January 26, 2022

Net-Zero Transition Plans: Advancing Abroad, With a Path in the U.S.

By Anne Perrault

In recent months, European Union institutions and the UK government have increased their commitment to net-zero transition plans, paralleling private sector-led commitments to such plans through the Glasgow Financial Alliance for Net-Zero (GFANZ). This factsheet describes these efforts, outstanding challenges, and proposed U.S. legislation that would accomplish transition plan objectives.

What are net-zero transition plans?

The concept of ‘Net-zero’ in the context of climate change refers to the need to effectively zero-out greenhouse gas emissions by mid-century. Overwhelming scientific consensus reflects that reaching this goal is central to limiting temperature rise to around 1.5 degree Celsius and preventing the worst impacts of climate change.¹ The ‘net’ in net-zero references the idea that, in addition to limiting anthropogenic emissions toward zero emissions, various ‘sinks’ – natural or other sources – can accumulate and store carbon-containing physical compounds.² ‘Net-zero’ plans for banks and other financial institutions are, at least in concept, plans that will support their efforts to ensure that their financing and other services are consistent with net-zero emissions by 2050. Plans could include measures to limit the financing of GHG-emitting activities, incentivize and/or compel clients to shift to renewable energy sources, among other measures.

What is the European Union’s approach?

European Central Bank (ECB) Executive Board Member and Vice President of the Supervisory Board Frank Elderson has signaled that the European Union is moving to require banks to develop “Paris-compatible transition plans” that will “steer their business towards a smooth transition to carbon neutrality.” 

Noting the ECB’s hope that banks will move “forcefully towards fully integrating [climate-related and environmental] risks into their DNA,” Elderson welcomed the European Commission’s (EC’s) proposal for a legally binding requirement for banks to develop, implement and disclose their transition plans. The EC’s Strategy for financing the transition to a sustainable economy states, “Financial institutions should disclose their own sustainability transition and decarbonisation plans, including intermediate and long-term targets and how they plan to reduce their environmental footprint.”

The ECB’s attention to net-zero transition plans is rooted in its supervisory responsibility to manage risks to the financial system,³ and the related observation that achieving the EU’s Paris Agreement pledge to become carbon neutral by 2050 requires immediate action:

There is no doubt that time is running out for us to tackle the climate and environmental crises…. Banks can no longer simply declare their intention to be Paris-compliant by 2050. They must make structural changes to their way of doing business so as to make sure that they actually reach that goal and avoid the build-up of risks for them and the entire financial system.⁴

After reviewing bank self-assessments of their performance under ECB supervisory expectations, the ECB has determined that banks are not doing enough to address material climate risks. Bank transition plans, according to Elderson, are among the steps necessary to ensure a response to these results. They should be compatible with EU policies implementing the Paris Agreement, and “include concrete intermediate milestones from now until 2050, and disclose progress towards these goals on an annual basis.”

What is the UK approach? 

The UK intends to require certain companies to disclose transition plans aligned with the UK’s net-zero commitments or explain why they are not doing so. This requirement will apply to “asset managers, regulated asset owners and listed companies.”⁵

The UK’s Conservative-led government plans to adopt standards for these plans, as well as measures to increase financial sector adoption. There are indications that consultations will begin next year and the rules will likely be extended to a broader range of companies once a clear set of standards for the plans have been developed. 

What is the Glasgow Financial Alliance for Net-Zero (GFANZ)?

Efforts by EU institutions and the UK government parallel, and attempt to respond to concerns about, the private sector-led Glasgow Financial Alliance for Net-Zero (GFANZ) initiated by the United Nations in April 2021. GFANZ’s six-month progress report reflects that the alliance has grown to “over 450 major financial institutions from across 45 countries, controlling assets of over $130 trillion,” with members representing “every segment of the financial-sector value chain—asset owners, insurers, asset managers, banks, investment consultants, exchanges, rating agencies, audit firms, and other key financial service providers.”

Financial sector initiatives within GFANZ include the Net-Zero Banking Alliance (NZBA), the Net Zero Asset Managers Initiative, the Net-Zero Asset Owner Alliance, the Paris Aligned Investment Initiative, the Net-Zero Insurance Alliance, the Net Zero Financial Service Providers Alliance, or the Net Zero Investment Consultants Initiative. The NZBA represents the largest share of total assets under the GFANZ, with 92 members, including Goldman Sachs, JP Morgan Chase, and Bank of America.

GFANZ Members commit to setting near-term decarbonization targets, preparing and releasing plans to support their longer-term pledges, and reporting progress annually. Chair Mark Carney has said that GFANZ “will be working closely with policymakers, standard-setters, and regulators next year to support those who want to start moving transition plans to a rules-based (regulatory) footing.”

To date, the standards for transition plans and other measures are too lax and conducive to greenwashing. Civil society organizations have observed that most signatories lack measurable interim targets for emissions reductions, have not ruled out significant reliance on offsets and other unproven carbon dioxide removal technologies, and have issued new financing to expand fossil fuel infrastructure since becoming members. The ECB voiced similar concerns about existing bank transition plans and urged greater attention to intermediate milestones in them.

The UN Secretary-General, Antonio Guterres, is establishing an expert panel “to propose clear standards to measure and analyze net zero commitments from non-state actors.”

What are a few key issues raised by transition plan efforts?

