Big girl pants and a superhero cape

On the first full day of business at COP26, the challenge of meeting climate change was made abundantly clear by every single person who took to the stage but so too was the opportunity - and responsibility - of the Financial Community to deliver the outcome we need to see. Not entirely on their own, but certainly the single biggest entity who can make the single biggest difference at this literally life threatening moment for humanity.

I woke up today wondering about my dentist appointment for the veneer I broke yesterday and whether or not I’d still be able to speak clearly for my meeting afterwards. Others may have woken up wondering about far more important things but all of us need to wake up to the emergency facing all our futures and the Global Financial community must surely have woken up to the realisation that this is their moment to be the Superheroes this moment calls for. And even if they don’t have a full blown Superman/woman/person to hand, the must surely start wearing their Big Boy/Girl/Person pants. Today and everyday.

This excellent report from Oliver Wyman identifies that the carbon efficiency of the top-performing 25% of companies in each sector is double that of the bottom 25%, pointing to wide skews in progress to date, as well as differences in business models.

By James Davis, Jennifer Tsim, Francois Austin, and Simon Glynn

Europe's companies are reporting impressive progress in their action on climate change - but not yet nearly the progress required to hit the 1.5°C target of the Paris agreement.

Our latest research with CDP Europe analyses data from nearly 1,000 of the largest companies in Europe, worth around 80% of the region's market capitalization. It looks at the progress made by companies in reducing emissions and their transition plans to net zero. It also explores the consequences of this for financial institutions, many have now made pledges to reduce the emissions of the companies they finance in line with the Paris agreement.

European companies are on course for a 2.7 °C increase in global warming by 2100

The 2015 Paris agreement to limit global warming to well below 2°C, preferably 1.5°C was a landmark in the fight against climate change. This year’s report shows strong progress in reducing carbon emissions by many of Europe’s largest companies. The top-performing 25% of companies have already reduced their absolute emissions by 15% and their emissions efficiency – greenhouse gases per unit of revenue – by 20% (using measurements taken before the COVID-19 pandemic). But this progress is uneven. The carbon efficiency of the top-performing 25% of companies in each sector is double that of the bottom 25%, pointing to wide skews in progress to date, as well as differences in business models. The current target setting of European corporates is in line with the level of emission reductions associated with global heating of 2.7 °C, well above the Paris target and falling far short of the European Union’s policy ambition.

The financial system as an accelerator – A €4 trillion force

Many financial institutions have the ambition to be Paris-aligned. This means they need the emissions of the companies they lend or invest in to cut emissions at a rate commensurate with the Paris goals. This has the potential to be a major force in accelerating company commitments to reduce emissions. Banks representing 95% of all lending to European corporates have such an ambition, even as the necessary metrics, data, and processes are still being built. This contrasts with just 8% of European corporates having set targets in line with a well-below 2°C rise. This has created a gap of more than €4 trillion between the lending that banks plan to align with Paris and the current available demand for such financing. This gap has the potential to galvanize industry to greater action, as companies with greater ambition to reduce their emissions are able to raise capital on better terms.

Growing momentum – 56% of companies have a transition plan

The transition to net-zero emissions is moving to the top of the agenda for many companies. Encouragingly, over 50% of European companies by market value have now joined the Science Based Targets initiative, which approves whether emissions targets are aligned with the Paris agreement. We found that 56% have developed a transition plan so far – and more in the highest impact sectors. In the best cases, these plans include externally validated science-based targets, significant investments in long-term initiatives and development of low-carbon products, as well as clear governance and accountability. But as highlighted, the majority of these existing ambitions and plans fall short of Paris. Delivering the change required is challenging in a large company – but failure brings risks. Green challengers are showing they can move fast and attract strong investor interest and valuation premia; incumbent companies will be challenged to show that they can keep up.

A collective action problem – Less than 35% of companies disclose scope 3 emissions

A major problem for corporates is the assessment of Scope 3 emissions – those that occur beyond corporate boundaries in their respective value chains. These are far harder to trace than Scope 1 emissions (direct emissions, largely from fossil fuel combustion) and Scope 2 (indirect emissions from the generation of purchased electricity, steam, heating and cooling consumed). Yet, Scope 3 forms the vast majority of the emissions impact for European corporates as a whole. Currently, less than 35% of companies in high-impact sectors are disclosing meaningful information on Scope 3 emissions. Addressing this requires new forms of collaboration, working across boundaries, and ambitious companies are already pushing to make this happen.

Re-working the financial plumbing – Banks may need to rotate 20 – 30% of their portfolios in a moderate acceleration scenario

Financial institutions have an important role to play in engaging with companies, to encourage and incentivize them to develop credible transition plans, and deliver against these. Yet there is a risk that without a step change in progress, probably triggered by a major policy change such as a carbon tax or a tech breakthrough, the corporate sector will not reduce emissions as fast as the Paris agreement requires. In such a scenario only those banks and asset managers willing to proactively align their portfolios will be able to meet their Paris goals. In our “modest acceleration” scenario, we estimate that banks may need to adjust 20 to 30% of their large corporate lending portfolios to be aligned with Paris by 2030. However, despite most of them having the ambition to align their portfolios with Paris, only half of financial institutions have to date assessed whether their client and investee strategies are aligned with the Paris agreement. With the typical corporate loan lasting 5 to 7 years, to make progress by 2030 they need to act now, even while data remains imperfect. As disclosure requirements on financial institutions grow it will be increasingly clear which are making real progress.

Setting Europe on the right path – At least 65% of companies need to be Paris-aligned

Europe is at a critical inflexion point. To have a good chance of meeting the Paris goal of 1.5°C, our economy should shed 50% of emissions over the next decade. This report estimates that at least 65% of companies need to be fully Paris aligned by then, with many going beyond that ambition level, to succeed. The financial system can help accelerate the path to Paris, by mobilizing capital towards the companies that will prosper in the transition, but only if it acts now. A supportive policy environment will be key. Governments across the region have an important role to play. Country-level differences in current temperature levels in the European corporate sector, ranging from 2.3°C to 3.0°C, point to the different challenges across governments and potential for sharing of best practices across the region. As the world steps up to fight climate change, Europe’s companies can play a leading role. Realizing this potential requires not only ambition but also action – action that is most impactful when taken in collaboration. Corporates, financial institutions, and governments all need to build on the momentum that is developing and hold each other accountable to deliver.