This is the hottest debate in climate finance: whether to divest high-emitting industrial assets or finance them until they can be shut down.
A global coalition of 500 banks, asset managers and insurers has published its plans and procedures for dealing with assets such as coal mines, oil fields, steel mills and cement works that fall short of the target to reach net zero carbon emissions. by 2050, but can still be used. This is called managed phase-out.
The Glasgow Financial Alliance for Net Zero, or GFANZ, has compiled a long list of guidelines that financial institutions will use to transform their businesses to align with the goals of the Paris Agreement on tackling climate change. The net-zero transition plans include a series of recommendations for lenders and investors who have pledged to use their financial muscle to accelerate the transition to a low-carbon economy.
Mark Carney, the former Governor of the Bank of Canada and the Bank of England, led the formation of the group of financial institutions from 45 countries. The proposed framework represents the start of real work with GFANZ signatories – which include major Canadian banks – and the group is seeking public comment.
The section on managed phase-out of polluting assets might be the trickiest to pin down.
There is no doubt that this needs to be dealt with. According to the Intergovernmental Panel on Climate Change, in a business-as-usual scenario, emissions from fossil fuel infrastructure in operation today would exceed the goal of maintaining the increase in global temperature at 1.5 degrees Celsius. If the currently planned infrastructure is added, it would exceed this target by two-thirds.
Banks and other institutions are under intense pressure from environmental activists and shareholders to withdraw funding from high-emission industries such as oil and gas. The argument goes, cutting off access to capital will force environmental laggards to transform their businesses so that operations no longer emit greenhouse gases, or are forced to close in the name of meeting the global carbon budget.
The GFANZ-run phase-out task force, which included representatives from BlackRock, Goldman Sachs, Citigroup, HSBC and other major institutions, warns of unintended consequences. Chief among them is that high-emission assets are sold to entities that have no interest in achieving zero emissions goals, and these entities continue to operate the assets without doing anything to reduce emissions.
“Many high-emitting assets need to be operated and financed in the short term while technologies to replace them are deployed,” the group said. “These consequences may be particularly relevant in emerging markets and developing economies.”
This is because high-emission assets tend to be built more recently in these regions than in developed economies. This makes them much further from the end of their expected economic life and more expensive to reduce.
But the problems are not just there. European consumers have been under severe strain since Russia invaded Ukraine, and Western allies have responded with sanctions, sending energy prices skyrocketing. It showed how economies are still dependent on fossil fuels, despite an ambitious drive to embrace renewable energy sources.
Mr Carney told The Globe and Mail in April that the crisis will require funding more oil and gas production to offset Russian supplies, and that new expansive fields will eventually be added to the list of stranded assets that need to be dealt with. .
Managed disposal offers a number of benefits, according to GFANZ. On the one hand, it allows companies with strong transition plans to manage their high-emissions assets. This allows financial institutions to stay engaged with businesses as they shift away from carbon-intensive operations. It will also attract other stakeholders to support the retraining of workers and keep essential services running, the group said.
According to GFANZ, phasing out an asset would start with identifying how the plan fits into a company’s net zero strategy and how workers and communities will be affected. The financial institution will assess the risks, specify how its plan is funded, and outline the incentives for early closure.
The group prescribes having a back-up plan if emission reductions or retirement deadlines are not met. There are also governance considerations, including determining who in the organization is responsible for disposal and tying compensation to its goals.
The hardest part for companies and their lenders is balancing it all against the disposal option, when selling might provide more immediate value or when the returns from operating to early retirement are not at height. GFANZ also said some institutions may not have the ability to fund an asset for early retirement, which may require partnerships.
Public funds might be needed in some cases, given the shortened economic life or when private funds have been invested in public assets.
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