That’s the scenario the finance sector has been facing in the transition to Net Zero. Financial institutions play a crucial role in the transition, and they need to be well informed. But this is particularly tricky in a world of limited and inconsistent sustainability data. 

Sustainability data is notoriously difficult to get in the first place and challenging to use. Several pioneering data providers have attempted to supplement high level top-down data collection with bottom-up data collection, to provide a solution. The outcome has not been conclusive. The result is often inconsistent data, inconsistent rating of sustainability performance and risk, and general confusion around who is doing well and who is not. This hasn’t helped the overall credibility of sustainability-labelled financial products and has led to a criticism of greenwashing. 

In the last two years, there have been clear actions to amend this, with a push towards the reporting of key sustainability metrics by all participants in the space. Firstly, we need companies to report their sustainability metrics so that the financial institutions have the information they need. We then need the financial institutions to report, so that the asset owners or investors know where their money is going. The diagram below describes the flow of information and capital.

We have seen the emergence of frameworks on what to report, such as the Task Force on Climate-related Financial Disclosures (TCFD), Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB). We’ve also seen guidance on how to report – for example, the Greenhouse Gas Protocol, the PCAF Global Standard on Carbon Accounting Financials and Science Based Targets initiative (SBTi) guidance for various sectors. Although there is increasing clarity on the how and what, without mandatory reporting, being a first mover has limited attractiveness. As a CEO, you might be reluctant to expose your company’s value at stake due to climate change if your competition isn’t doing the same. UK regulators have picked up on this reluctance. 

A roadmap to Net Zero

However, there has been concerted movement from the government to move things in the right direction. In the run up to COP26, the UK government published a cross-departmental sustainability disclosure requirement roadmap, Greening Finance. This included more details on the already-announced mandatory reporting of climate risk and opportunities, in line with TCFD, as well as the degree to which activities (for companies) or investments in activities (financial institutions) are sustainable. This is to be defined by the forthcoming UK Taxonomy, which will build on the work of the EU Taxonomy, which works to identify environmentally sustainable investments. 

During COP26, the UK government also announced that it wants firms to publish plans for reaching Net Zero, in line with the UK’s own target. For this aspect of the disclosure roadmap, it will be mandatory to disclose a transition plan but not mandatory to commit to Net Zero. The government also intends to publish a ‘gold standard’ for transition plans and metrics for guidance, and assurance and transition pathways for the financial sector. The aim is to create a Net Zero-aligned UK financial centre. 

The disclosure regulation follows in the footsteps of the EU, but the UK takes disclosure a step further by requiring transition plans. And although UK-focused, the regulation will have a global impact as British multinationals transition to Net Zero and UK asset managers, many with global investment portfolios, look to decarbonise. 

The confidence to take action

We welcome this push towards disclosure as it will help with data challenges, supplementing the regulation with a taxonomy on what is sustainable. A standard for transition plans adds credibility and clarity. 

This move is to be further strengthened when the forthcoming global corporate reporting standards for sustainability are published by the new International Sustainability Standards Board (ISSB), created by the IFRS Foundation. This will help ensure sustainability data becomes more like financial data, which means consistent and comparable. Helpfully, the UK government has also committed to adopt and endorse these new standards. 

With clarity on disclosure requirements, financial institutions can be confident about what steps to take today. To comply with the requirements, it will not be enough to leave it to a small internal team to get on with it. In most cases it will require a fundamental shift in operations with buy-in, knowledge, understanding and action required at all levels, including board and management. Of course, real action and impact is the nudge the requirements are hoping to achieve. 

So, where do we start with disclosure?

To begin with, baseline footprinting is an absolute minimum, and it should include a firm’s value chain. For a financial institution, that means portfolio footprinting. Next is aligning with TCFD recommendations by starting to understand climate risk and opportunities throughout the value chain. Firms should also start formalising transition plans in line with current best practice (i.e., from the SBTi – we would expect the UK gold standard to be built on the already comprehensive work by the global initiative). Finally, firms would benefit from understanding how sustainable their activities are, starting by exploring the EU Taxonomy. 

They say knowledge is power. As the financial sector gains more knowledge through disclosure, hopefully we can all power to Net Zero faster.