• The role of offsets in transition plans for achieving net zero. “The Paris Agreement requires that Parties achieve a “balance between anthropogenic emissions by sources and removals by sinks of greenhouse gases in the second half of this century.”⁶ Significant concerns exist, however, about the efficacy of relying on forests, wetlands, and carbon removal technologies as sinks of greenhouse gases. Among these include difficulties quantifying benefits, protecting natural sinks from human and natural impacts, and developing technologies that are credible and dependable. GFANZ Chair Mark Carney has indicated that use of such “carbon offsets” should be a “last resort” to cover emissions that remain at the conclusion of a process to reduce absolute emissions to zero; net-zero claims should be based primarily on reducing financed emissions. The European Commission and Parliament recently provisionally agreed on the need to prioritize emissions reductions over emissions removals. 
• The adequacy of transition plans that allow for new fossil fuel development or do not prioritize phasing out of fossil fuels. The International Energy Agency’s Net Zero Emissions Scenario and related Roadmap for the Global Energy Sector say that, to limit global temperature rise to 1.5°C and meet Paris Agreement goals, new fossil fuel development cannot be permitted. Most GFANZ financial institutions have not committed to avoiding expansion and, as noted by the Financial Times, NZBA members have previously rejected an explicit commitment to phasing out fossil fuel financing. Credible “net-zero” plans must include these commitments.
• The effectiveness for net-zero transition plans of a ‘comply or explain’ approach. The comply-or-explain approach to financial regulation and reporting is in use in the UK, U.S. and elsewhere. It requires an institution to either comply with a requirement, or explain why it has declined to do so. Advocates of the approach suggest that it incentivizes and advances progress in politically difficult contexts. But critics believe it can compromise regulatory effectiveness, giving regulated entities a path to avoid meeting important and urgent requirements.
• Compliance with plans. The plans will be useful only if implemented well. GFANZ has not described how compliance will be enforced. Suspension and rejection of membership, as reputational concerns, are one approach. 

Is the U.S. considering transition plans?

The Fossil Free Finance Act, introduced in the House of Representatives by Congressman Jones and fifteen other Representatives in September 2021, and in the Senate by Senators Markey and Merkley in November 2021, offers a promising approach to ensure that banks create credible effective plans to transition to net-zero emissions. The legislation specifically mandates that all bank holding companies with more than $50 billion in assets, and all systemically important nonbanks, write plans to reduce their financed emissions by 50 percent by 2030 and 100 percent by 2050—in line with the reductions necessary to avoid the most dangerous levels of warming. It directs the Federal Reserve to evaluate the plans. The bills have a growing number of sponsors.

Connecticut recently adopted a law requiring its insurance department to incorporate state climate targets into supervision and regulation of insurers.⁷ 

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Endnotes:

1. The Intergovernmental Panel on Climate Change (IPCC) Special Report on 1.5°C provided a widely- accepted warning that in pathways that limit global warming to 1.5°C, the world needs to halve carbon dioxide (CO2) emissions by around 2030 and reach net-zero CO2 emissions by mid-century, accompanied by deep cuts to non-CO2 greenhouse gas (GHG) emissions. The report defined the net-zero state as the point when “anthropogenic emissions of greenhouse gases to the atmosphere are balanced by anthropogenic removals over a specified period.”

2. Article 4.1 of the Paris Agreement reflects this idea, stipulating, “Parties aim to reach global peaking of greenhouse gas emissions as soon as possible….so as to achieve a balance between anthropogenic emission by sources and removals by sinks of greenhouse gases in the second half of this century.”

3. The ECB can act only to achieve the European System of Central Banks’ objective of achieving price stability and to meet prudential supervision responsibilities within the framework of the Single Supervisory Mechanism. It is an independent institution within the European Union that cannot take instruction from another Union institution, including the European Commission. Its independence is established by Article 130 Treaty on the Functioning of the European Union: “When exercising the powers and carrying out the tasks and duties conferred upon them by the Treaties and the Statute of the ESCB and of the ECB, neither the ECB, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Union institutions, bodies, offices or agencies, from any government of a Member State or from any other body.”

4. Keynote speech by Frank Elderson, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, 20 October 2021. In an ECB blog, the ECB reflects on the need for transition plans to ‘avert the build-up of stranded assets on their balance sheets’.

5.  Importantly, the UK is not requiring ‘firm-level’ net-zero commitments. A UK factsheet notes on this point, “The UK has set some of the most ambitious legally binding net zero targets into law. Firms and their shareholders will decide how their business adapts to this economy-wide transition, including how they plan to decarbonise the emissions they finance. Firms will have different overall targets. A good transition plan sets out these decisions publicly in a comparable way and quantifies the interim targets and milestones to meet the overall firm-level goal.”

6. Paris Agreement, ‘Article 4, 1. In order to achieve the long-term temperature goal set out in Article 2, Parties aim to reach global peaking of greenhouse gas emissions as soon as possible, recognizing that peaking will take longer for developing country Parties, and to undertake rapid reductions thereafter in accordance with best available science, so as to achieve a balance between anthropogenic emissions by sources and removals by sinks of greenhouse gasses in the second half of this century, on the basis of equity, and in the context of sustainable development and efforts to eradicate poverty.’

7. Section 346, pgs. 509 – 510.