Climate-Aligned Finance 101: What Is It, and Why Should You Care?

Last month’s Leaders Summit on Climate brought a renewed sense of hope and a wave of climate commitments from corporations, financial institutions, and governments. Those commitments are a great starting point, but to move forward in the same direction, we need a framing mechanism to think about our roles in tackling the climate crisis—a simple prism through which we can look at a problem and identify each actor’s place in the solution.

Thinking about the climate crisis can be overwhelming even for those of us working in the climate space, never mind for the average concerned citizen. The challenges before us are complex, and the payoffs are distant. There’s also no one person, group, or organization that can do it alone. We need to work together, moving in the same direction, and an organizing principle like climate alignment can help us do that.

Climate alignment is the process of bringing the global economy’s greenhouse gas (GHG) emissions in line with 1.5°C temperature targets. This means addressing emissions from the production and purchase of goods and services—what is often called the “real economy.” If we are to avoid the worst-case climate scenarios and the associated risks to global economies and development for billions of people, 1.5°C is the maximum warming allowable. Climate alignment helps each of us engage the real economy and work directly with the leaders in the most carbon-intensive sectors in a way that hasn’t been done before.

What Climate Alignment Does

Though we welcome net-zero commitments from heads of state, they are only one step toward a 1.5°C future. If climate commitments state the destination, climate alignment maps the journey. The concept of climate alignment moves beyond top-down national emissions targets, whose relevance to actors in the real economy is limited. To decarbonize the real economy, you must think and act like the real economy.

That’s why climate alignment begins with credible commitments and mechanisms for accountability, but it culminates by informing day-to-day decision-making across companies and stakeholders. “No government is going to be able to save us from this crisis. There just isn’t enough money,” said US Special Presidential Envoy for Climate John Kerry at a recent Ceres event. “The only way we get there is by having the private sector moving in the right direction.”

Climate alignment is important because it can align the market-driven interests and incentives that steer day-to-day decision-making within high-emitting sectors like power generation, shipping, aviation, steel, and others. When a sector or company is climate-aligned, it means they have specified a science-based transformation pathway to reach net-zero emissions, the metrics needed to measure progress, and the range of decarbonization commitments from industry, finance, customers, suppliers, and governments needed to move down that pathway.

Achieving net-zero emissions in the real economy will require scaling up low-carbon solutions (e.g., wind and solar) while transitioning high-carbon assets (e.g., coal plants) across carbon-intensive sectors where emissions abatement remains especially difficult. Every actor in the global economy has a role to play in this transition, from governments and regulators with influence in individual countries to energy companies and industrial corporations whose supply chains span multiple continents.

What Climate-Aligned Finance Does

Decisions made within the financial sector affect the pace at which we replace aging, carbon-intensive infrastructure and assets with net-zero alternatives. At RMI’s Center for Climate-Aligned Finance, we focus on the global financial sector’s crucial role in the net-zero transition. So, what does climate alignment actually mean for a financial institution?

Financial institutions are increasingly expected to play a critical and proactive role in the net-zero transition—not only scaling up green investments or restricting finance to high-emitting activities, but also actively supporting the transition of carbon-intensive industries to net-zero emissions. However, financial institutions cannot transition the global economy to net zero through their actions alone, considering that in the global economy’s current state, global warming is expected to exceed 4°C by the end of the century. A 4°C economy simply does not have enough 1.5°C assets or companies.

Faced with a limited universe of climate-aligned investment opportunities, a large financial institution would find it impossible to align its portfolio or loan book with a 1.5°C pathway today. Therefore, to be climate-aligned, financial institutions must work in partnership with both corporations and governments to create a net-zero global economy.

For private financial institutions (i.e., Wall Street firms, your mortgage lender, the company managing your 401k, etc.), climate alignment means actively using their levers of influence with the intent of helping move the real economy toward net-zero emissions. Those levers of influence could include lending and investment decisions, advisory services, capital markets activities, and non-revenue generating efforts like stewardship and advocacy.

Numerous articles highlight the increasing pressure on financial firms to act on climate from their shareholders, clients, regulators, and customers. However, there is also enormous opportunity for financial institutions to proactively create and capture value from an expanding pool of low-carbon investable opportunities through innovative alignment-linked products and services. Bank are issuing loans, for instance, where the interest rates decrease if the borrower lowers its emissions.

By reorienting their strategies to reduce the carbon footprints of their lending and investment activities, and by supporting their clients’ transitions toward net-zero emissions, financial institutions can minimize risk, create a competitive edge, and actively support progress toward global climate goals in the real economy. To achieve climate alignment, banks, insurers, asset managers, and asset owners need to address five key barriers.

Though the transition won’t be easy, promising work is under way. Climate-alignment efforts in the financial sector exist at the firm, sector, and system level, including:

• The Poseidon Principles, the world’s first climate-alignment agreement, which brings together 15 banks that have agreed to align their collective $150 billion ship loan portfolios with a 2050 decarbonization trajectory. Similar efforts are under way across other high-emitting sectors.
• A wave of leading global banks that have made commitments to reduce the carbon intensity of entire portfolios in line with net zero by 2050.
• Financial-sector coalitions like the Net-Zero Asset Owner Alliance, Net-Zero Asset Managers Initiative, and, most recently, Net-Zero Banking Alliance. The UN launched these coalitions to effectively channel the efforts that different kinds of financial institutions are taking on climate alignment.

The financial sector doesn’t operate in a vacuum, and it can only meet its climate goals if it can coordinate its path to net zero with its customers and regulators—especially in high-emitting sectors. So RMI is supporting initiatives like the Mission Possible Partnership to empower corporates in these heavy industries to play a leading role in solving the decarbonization puzzle through collective action. Collective action creates space for all relevant actors within a given sector to agree on what needs to happen for a sector to decarbonize, and to take the necessary steps to make that shared vision a reality.

Putting the Process in Practice

Whether you’re a regional bank creating your net-zero policy or a voter who wants to understand your elected officials’ progress on climate, climate alignment helps us all get on the same page so we can move in the same direction. We will be drilling deeper into what climate alignment means for specific actors in the global economy in coming months. Watch this space!