Net-zero emissions and financial industry dilemmas

With the clamor for a net-zero global emission to be implemented quickly, pity the financial sector players who find themselves between a rock and hard place, having to choose between unpleasant courses of action affecting their sector. But let us be realistic, as tackling climate change is not something that is going to be politically tidied away in the November 2021 COP 26 Climate Change meeting in Glasgow. Reaching net-zero, the point when the amount of carbon released into the atmosphere is the same as the amount removed, will reshape global economies and put the financial sector under stress.

The 2007-2008 financial crises illustrated the fragility of the financial sector and how far systemic risk could go. Today, the financial sector has a small window for an orderly transition to a politically driven low-carbon world and action needed to be taken from now, raising the question whether banks in Saudi Arabia are prepared to meet the new regulatory environment or continue lending in the traditional manner.

Why is tackling climate change important for the global financial sector? The reason is simple: New business opportunities for those that meet the challenge and the business opportunities it will bring them. Does this mean that the financial services sector really wants to stop climate change, or is it merely paying lip service? Those more cynical might believe this to be the case, but in reality there is great public pressure now on governments and regulators to put meaningful pressure on polluting industries. This in turn will inexorably ensure that central banks, financial regulators and legislators push financial sector players to channel funding away from polluters toward “green” solutions.

How is this to be done in a practical manner, besides imposing carbon taxes on polluters? The UK wants to be the first G20 country to have mandatory disclosures across the economy in line with the recommendations of the awkwardly named Financial Stability Board’s Task Force on Climate-Related Financial Disclosures, with a target implementation date of 2025.

That is not far away and will be watched carefully by other financial regulators. The UK’s approach is to begin mandatory disclosures for listed companies and large asset owners, including life insurers and pension providers, with new rules coming into force for these financial players on Jan. 1, 2022.

Capital market regulators such as the Saudi Capital Market Authority will be keenly watching to see the outcome of these new regulations given the importance of energy-related listed Saudi companies. Will this be easy to implement, the cynics will argue? Even the UK’s Financial Conduct Authority points out that there are “challenges” in preparing climate-related financial disclosures, given multiple and often contradictory definitional issues on precise climate change pollution levels, difficulty in getting hold of primary data, and, above all, to a basic problem of lack of in-house skills by both regulators and financial firms in analyzing the data.

Again, this will be a major constraint for regulators and financial players in developing countries such as Saudi Arabia, which is politically committed to climate change controls. In parallel with the UK’s own initiative, the country is also keeping an open view on the work of the International Financial Reporting Standards Foundation, which is aiming to establish a global sustainability standards board.

Not to be outdone, in the US the Security and Exchange Commission (SEC) is looking at making disclosing climate risks part of regulatory filings, to avoid law suits from investors, but some argue that financial institutions are indeed caught between a rock and a hard place as they will also be sued if they issue or do not issue such climate change disclosures.

In summary, despite recognizing the urgent need for change and activists pleas to move faster, the financial services industry will not be able to turn around quickly without being pushed hard by regulators, and more importantly, by their shareholders, who might be idealistic but are faced by hard-nosed financial managers who truly believe that it will take time for renewable power to replace fossil fuels.

In the meantime, from now until the November COP 26 meeting and after, there will be many well-meaning announcements made on what the financial services firms intend to do to achieve net-zero emissions, and on what they really should do as demanded by climate activists. Those that thought that being in the financial sector was a highly rewarding career with lessons learned from past financial crisis to take them forward are now going to be faced by a new climate risk assessment world, where they not only have to understand and implement new unknown and untried risk valuation complexities, but also to educate their polluting clients if these are still to be funded. In Saudi Arabia, the change in mindset and climate risk implementation has to start being applied from now.

Pity then the new generation of bankers, but without these changes global lending will shrink to avoid lawsuits, with unintended consequences of reduced economic growth. Financial institutions that do make the new climate risk assessment transition will not only survive but also take over those lagging behind as their brand valuation becomes diminished.

• Dr. Mohamed Ramady is a former senior banker and professor of finance and economics, King Fahd University of Petroleum and Minerals, Dhahran.