Innovation is the key to solve our climate issues (part 2) - The financial services sector as change enabler

Last week I published the first article of this series of 3 blogs (https://bankloch.blogspot.com/2020/08/innovation-is-key-to-solve-our-climate.html), introducing how our climate issues can be solved through a worldwide roll-out of technological innovations and by ensuring that these innovations are economically viable. In order to ensure this viability, a drastic change in the behavior of all corporate stakeholders needs to be established. This second blog focuses more specifically on what the Financial Services sector can bring to the table.

Although the financial services industry does not generate much global warming emissions itself, they are perfectly positioned to support and enhance this change thanks to their large influence on the decision process of companies and consumers. As such they can be a big part of the solution, when they put their influence to good use.

With 70% of banks recognizing that climate change poses serious financial risks, the Financial Services industry has a strong interest in reducing global warming. Unfortunately, only 10% of the banks have started to adapt their business models in context of a long-term strategic plan to cope with these risks. A much bigger percentage of banks still categorizes global warming initiatives under corporate social responsibility. This means the topic of global warming needs to be put higher on the agenda at the majority of financial service players. Fortunately, good steps are being taken, like e.g. the signing of the "Collective Commitment to Climate Action" in September 2019 by 33 international banks (like ING, KBC, BNP Paribas, BBVA, Santander, …​), committing themselves to help wherever possible in facilitating the economic transition towards climate neutrality.

Once put on the agenda, the Financial Services industry has enormous power via their strong relationships and the enormous value of their balance sheets. This power can be put to great use via different mechanisms:

• Investment policy definition, i.e. the way a financial services player invests its money (i.e. its own money, but also the client assets under management, like e.g. funds) and how it advises its customers to invest their money. This can go from setting targets in sustainable investments (e.g. boosting investments in innovative clean technologies), to providing SRI funds and other SRI investments, up to setting restrictions on specific heavy polluting sectors, companies and/or countries.
  Such an investment policy does not only require the definition of the policy, but of course also the follow-up and enforcing. For this, necessary tools and processes need to be put in place, e.g. determine a sustainability scoring of companies/sectors/countries (and the regular review of it), forcing companies to be more transparent about their pollution and sustainability efforts, allow to calculate the total exposure in sustainable and non-sustainable industries, allow to define and automatically check restrictions, calculate the total emissions of an investment portfolio (via a standardized carbon accounting)…​

• Sustainable financing, i.e. allow customers to define projects (such as solar panels, green plants, windmills…​) to be financed via “Sustainable Finance” mechanism (such as Green Bonds, CO2 emission certificates, SRI funds…​). The bank can not only facilitate the intermediation with sustainable investors, but can also manage aspects like certification and handling of subsidies and tax reductions.
  More in general, banks can drive demand and supply for green lending products, e.g. by accepting easier consumer credits for ecological expenses, like eco-renovations (such solar panels, isolation…​) and low-emission cars.

• Further build out the emission trading market: the European Union Emission Trading System (EU ETS) was created in 2005 and works on the 'cap and trade' principle. It uses a market-based approach to reduce pollutions by providing economic incentives. The idea is that every company gets a 'cap' (i.e. a maximum allowed level of pollution), which is gradually reduced over the coming years. When the company, pollutes less than its 'cap', it can issue C02 emission rights on the market, otherwise it needs to buy emission rights to cover their excess pollution. This way companies reducing their emissions are rewarded financially for their efforts.
  This EU ETS market is definitely a powerful mechanism in the fight against global warming, but it needs to become a worldwide market, covering all industries (currently only covering around 50% of European companies) and become much more transparent. The financial services sector, which is already well acquainted with trading markets (cfr. the stock-market) is very well positioned to make the access to this emission trading market (i.e. access for trading, but also access to information, like market news, prices and analytics) much simpler and more user-friendly.

• Increase digitalization: a further digitalization of financial services will not only avoid unnecessary displacements (resulting in emissions) by customers to branches and by employees to offices, but will also reduce paper (e.g. by introducing digital signature, no printing of statements, digital reports, digital marketing material…​), which will also indirectly reduce pollution.

• PFM/BFM services and general concierge services offered by banks to their customers can also help to change customer behavior. A PFM (Personal Financial Management) or BFM (Business Financial Management) tool could offer services like:

  • Estimating and monitoring (aiming to improve) the customer’s carbon footprint, based on the identified expenses and other data collected by the bank

  • Automatically propose more ecological alternatives for certain recurring expenses

  • Warn customers if they spend money at shops with bad sustainability scorings and more general show a scoring based on the customer’s choice of merchants (with regards to their sustainability)

  • Allow to set investment restrictions and goals as a customer with regards to sustainability, after which all (automated) investment advise takes this into account. A good example is "Waves", which is a robo-advisor, allowing the customer to create an investment portfolio based on a selection of UN Sustainable Development Goals the customer finds the most important.

  • Offer customers the possibility to neutralize their emission footprints, e.g. via a donation mechanism (to green initiatives) or via a sort of emission-neutralization insurance.

• Insurance premium calculation: insurances can also help to facilitate change via premium discounts or penalties, with regards to sustainability. E.g. the premiums of a home or car insurance could be linked to their ecological scoring.
  On a global scale, insurers have a strong incentive to reduce global warming, as insurers will be exposed to more significant - and unexpected - pay-outs, e.g. claims for flooding and other extreme weather conditions will increase due to global warming.

• Data sharing: banks have enormous amounts of data on people’s consumption habits. By reporting and sharing aggregated and anonymized reports of this data, banks can provide a good measurement tool of how certain actions taken by other stakeholders positively (or negatively) impact the sustainability in people’s shopping habits.
  At the same time, insurers have also very complex and detailed models on climate-related risks. Making those models public or at least the predictions public, can support the movement as well.

• Marketing: Financial Services companies have very large customer bases, with typically also high click and read rates when mailings are sent. As such a bank or an insurance company can use its communication channels to spread important messages around climate change. A good example is Lloyds bank, which is sponsoring a social media campaign, asking its customers to use the hashtag #YesBusinessCan to highlight stories of UK businesses reducing their carbon footprint.

• Internal targets: even though financial services industry is not a big polluter, with their thousands of employees coming to work in big offices and their immense computer server parcs, their emission is definitely not 0. As a result, banks and insurers should internally also set targets to reduce their footprint. If done well this will be a profitable endeavor in terms of electricity bill, productivity and motivation of employers, talent acquisition and retention, cost of servicing customers…​

The above shows that banks and insurance companies have a variety of tools available to facilitate the necessary change to reduce global warming. It will be interesting which financial services companies (and how many) will be adopting these tools.
The next blog in this series (coming out next week) will show that the IT/Tech sector has also a whole toolkit available to help in this transition.