How can sustainable finance transform 2050 pledges into real-world impact?

Our framework is not intended to replace financial firms’ existing strategic modelling tools for investment, credit or underwriting. Instead, its goal is to help FIs and their corporate clients understand and engage with the high-level climate transition pathways of key economic sectors, and begin transforming themselves in response.

To do this, the framework goes back to first principles. It examines the drivers of the proximity and clarity of different sectors’ transitions. It develops transition archetypes, recommending a sustainable finance lens through which FIs can view the future needs of each industry. And it charts potential futures, to illustrate how sectors and their financial needs may develop over time — and how FIs themselves will need to evolve as a result.

FIs can use this concept to cut through short-term noise and understand the evolving transition pathways of any sector or sub-sector. This will allow them to begin transforming themselves for the future, by developing sustainable finance strategies that:

• Move beyond simplistic binary decisions between “divest or engage”
• Use insight and collaboration to help high-carbon businesses transition, while scaling up climate solutions
• Mitigate the second- and third-order economic and social effects of decarbonization
• Discharge FIs’ fiduciary duties by meeting the needs of customers, investors and the environment

FIs seeking to apply the framework need to follow four key stages. These build on each other to construct a well-argued vision for decarbonization pathways, providing the basis for visualizing how individual FIs and the financial industry as a whole will be transformed during the decades leading up to 2050.

Stage one: Analyze

Analyze the proximity of each sector’s transition.

Proximity is a combination of urgency and capability, which are shaped by four key groups:

1. People: Individually and collectively, we all exercise a significant influence on the speed and urgency of each industry’s transition. Grassroots climate activism is proving powerful, and spiraling costs are fueling greater energy awareness. Whether they’re consumers, employees, activists or investors, people are demanding faster climate action, and public scrutiny is likely to increase over time. However, there are also major sensitivities over the costs of decarbonization. Public opinion in the social media age not only varies significantly between different regions and markets, but can change rapidly and unpredictably.
2. Governments: Whether responding to public opinion or shaping it, governments and other public bodies have critical roles to play in influencing the pace of transition. This includes addressing legacy problems such as market failures or the stranding of assets; facilitating the future by enabling new technologies and techniques through co-investment, subsidies, fiscal incentives or regulation; and ensuring that social risks are addressed. However, national variations on key issues like nuclear power and the potential for politicization and polarization could also become major obstacles to a global transition.
   
3. Technology providers: The availability of technology is often the biggest influencer of proximity. Simply put, the technologies required to decarbonize many industries are not yet available. In the long term, however, technology has the greatest game-changing potential — whether by scaling up capture and sequestration, or by entirely reimagining industry norms.
4. Industry bodies: Trade bodies, professional bodies, single-issue groups and other collaborative initiatives can have significant influence on the speed of transitions – for example, by coordinating change, organizing investment, or agreeing on shared standards.

Stage three: Assess

Use insights into the proximity and clarity of the transition to appraise the risks and opportunities facing different industries, and help those industries maintain affordable access to funding and insurance during their transition journey.

As part of this process, FIs can map sectors and subsectors into one of four sustainable finance archetypes. Each archetype indicates a specific set of financial challenges and needs, with corresponding implications for FIs’ sustainable finance activities and, ultimately, for their own structures and behaviors.

Mapping decarbonization transitions by sector

Individual sectors’ positions in each quadrant may change over time as their transition pathways grow nearer or clearer. Some industries’ transition pathways are already relatively clear and are evolving rapidly. In contrast, other sectors and sub-sectors have barely begun to model their transitions, let alone implement change.

The four archetypes and some of their typical risks and opportunities are:

• Maintain and grow: The sector’s transition is near, clear and already underway. FIs have an imminent opportunity to finance, invest in or de-risk ongoing transition activities.
• Risk manage and reimagine: The transition is urgent, but challenging or complex. FIs should engage closely with the sector, encouraging laggards and managing risks while financing more advanced players or initiatives.
• Partner in innovation: Transition pathways are relatively clear but will take time to implement. FIs should begin delivering the long-term finance, investment and risk management the industry needs to establish a robust transition pathway. This is likely to require scaled-up or entirely new financial solutions.
• Stay close and support: The transition journey remains unclear and will take time to emerge. FIs should maintain a watching brief as clarity gradually improves, monitoring industry developments and preparing innovative solutions that can be applied when opportunities to finance, risk manage or divest arise.

Stage four: Imagine

Imagine detailed potential futures for every sector.

Potential futures help FIs to identify and anticipate likely obstacles and milestones in each sector’s transition pathway, and their probable impact on emissions.

