Looking ahead in 2022, we can be sure that the sustainability themes of last year will continue to gain prominence in the discussions surrounding the role of the finance sector. Yet after a year of pledges, 2022 must be a year of action.
In particular, there are growing expectations for financial institutions to assess and improve their impact on systemic issues such as climate change and social justice, with regulators watching closely to ensure they are walking the walk. The sector is expected to consider how capital allocation impacts the transition, whether providing funding to new climate solutions or withdrawing capital from harmful activities.
Furthermore, pressure is mounting on investors to responsibly steward the assets they invest in. This means not just factoring environmental, social and governance issues into investment decisions, but engaging with investees to support and drive them towards a more sustainable footing. Advocacy with policy-makers is also key in shaping a system that operates more effectively in the interests of end-investors, society and the environment.
We can expect the focus on climate to continue throughout this ‘decade of action’, with more detailed transition plans from financial institutions, companies and governments. For financial institutions, this means understanding their current climate-related risks and impacts, and identifying how to mitigate the negative impacts and mobilise capital to support the transition. It is crucial that targets and implementation strategies incentivise real world emissions reductions and encourage an engagement-first approach, with divestment as a last resort. There will also be greater focus on how to better support emerging markets and developing countries to reach net zero, and more broadly on how to ensure that we have a ‘just transition’.
But other environmental issues – in particular biodiversity and nature – are rising rapidly up the agenda. Among the noise of the COP26 build-up, some may have missed the first part of COP15 on biodiversity in October. COP15 is focused on agreeing the post-2020 global biodiversity framework, which will set out targets for governments to meet by 2030 to tackle the root causes of biodiversity loss. After high-level discussions in October, in-person negotiations are planned for April and May in Kunming, China.
During COP26, we saw a greater focus on biodiversity, particularly the issue of deforestation, in recognition of the interlinked nature of these two environmental crises. Healthy ecosystem services are an important part of climate change mitigation, for example through natural carbon sequestration.
We are pleased with the progress so far. Several financial institutions – including the international business of Federated Hermes – responded to the United Nations High Level Champions’ Call to Action by committing to strengthen efforts to tackle deforestation in their portfolios. We also joined the Natural Capital Investment Alliance which aims to accelerate the development of natural capital as a mainstream investment theme. All members have plans to launch, or have launched, investment products aligned to natural capital themes that target mobilising more than $10bn in aggregate by the end of 2022.
Much as with net zero commitments, the financial sector will now be focusing in earnest on how to deliver on these pledges. This means collaborating both within and beyond the industry to develop methodologies to better measure companies’ biodiversity impacts (positive and negative) and pushing for increased data availability through company disclosure and improved reporting frameworks.
As the financial sector becomes even more vocal on environmental and social issues and client demand rises, we can expect regulators to maintain their focus on scrutinising the authenticity of financial products. The UK and the European Union have both set out clear sustainable finance strategies with increased transparency as a key aim. The EU Taxonomy and Sustainable Finance Disclosures Regulation is already driving increased corporate and financial disclosures.
Other jurisdictions are also ramping up disclosure expectations, and the potential for a ‘common ground taxonomy’ could offer a baseline level of global comparability. This would support financial institutions’ disclosures which are underpinned by data from the companies they invest in, lend to and underwrite.
As well as jurisdiction-specific reporting requirements, the International Sustainability Standards Board launched at COP26 by the International Finance Reporting Standards Foundation offers the potential for much-needed standardisation of corporate disclosure. The first draft ISSB standards will be published in 2022 with an initial focus on climate-related disclosure.
Given the level of focus on other environmental and social issues, there will no doubt be pressure to expand this fairly rapidly to improve data availability along the investment chain. Several jurisdictions have already indicated they are likely to use the ISSB standards as a baseline for reporting on environmental and social factors.
This year, all eyes will be on financial institutions and how transparent they are about their current position on these systemic issues. They will be urged to collaborate with others in and outside of the industry to move forward on a positive trajectory. Those firms who can demonstrate authenticity in driving a more sustainable financial system – including through the increased disclosure regimes – are set to benefit.
Kate Fowler is Senior Responsibility Analyst, international business of Federated Hermes.