How we’re engaging with banks on their fossil fuel financing

Although “net zero” is gaining momentum across the world, overall levels of commitment remain low in the banking sector. At the time of our initial analysis in the middle of 2020, less than 20% of the global banks included in our universe had committed to aligning their financing activities with the goals of the Paris Agreement or a national net zero ambition, or committed to set a science-based target.

For banks, fossil fuel financing far outweighs sustainable financing. Banks that are highly exposed to the fossil fuel industry face significant financial, regulatory and reputational risks as a result of the transition to a low-carbon economy.

As Schroders holds many bonds in the banking sector, we are keen to identify potential winners and losers in the global transition towards net zero.

Research

As part of our thematic research on this issue, our credit and sustainable investment teams developed a scorecard to help fund managers understand how a bank is performing against a number of factors relating to fossil fuel financing. Using both conventional and unconventional sources of data, banks are assessed on the scale of their fossil fuel financing activities, strength of long-term climate strategy and vision, sustainable financing capabilities, maturity of climate governance and risk management, and quality of climate reporting.

The scorecard is used to prioritise companies for deeper analysis and engagement. It currently covers more than 100 of the world’s largest banks plus a group of selected smaller banks to make sure we have sufficient coverage of the credit team’s banking exposure.

Engagement

Our credit team, along with a number of equity teams, selected around 50 banks across Europe, North America and Asia for deeper analysis and engagement. Their focus was on top financers to the fossil fuel industry as well as banks that may be highly exposed to the fossil fuel industry through their balance sheets.

Following each engagement, we highlight three to four objectives we’d like the bank to work on over the next 12 months. Examples include:

– Development of a commitment to align the bank’s financing activities with the goals of the Paris Agreement, plus related milestones and targets;

– Reviewing and strengthening the bank’s fossil fuel policies in line with latest science and / or good practice;

– Development of TCFD (Task Force on Climate related Financial Disclosures) / climate risk reporting, including disclosure of additional climate metrics.

For banks that have already made progress in these areas, our discussions have focused on the robustness and evolution of their measurement and target-setting methodologies in relation to the bank’s commitment to align its financing activities with the Paris Agreement.

The response so far

While it is still too early to assess the impact of our discussions, we have had a good response from banks so far. Out of the 50 banks contacted, we’d met with 25 by end of June 2021.

We’ve seen a huge amount of positive momentum on this issue, with banks strengthening fossil fuel policies, improving climate risk disclosure and committing to align their financing portfolios with the goals of the Paris Agreement.

We’ve identified a breakaway group of leading banks that already have, or will soon have, targets and detailed plans backing their financing commitments and are well positioned to finance the global energy transition.

But we’ve also identified hurdles around data collection, lack of internal resources available to support this issue, and concerns around the lack of an established portfolio measurement and target setting methodology.

For these companies, our engagement has helped us point banks towards good practice we have seen elsewhere. But ultimately, banks that do not show progress on the issues we have raised with them may have environmental ratings downgraded in future assessments.

Once we’ve completed our first round of engagements, we plan to engage additional banks and extend our scorecard to include other types of financial companies such as insurers.

Integration into our investment process

Credit ESG individual company assessments: We use the insights from our engagement to identify potential risks to a company’s cashflow and increase the quality of both our internal ESG and credit assessments.

Credit ESG sector review: The information from our fossil fuel financing research and engagement is incorporated into credit analyst ESG sector reviews. During these reviews, analysts discuss with portfolio managers the ESG factors and ordinal rankings of their companies’ exposures to ESG risks and opportunities that could impact the ability of companies to service their debt comfortably.

Schroders’ proprietary tools: The development of our fossil fuel financing scorecard has helped us identify new environmental metrics for our proprietary sustainability tools such as CONTEXT, which is used by both credit and equity investors within Schroders.

Voting approach: As a result of our research and engagement, we have refined our expectations of banks relating to fossil fuel financing and climate change more broadly. This has been reflected in the annual review of our voting policy and recent voting decisions on climate-related shareholder resolutions for banks.