Paris Alignment: How Can the Financial Sector Accelerate the Transition to Net-zero?
In 2015, representatives from 196 country members of the United Nations Framework Convention on Climate Change (UNFCCC) met in Paris to develop a global approach to mitigating and adapting to climate change. The resulting plan is known as the Paris Agreement.
The primary goal of the Paris Agreement is to limit global greenhouse gas (GHG) emissions to keep the average global temperature increase to 2.0 C or less; preferably 1.5 C or less. Countries that have signed on to the Paris Agreement must lower their emissions according to their stated commitments – Nationally Determined Contributions (NDCs). Signatory countries are also developing Long-Term Strategies (LTSs), paths to a low-carbon future. These country specific NDCs and LTSs keep the Paris Agreement grounded in reality, ensuring that we can reach the goal.
Meeting the Paris Agreement goal relies on global GHG emissions reaching net zero by 2050, with a reduction of 45% by 2030 compared to 2010 levels. Investments that conform to this goal are “Paris Aligned.” Citizens, businesses, and financial institutions all have a role in working toward this goal.
“Paris was important, but it’s only the beginning.”
Former Secretary General of the United Nations
The Role of Financial Institutions
Financial institutions (FIs) have a unique role in working toward the goals of the Paris Agreement. FIs can direct financial resources toward Paris Aligned projects and investments, which will result in lower GHG emissions. When FIs are reluctant to finance projects that increase fossil fuel use, more sustainable projects are encouraged. Without active participation from FIs, the Paris Agreement goals will not be met.
Reasons for FIs to Become Paris Aligned
When FIs announce plans to become Paris Aligned, they signal that limiting climate change is a priority. This attracts investors and clients. By investing in Paris Aligned projects, FIs are future-proofing their portfolios, ensuring that project proponents have identified and decreased climate risks that could affect future profitability.
Many FIs are setting targets based on the goals of the Paris Agreement. The Climate Policy Initiative (CPI), an independent non-profit organization funded by a wide range of organizations, reports that, as of June 2022, at least 547 FIs representing $129 trillion in assets have announced net-zero targets. Of these, 128 are commercial banks. FIs that do not develop and promote a climate agenda will be left behind.
“We believe the market continues to underestimate both the rate of change needed to decarbonize and the magnitude of the positive impact on companies helping this transition.”
Head of Sustainable Investment Team, Liontrust Asset Management
Green Finance Versus Paris Alignment
Financing, measuring and reporting green projects in a portfolio is similar to ensuring that investments are Paris Aligned. However, not all green investments are Paris Aligned. There are some key differences.
- Climate finance (green finance) is focused on creating a positive impact on climate change. Paris Aligned projects do no harm to the goals set out in the Paris Agreement. Depending on a country’s NDC and LTS, Paris Aligned projects may not necessarily be “green” under some climate finance classification systems.
- Under most climate finance standards, a portion of a project may be classified as green. Paris Alignment allows for only a binary outcome: a project is either aligned or not aligned.
- Climate finance may fund projects for mitigation and/or adaptation. Paris Aligned projects must be in alignment with both mitigation and adaptation goals.
The Paris Aligned Investment Initiative (PAII) is an investor-led global forum whose members are aligning their portfolios to the goals of the Paris Agreement. Through the PAII, 118 investors representing $34 trillion in assets are developing the Net Zero Asset Framework.
Paris Alignment and Multi-Lateral Development Banks, Including IFC
Multi-lateral development banks (MDBs), including IFC, have developed a framework for aligning with the goals of the Paris Agreement. This Framework includes six building blocks. The first two building blocks relate to how MDBs will screen their direct investments for Paris Alignment. The remaining four blocks describe further work that will be done by MDBs toward meeting the Paris Agreement goals.
Building Block 1: Ensure investments are aligned with Paris Agreement mitigation goals
- To be Paris Aligned, investments must be consistent with the climate change mitigation goals set out in the Paris Agreement – that is, consistent with a future based on low levels of GHG emissions. Each investment is either “aligned” or “not aligned.”
