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UN’s finance climate action pathway: Key expectations

A summary of the United Nations Framework Convention on Climate Change’s new Finance Climate Action Pathway 2021 detailing how the financial markets can support the transition to a net-zero future.

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15/11/2021

The United Nations Framework Convention on Climate Change’s (UNFCCC) new Finance Climate Action Pathway 2021 provides an ambitious and detailed roadmap for the financial markets to support the transition to a net-zero future.

Launched in 2019, the Climate Action Pathways set out sectoral visions for achieving a 1.5° C resilient world by 2050, with transformational milestones and key actions that need to be achieved to realise them.

For the financial sector, the goal is that by 2050, markets are placed to fund a zero-carbon world. The pathway’s targets, proposed transition process, and deadlines are outlined in this global insight report.

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UN's finance climate action pathway 2021: Key expectations

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Principal objectives

As wide-ranging as it is far-reaching, the UN’s action plan envisages the following by 2050:

  • Implementation of the vision that “every financial decision takes climate change into account.” Accordingly, the finance system has complied with Article 2.1 of the Paris Agreement — that finance flows are consistent with a pathway towards low-emission and climate-resilient development.
  • A shift in society’s expectations of the financial system to the degree that people now expect it to support sustainable growth. As a result, the system has responded, supporting the needs of today’s society without compromising the ability of future generations to do the same.
  • A change in the long-term investment horizons of the system, so now only those whose purpose has people and the planet at its heart are rewarded.
  • Commitment on the part of businesses and their financiers to a resilient, net-zero transition resulting in them thriving, avoiding the increasing costs and risks of the high-carbon economy.
  • A furthering of public and private sector collaboration to develop zero-emission infrastructure to the extent that such cooperation is now “business-as-usual.”
  • The avoidance of a “Minsky moment” of financial collapse after over a century of emissions-intensive growth, due to the focus of market participants and regulators on stewarding a smooth transition.
  • Greater trust in the financial system based on a foundation of circular economies supporting a fair and just increase in living standards across the world’s communities.

Key actions

The pathway maintains that if finance transitions in line with an under -1.5 °C resilient future, the result will be that the financial system will be able to fund the transition to that future. The following topics are considered.

1. Valuation gaps

The blueprint identifies the need to correct market failures and unpriced externalities — that is, activities which affect others without this being reflected in market prices. Mechanisms include:

  • Ending fossil fuel subsidies.
  • Accounting for the cost of climate-related physical, transition, and liability risks.
  • Advancing a circular economy.

2. Short-termism

The pathway advocates for the shifting of finance and investment onto a long-term path aligned with the Paris Agreement and beyond. For example, investment horizons should be in line with the long-term needs of customers and society.

3. Systemic transformation tools

The pathway calls for governance to promote accountability and standards across financial systems.

While education, training, and tools are used to integrate climate-related risks, digital currency technologies monitor climate impact through transaction data.

4. Risk management

The necessity of relevant and material climate-related data is highlighted, as well as prudential risk management. The UNFCCC is calling for alignment of executive and board remuneration with net-zero goals and physical risks posed by climate change.

5. Zero-carbon infrastructure

The report recommends the financial sector ensures capital flows:

  • Foster an equitable and just transition away from high-carbon resources, infrastructure, products, and services.
  • Unlock finance for zero-carbon and resilient infrastructure, access to clean energy, and climate solutions for all, with a focus on the most vulnerable communities.

Milestones

The pathway provides a comprehensive timeline in order for the 2050 deadline to be met. Here are some of the targets.

Insurers and underwriting

In the first phase, insurers are urged to integrate the Taskforce on Climate Related Financial Disclosure (TCFD) recommendations. As the transition gets underway, they are called upon to engage insureds to assess and report all climate-related risk. By 2040, the aspiration is to have insurers’ underwriting and investment portfolios aligned with achieving net-zero emissions, while supporting resilience to climate-related impacts.

Underwriters will ultimately seek more information from insureds on both their current status regarding net-zero objectives and transition commitments.

The markets heeding the call to action

Not all markets are moving at the same speed to achieve these non-binding goals but a number of European bodies are already working on the pathway’s objectives, including ClimateWise, the Sustainable Markets Initiative, and the Net-Zero Insurance Alliance.

The UNFCCC also advocates for continued and increased mandating of climate reporting (for example, via the TCFD’s recommendations) as key to realising the ambition of net-zero underwriting in the timeframes the pathway has laid out.

Leading the way

Governments around the world (notably the UK and EU) are looking to adopt their own, more tailored, versions of the proposed TCFD reporting frameworks endorsed in phase one of the UN Climate Action Pathway (above) and have set various deadlines for when reporting will become mandatory for business ranging from 2025 to 2050.

However it is arguably in New Zealand, where things are moving the fastest.

New Zealand has just become the first country in the world to make climate risk reporting mandatory for banks, asset managers and insurers, thanks to new legislation that was passed on 1 December 2021.

The new laws will apply to about 200 institutions (incl. banks and insurers with over $NZ1bn in asset under management). These institutions will be required, by law, to report their climate related financial risks in 2023. The preamble to the NZ legislation states that “the goal of mandatory climate-related disclosures is to:

  • Ensure that the effects of climate change are routinely considered in business, investment, lending and insurance underwriting decisions
  • Help climate reporting entities better demonstrate responsibility and foresight in their consideration of climate issues
  • Lead to more efficient allocation of capital, and help smooth the transition to a more sustainable, low emissions economy.”

While Australia is yet to mandate specific climate risk reporting by law, the Australian Prudential Regulation Authority (APRA) has endorsed the use of the TCFD framework and it has told financial institutions that it expects them to report on the risks under existing prudential rules.

In November 2021 APRA released its Final Prudential Practice Guide on Climate Change Financial Risks (CPG 229). The Guide is designed to assist banks, insurers and superannuation trustees to manage the financial risks of climate change. It imposes no new regulatory requirements or obligations, but will instead assist APRA-regulated entities to manage climate-related risks and opportunities within their existing risk management and governance practices.

The Guide covers APRA’s view of sound practice in areas such as governance, risk management, scenario analysis and disclosure of climate-related financial risks. It is designed to be flexible in allowing each institution to adopt an approach that is appropriate for its size, customer base and business strategy.

Some Australian businesses have welcomed the regulatory guidance and are effectively embarking on a similar (albeit it voluntary) TCFD trajectory as their neighbours in NZ.

 

What’s next? In 2022, APRA says it intends undertaking a survey to help gauge the alignment between institutions’ management of climate change financial risks, the guidance set out in CPG 229, and the Financial Stability Board’s Taskforce for Climate-related Financial Disclosures. In addition, APRA says it continues to advance its climate-related program of activities, including the climate vulnerability assessment that is underway with Australia’s five largest banks.

For more information, please contact Marsh Advisory.

This publication is not intended to be taken as advice regarding any individual situation and should not be relied upon as such. The information contained herein is based on sources we believe reliable, but we make no representation or warranty as to its accuracy. Marsh shall have no obligation to update this publication and shall have no liability to you or any other party arising out of this publication or any matter contained herein. LCP 22/016.

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