidance on managing climate risks and navigating emerging regulations.
This global undertaking carries a substantial price tag. For example, the United Nations’ Intergovernmental Panel on Climate Change estimates that adhering to the Paris Agreement will require annual investments of about $3 trillion through 2050. The private sector is already taking on this challenge. In conjunction with the November 2021 COP26 climate change conference in Glasgow, Scotland, the Global Financial Alliance for Net Zero (GFANZ), which represents more than 450 financial institutions, pledged $130 trillion in financing for clean energy. GFANZ members have also committed to eliminating carbon emissions from investment and lending portfolios by 2050.
Financial services companies are well along the path to a greener future. As a 2020 KPMG report notes, banks are rolling out new sustainable products and services, wealth managers are moving toward ESG investing, and capital markets are introducing "green underwriting." Almost three-quarters of bank CEOs surveyed said they "believed their future growth will be largely determined by their ability to anticipate and navigate the shift to a low-carbon, clean-technology economy."
Here are the four ways the financial services industry is embracing ESG and a low-carbon future today:
Enabling Private Investment
Shifting the economy to clean energy will require a vast reallocation of capital, a process that’s already underway: Moody’s reports that global issuance of sustainable bonds is expected to top $1 trillion in 2021, more than 60% above 2020 levels. That total includes $500 billion in green bonds that finance clean energy and other environmental projects. Firms in the financial, real estate and energy sectors are by far the leading private issuers of green bonds, markets data firm Refinitiv reports.
Fifth Third Bank has pledged $8 billion in sustainable finance by 2025, including lending and financing for solar, wind, geothermal, biomass, and hydropower renewable energy projects. In 2021 the bank announced its inaugural $500 million green bond, which will fund the likes of green buildings, renewable energy, energy efficiency, and clean transportation.
Demand for ESG credit products should remain strong, says Maria Yamat, Head of Bond Capital Markets at Fifth Third Bank. A 2020 report found that globally there is $40.5 trillion of fixed income assets under management committed to ESG, Yamat notes, but only $3.9 trillion in sustainable bonds has been issued since 2013. "This creates an opportunity for any issuer," Yamat says.
Harnessing the Power of Insurance
Insurance companies may be the most under-the-radar power player in the ESG space, says Joshua Landau,Corporate Banking Group Head—Financial Institutions Group at Fifth Third Bank and President of the International Insurance Society, a nonprofit industry thought leadership and educational organization. When it comes to ESG, insurers can exert their influence in a number of ways. For starters, these financial companies have trillions of dollars in customer premiums to invest—in 2020 U.S. insurers’ cash and investments totaled nearly $7 trillion, according to IR+M. "Insurers have the power, given they manage so much investment capital." says Landau. "Any one company individually probably can’t influence a market. Collectively they can."
For example, Zurich Insurance Group has committed to a net-zero carbon investment portfolio by 2050. Allianz’s ESG Integration Framework includes evaluating the ESG performance of its assets and prohibiting investments in sectors like coal-based businesses.
The other lever insurers can pull is in deciding what to insure, and what not to insure. According to a 2021 survey by the credit rating firm AM Best, 6 out of 10 U.S. insurance companies say the demand from stakeholders "to explicitly consider environmental, social, and governance factors in their decision-making is growing."
Navigating Evolving Regulations
As ESG catches on with consumers, businesses, and investors, regulations governing how ESG is measured and disclosed are just starting to emerge in the United States, adding uncertainty to how companies operate and report ESG. "With no solid regulatory rules in place," says Yamat, "there’s no sense of right or wrong in terms of one’s approach to ESG and disclosure."
More consistent reporting and disclosure standards may be on the way. The Securities and Exchange Commission has proposed new regulations requiring companies to disclose the climate-related risks they face, and pending legislation would require the largest U.S. banks to submit reports to the Federal Reserve detailing 17 ESG-related business areas. The financial industry isn’t waiting for Washington. The Partnership for Carbon Accounting Financials, a worldwide consortium of more than 200 financial firms, including Fifth Third, is working to standardize the measurement and reporting of emissions associated with lending and investment activity.
Complicating matters for companies that operate globally, the European Union is far ahead of the United States when it comes to regulating ESG disclosures. "It doesn’t work," says Landau, "unless there’s a consistent approach."
Meeting Consumer Demand
Just as investors and consumers are taking ESG into consideration, companies are seeking to integrate ESG factors into their operations. That can mean changing how they do business as well as disclosing their impact on the environment and society as a whole. A full 95% of companies on the S&P 500 have made detailed ESG information publicly available, according to the Center for Audit Quality. "Companies want to prove their value to society," says Yamat, and banks will have a role in providing guidance to clients with ESG goals. Adds Landau: "While it’s not compulsory yet, it is the right thing to do, and at some point it is going to be expected."
Financial service companies are also meeting investor demand for ESG products. A traditional mutual fund may not serve the purposes of a client who wants to be free of companies that make cigarettes and mine coal, for instance. The number of sustainable mutual funds grew to more than 500 in 2021, up 36% from the previous year, Morningstar reports, and these funds attracted a record $69.2 billion in net new investments. "This is a popular thematic investing trend," says Yamat, "so make sure you have the products to meet the demand."