As the world descends on Glasgow for COP26, a host of global leaders are making grand promises about their ambitions to cut fossil fuel emissions to halt the unfolding disaster of climate change. Yet, the gap between rhetoric and action remains substantial. A recent report, based on a survey of over 4000 ‘significant entities’ (including countries, businesses and other organisations) found that there was a lack of high-level ambition. In short, wholesale failures to comply with the minimum criteria for robustness set out by the UN Race to Zero Campaign. Moreover, pre-COP 26 commitments by these entities aggregate to less than a one per cent reduction of emissions by 2030 compared to 2010 levels. In contrast, the scientific community’s estimates – enshrined in the Paris Agreement – hold that to keep global warming below 1.5 degrees Celsius, emissions must be cut by at least 45 per cent by 2030.
Finance and sustainability
Delegates at COP26 are today focusing on finance. The financial system is recognised as a crucial lever in stemming global heating. Yet, global banks continue to fund fossil fuel exploration. Not only this, as recent research by Global Witness has revealed, banks continue to heavily fund activities which exacerbate climate change by destroying one of nature’s mechanisms to absorb carbon emissions: trees. According to this research, banks and asset managers based in the EU, UK, US and China have made deals worth $157 billion with firms accused of destroying tropical forest in Brazil, Southeast Asia and Africa since the Paris Climate Agreement.
The negative externalities associated with deforestation and other land-grabbing activities are legion. Perhaps the most startling is the revelation that significant tracts of the Amazon rainforest are now net carbon emitters, thanks to the industrial emissions associated with deforestation and lengthier dry seasons precipitated by tree clearance. Other consequences, as outlined by the UK’s 2021 Dasgupta Review, include biodiversity loss (tropical rainforests are the habitat for more than 50% of Earth’s plants and animals), soil degradation: impacts on local communities, and increased emergence and spread of infectious diseases.
In spite of the recognition that a collapsing ecosystem will impose inordinate costs on both planet and people, the financial risks associated with environmental breakdown are not well understood. The threats from phenomena such as soil erosion, biodiversity loss and groundwater depletion exhibit high levels of interconnectedness and interdependence but the eventual toll of such damages on planetary function is difficult to estimate. Moreover, as noted by the Dasgupta Review, the very act of attempting to place a value on nature is meaningless; whatever financial ‘value’ is placed on the ecosystem as a whole, ‘if Nature is destroyed, life would cease to exist. But then who would then be here to receive the [financial] … benefits if humanity were to exchange its very existence for them?’.
The COP26 Agreement on Deforestation
Delegates at COP26 yesterday announced an agreement to halt the destruction of the world’s great forests, in a pledge signed by more than 100 world leaders, who promise to continue ‘working collectively to halt and reverse forest loss and land degradation by 2030 while delivering sustainable development and promoting an inclusive rural transformation’.
The country-level initiative is supported by pledges from thirty large financial institutions – who collectively manage more than $9 trillion in assets – to end their exposure to agricultural commodity-linked woodland destruction by 2025.
This provides cause for hope. Yet the signatories – which include Brazil, Russia, Canada and Indonesia, as well as the US and UK – did not expand upon how implementation of the agreement would be tracked, nor was any sanctions regime discussed should countries fail to adhere to their obligations. Indeed, previous initiatives – such as the 2014 New York Declaration on Forests, which promised to halve the rate of deforestation by 2020 – failed entirely.
Perhaps most significantly, it was asset managers and investment firms which dominated the pledge by private financial institutions, rather than banks. Global Witness’s research shows that the top five banks by total deal value – including BNP Paribas and the Industrial and Commercial Bank of China – issued almost 570 bond, credit and underwriting deals, worth an aggregate of $32 billion, which contributed to deforestation, in spite of all but one of the banks having a public commitment to ‘no-deforestation’ policies.
Wielding the axe on lending for deforestation
In the absence of sanctions for non-compliance, the COP26 ‘deforestation’ pledge is likely to descend into nothing more than rhetoric, with no discernible action. In these circumstances, there are a number of responses available to combat the threat of bank-financed environmental destruction, ranging from altering credit and capital regulations, to requiring more intervention from central banks, to directly regulating the financing contracts of certain harmful activities. Voluntary guidelines have shown to have little effect.
Regulators should therefore consider more active intervention. In light of the complexity and uncertainty of the exact impacts of environmental harm, regulators should proceed from the potential ‘worst-case’ scenario. In other words, a precautionary approach to regulation is warranted, particularly in the case of deforestation. Deforestation creates vast, yet incalculable, negative global externalities whilst benefitting only a very narrow group.
Accordingly, well-designed regulation should target activities with the potential to cause or contribute to severe environmental impacts. Alongside the COP26 pledge – and to ensure the chances of relapse on the part of signatories to the deal – the financial authorities should consider immediately imposing the following:
- Global capital requirements regulations should be amended to require banks to hold more capital against loans which are made to finance acquisitions of interests in land in which there is a high risk of environmental destruction – a so-called ‘harmful activity factor’. A supranational expert group or committee – modelled along the lines of the EU’s High-Level Expert Group on Sustainable Finance – should be established to define environmental destruction in this context. Such definitions could build upon the work that has already been undertaken via the EU’s Taxonomy for sustainable activities;
- New global regulations should be introduced to require commercial loans or credit facilities, syndicated loans, or project finance agreements be made subject to a mandatory due diligence assessment before they are agreed. In conducting this assessment, financial institutions should use the OECD bank-specific guidelines for project finance, while encompassing all relevant environmental, social and governance issues. Regulators should mandate that financial institutions require positive demonstration from borrowers acquiring interests in land that the land will not be used for any purpose or use that is associated with environmental destruction unless those due diligence requirements have been satisfied;
- Central banks should amend their collateral frameworks to prioritise the acceptance of sustainable bonds, and disincentivise the use of non-sustainable assets as collateral for liquidity operation; and
- Infrastructure investment definitions ought to be tightened to remove preferential treatment for insurance undertakings where they invest in or underwrite projects which entail deforestation risk. This will make it more expensive for insurance companies to fund projects involving possible deforestation risk thereby reducing the flow of finance to such projects.
Time to reconsider the social license for financial institutions?
Forests and woodlands have been on the planet for hundreds of millions of years; humans have been here for an eye blink in comparison. Yet, in the last 5,000 years, a third of the world’s forests have disappeared entirely – all because of human activity. The rate of these losses has ramped up considerably over the past century, as gigantic agribusiness and timber operations have industrialised their processes, all the while funded by our largest financial institutions. As the planet continues to heat, ending deforestation is a clear step that must be taken.
Cutting down forests is simply a microcosm of how humans have continued to destroy nature on an industrial scale for over a century, virtually unopposed. All financial institutions operate under a social license, which they earn through a track record of exemplary conduct, a reputation for integrity and refraining from the violation of laws designed to tackle unethical financial activity. We should not hesitate to withdraw such licenses if pledges to end the financing of environmental destruction are not honoured.