They also help FIs to overlay industry journeys with the developments in sustainable finance that will be required at key points in each sector’s transition. This enables investors, credit providers and risk carriers to:

• React to change — by protecting assets and minimizing liabilities
• Enable change — by financing new technologies and assets
• Enact change — by transforming their own structures and processes

At the highest level, mapping transition pathways will give FIs a good overview of how industries may “drift” between archetypes over time. Charting the potential evolution of an industry provides a stylized way for FIs to visualize the future of key sectors. FIs can then combine multiple client journeys, helping to formulate an enterprise-wide, cross-sector strategy and transition plan.

At the strategic level, a detailed understanding of future obstacles will help FIs match anticipated needs with solutions, as well as identify likely funding requirements, durations, timelines and partnering requirements. This includes deciding the potential roles of debt and equity, public and private finance, and primary or secondary markets in future solutions.

At the operational level, banks, insurers and investment managers can begin to drill down, identifying detailed developments that will be required in lending, investment, underwriting and advisory solutions. This will lead to the creation of short and medium-term action plans FIs can begin implementing immediately as part of their overall transition plan. A viable plan might include steps such as:

• Enhancing understanding of specific climate solutions and emerging technologies
• Training and educating relationship managers, risk managers and key decision-makers
• Building new targeted datasets focusing on key industries or technologies
• Developing multi-asset decarbonization investment strategies
• Harnessing public money and guarantees, using blended finance to mobilize risk appetite
• Facilitating data sharing and aligning data standards across industry supply chains
• Changing covenants in light of emerging trends
• Sharing estimated residual values of green assets with peers
• Supporting client calculations of Scope 1 (direct emissions) and Scope 2 (emissions arising from energy use)
• Planning how to finance the decommissioning of carbon-intensive assets

FIs will know they have applied the framework successfully when they can visualize the evolution of different sectors and their financial needs over a period of decades; identify tangible actions they can take now to tailor their products and services to those needs; and begin altering their own organization to deliver those altered offerings.

To illustrate the potential of this approach, we’ve applied the framework to four industries that are currently high emitters of greenhouse gases, one from each archetype. They are: Automotive (1), Agriculture (2), Energy (3) and Aviation (4).

A deeper dive into representative sectors

Looking to the future

Vast amounts of finance must be mobilized if the world is to achieve a successful transition to a more sustainable future. The ways in which different industries undergo this journey will depend on evolving social, technological, economic and political factors. A deep understanding of these pathways is vital if FIs are to enable the transition over the coming decades, and transform themselves and their activities in the process.

Future winners in sustainable finance will be those FIs that can anticipate the transition trajectories of key industries and adapt their sector strategies accordingly, dynamically managing their portfolios in line with their chosen risk appetites. Just as FIs succeeded in the past by being sector specialists, they will succeed in the future by becoming transition specialists able to support clients on their unique journeys to sustainability.

Early communication with stakeholders, setting out multi-sector views and their implications for lending, investment and underwriting, will be crucial to success. Leading firms will then actively manage their balance sheet exposures based on the decarbonization archetypes and future trajectories of their client base.

A structured framework that provides detailed, dynamic insights into the proximity and clarity of sectors’ transition pathways will allow FIs to engage constructively with the real economy, protecting value by minimizing risk and creating value by maximizing return while achieving tangible emissions reductions.

The framework can be applied to any sector or sub-sector, not just high-emitting industries. It can also be used to identify the transition pathways of large organizations’ key divisions or subsidiaries. Although designed to focus on decarbonization, it could potentially be adapted to address other environmental risks.

This value-led approach can help FIs to balance the need for decarbonization with the imperatives of resilience and profitability during the next 20 to 30 years. It can also allow them to adapt their thinking in response to as-yet unknown advances in technology. As the decades pass, the way FIs look and operate is poised to change significantly. In our view:

• By 2025, FIs will need to have a clear long-term view of, and approach towards, each archetype and sector.
• By 2030, future winners in sustainable finance will have already made material adaptations to their offerings, capabilities and structures.
• By 2040, industries in the “Maintain and grow” and “Risk manage and reimagine” quadrants will be largely decarbonized. Sustainable finance winners and losers will be clearly identified.
• By 2050, the transition archetypes will be obsolete. The global economy will have been transformed. There will be no sustainable finance — just a financial industry that looks very different from today’s.

FIs need to start imagining the future now and developing their transition plans. Understanding the likely transition pathways of key industries is crucial to visualizing and delivering the sustainable insurance, investment and lending that will be needed over the decades ahead.