This piece evaluates the merits of engagement with fossil fuel companies. My prior article discussed the benefits and importance of the divestment movement.
Fossil fuel divestment has grown into a socially influential and impactful movement. It has unquestionably succeeded in changing the conversation around the future of fossil fuels. However, when considering direct financial impacts and avoided emissions, divestment’s effectiveness has been less clear. Since the Paris Climate Agreement, global banks have provided over $3 trillion in fossil fuel funding.
Limits to divestment?
A coordinated divestment movement has the potential to increase the cost of capital for emitters. However, for individual financial institutions seeking to accelerate decarbonization, a pure divestment approach may have limitations. In largely efficient securities markets, for every seller there is a buyer at the right price. Thus, a firm may dump their fossil fuel shares only to see them snapped up by a less climate-conscious investor. This issue occurs in debt financing too, for when larger banks divest from international extraction projects, national banks often step in. These state-run banks are often less transparent and less accountable to environmental stakeholders. Likewise, divestment from private sector fossil fuel firms may advantage national oil companies (NOCs), who already hold the majority of global hydrocarbon reserves.
How finance can drive client transitions
These concerns have led many financial institutions to argue that engaging fossil fuel clients can be more impactful than simply divesting. As the world moves away from fossil fuels, financial engagement can promote economic and energy continuity by helping businesses effectively transition a low-carbon world. With a financial stake in emitting companies, climate-focused financial institutions have leverage to demand decarbonization. Investors can bring shareholder resolutions on climate disclosures and climate strategy. In recent years, the number of these resolutions has increased markedly. In addition, investors can vote against management decisions that are not aligned with societal climate goals. Banks often have even greater influence with their fossil fuel clients, as debt financing is required for capital-intensive exploration and production activities. Lenders can apply covenants to restrict certain environmentally damaging activities. In addition, they can tie future financing to decarbonization plans and verify progress through emissions data.
Across the financial sector, such engagement initiatives are gathering steam. Cambridge University is working with banks to develop a tool to help financial institutions “design and execute transition plans, assess decisions, and monitor progress.” Specific metrics on client progress are a critical consideration for any credible engagement program. Late last year, JP Morgan launched its Center for Carbon Transition to help their clients constructively manage the risks and opportunities of a low-carbon future. The center will aim to improve data and reporting on client emissions. Likewise, Aviva Investors started its Climate Engagement Escalation Programme, with a focus on the largest emitters in its portfolio. This initiative will require companies to provide a roadmap on immediate climate action and reach net-zero emissions by 2050.
Sincerity is essential
Despite the financial sector’s increasing focus on decarbonization, the impacts of many engagement strategies may take years to fully evaluate. Emitters will need to fundamentally reorient their business models to a low-carbon world. Furthermore, it is no guarantee that all of today’s emitters have a place in that world. Without hard commitments to emissions reductions, client engagement can look suspiciously like business as usual. Divestment activists are right to be skeptical, since business as usual is unsustainable both for the climate and the economy. Genuine financial engagement demands a genuine commitment to moving clients and society towards societal climate goals. Engagement strategies that fail to contemplate transformative change should be rightly condemned as greenwashing.
Expand the financial toolkit
Ultimately, climate action in the financial sector is far more complex than a choice between divestment and engagement. Institutions can use their financial leverage to push clients onto a more sustainable path through shareholder actions and lending requirements. Financial institutions can also be valuable long-term partners for clients looking to transition to a role in a low-carbon economy. However, financial institutions must also be willing to divest from companies who remain unwilling or unable to align with climate goals.
Beyond engagement and divestment, there are other ways for financial institutions to accelerate the net-zero transition. They can provide capital at critical stages in the development and deployment of green technologies. They can lobby for stronger public sector climate policies on issues such as efficiency standards, carbon pricing, and climate-resilient infrastructure. Ambitious climate action can be a boon to financial institutions, as capital markets benefit from certainty around strong future demand for green assets.
The financial sector has a wide range of tools for confronting the climate challenge, and given the size and urgency of that challenge, they must be willing to consider all of them.