- Investments are not aligned if they support power generation from coal or peat.
- Investments that generate GHG emissions but are still in line with the country’s NDC and LTS are Paris aligned.
- Investments that are not economically viable when the potential risks of stranded assets or potential risks are taken into account are not aligned.
- The technologies used by the project and the outputs delivered by the project can be considered during the evaluation. Analysis can also include whether the project depends on or promotes policies or regulations consistent with the low-GHG pathway.
Building Block 2: Ensure investments are aligned with Paris Agreement adaptation goals
- Investments are “aligned” with adaptation goals if the proponents:
- Identify and assess areas where the project is vulnerable to physical climate risks; and,
- Address the physical risks that have been identified to the extent possible; and,
- Ensure the project is consistent with the national context, that is, the project is aligned with the local NDC and LTS. A project not aligned with the relevant NCD and LTS is not Paris Aligned.
Building Block 3: Accelerated contribution to transition through climate finance
- Scaling up climate finance and supporting countries that are working to achieve their NDCs.
Building Block 4: Strategy, engagement and policy development
- Offering services that help clients develop LTSs consistent with the UN’s Sustainable Development Goals (SDGs) and local NDCs.
Building Block 5: Reporting
- Developing tools for characterizing, monitoring and reporting on Paris-Aligned activities.
Building Block 6: Align Internal Activities
- Ensuring that the banks’ facilities and internal policies are in alignment with the goals of the Paris Agreement.
“As part of the Paris Alignment commitment, we pledged to screen every project for physical climate risk and building our clients’ capabilities to adapt. As of 2025, all new projects will be assessed for physical climate risks.”
Manager, Climate Finance and Policy, IFC
How Financial Institutions Can Become Paris Aligned
Paris Aligned investments are in line with the mitigation and adaptation goals of the Paris Agreement. It is not likely that every asset in a FI’s current portfolio will be Paris Aligned. For example, almost all banks currently hold fossil fuel-related assets. But it is possible to set goals for the future. IFC has committed to aligning 85% of its real sector operations with the Paris agreement by July 1, 2023, and 100% by July 1, 2025.
FIs can assess existing portfolios to determine what share of their portfolios are already Paris Aligned. Potential investments can also be assessed for Paris Alignment. FIs can work with existing and potential clients to suggest changes that will lead to projects becoming Paris Aligned. Working with clients can help FIs facilitate global change while building stronger relationships with clients and also future-proofing the FI’s portfolio, to ensure long-term profitability.
In assessing an existing or potential investment, the first step in determining whether the investment is Paris Aligned is to consider the NDC and LTS in the country of operation. The next step is to determine the climate risks, physical and transitional, associated with the project.
“The conflict in Ukraine has set in motion a multi-dimensional crisis…. getting the world on track for net zero emissions by 2050 and delivering on the Paris Agreement goals means countries must cooperate to mobilize increased levels of finance for investments in the low and net zero emissions economy.”
Secretary General, International Chamber of Commerce
Working with IFC to Become Paris Aligned
IFC, based on its own experience of aligning business operations with the Paris goals, can support other financial institutions in this process. There are several areas where IFC can work with your FI to assist you in becoming Paris Aligned:
- assessing your current portfolio to determine which loans and investments are already Paris Aligned, according to Building Blocks 1 and 2 as described above;
- identifying the physical and transitional climate risks associated with existing and potential investments;
- developing capacity within your FI;
- working with you to develop internal policies and practices to screen new projects and determine whether they are Paris Aligned;
- developing new products that will be Paris Aligned;
- assisting with measurement and reporting; and,
- advising your clients as they work toward reducing emissions.
“Since 1850, the earth has warmed by 1 C. It looks small, but it’s enough to multiply by five the frequency of extreme heat waves: what used to be an exceptional heat wave happening once every 50 years, now happens every 10 years.”
Senior Climate Advisor, World Bank
Start Your Green Journey
For more information about how IFC ECA Green Banking Academy can help YOUR financial institution become Paris Aligned, please email email@example.com to contact a member of our team. We are looking forward to working with you. Stay green!