Sustainability Perspectives Credit Risk, Biodiversity, and Climate Change Canada’s Banks and the Fight Against Global Warming Canada’s Big Five banks have acknowledged the significance of global climate change. While it’s hard to exaggerate the need to move quickly towards reducing greenhouse gas emissions, actions undertaken to date indicate that the fifty-year transition to a carbon-free economy has begun. Who’s leading the race, who’s lagging … and what must be done next? March 2008 Brief At a Glance Climate change is the most significant environmental challenge of our time. Under pressure from shareholders and environmental organizations, Canada’s banks have begun to rise to this challenge. They acknowledge that anthropogenic climate change is occurring. They acknowledge that a failure to respond has the potential to devastate the economy. And they acknowledge that, as pillars of the Canadian economy, they have financial and moral reasons to take action. That action is occurring. Banks are putting in place the policy and governance infrastructure necessary to both assess the credit risks associated with climate change as well as preserve crucially important carbon sinks in Canada. TD Bank and the Royal Bank of Canada lead the parade, with CIBC and Scotiabank playing catch up. BMO lags the sector. Policy development has defined activity so far—but much more needs to be done. Benchmarks for evaluating performance must be set, targets established, and action plans implemented. In the months and years to come, bank shareholders and environmental organizations will be looking for visible signs of progress on meeting the climate challenge. Tackling climate change: the race is on … Because of their large size and broad economic participation, banks around the world are able to significantly impact how the companies they finance respond to the challenges posed by climate change. The environmental and human costs of failure are becoming clear—an increase in the frequency of extreme weather events, the spread of disease to flora and fauna and humans, extinction of species, ocean acidification, sea level rise, water scarcity, an increase in forest fires are among them. The evidence is indicating that impacts have the potential to be extreme and, in some cases, are already underway. Mountain Pine Beetle Cumulative Cumulative Percentage Percentage of Pine Killed of Pine Killed <1% <1% 1 - 10% 1 - 10% 11 - 30% 11 - 30% 31 - 50% 31 - 50% 51 - 70% 51 - 70% 71% - 100% 71% - 100% 0% pine killed 0% pine killed 2001 2007 Source: Ministry of Forests and Range, Government of BC Between 2003 and 2006, the area of British Columbia forest impacted by the Mountain Pine Beetle epidemic more than doubled from four million hectares to 8.7 million hectares. The Mountain Pine Beetle reduces a tree’s nutrient and water uptake, resulting in defoliation and tree mortality. The large areas of dead trees can increase the intensity of forest fires, change water runoff patterns and water temperature, affect soil and stream bank erosion, and degrade fish habitat. The commercial value of wood is significantly reduced if affected trees are not harvested within two to five years of infestation. Many observers suspect that the outbreak may be the result of climate change. The beetle thrives under warm weather conditions. The interior of British Columbia has experienced several mild winters and drought-like summers. While the long-term economic implications for British Columbia are uncertain, regional impacts could be devastating. Pay now or pay later The potential economic costs of climate change are also becoming clear. The Stern Review on the Economics of Climate Change is the most widely known and discussed report on the economic impacts of climate change. Written by the former Chief Economist at the World Bank, the report suggests that climate change could be the greatest market failure ever. The report maintains that a 2-3º Celsius rise in temperatures could reduce global economic output by up to 3%. If temperatures rise by 5º Celsius, up to 10% of global output could be lost. Under the worst case scenario, global consumption per head would fall 20%. In contrast, an effective climate action plan will cost 1% of GDP. Stern concludes: “Our actions over the coming few decades could create risks of major disruption to economic and social activity, later in this century and in the next, on a scale similar to those associated with the great wars and the economic depression of the first half of the 20th century.” Sustainability Perspectives – Credit Risk, Biodiversity, and Climate Change Page 2 While delay is potentially very costly, evidence suggests that taking action now is affordable. PricewaterhouseCoopers’ estimates that over the next fifty years, an effective strategy to reduce atmospheric concentrations of greenhouse gases to a manageable level could be expected to delay global GDP growth by a matter of just a few months. A heightened sense of urgency has now entered the public discourse on climate change. Science now indicates that the window of opportunity for taking effective action to reduce the worst impacts of climate change is beginning to close. Transitioning to a carbon free economy There’s good news. The global financial sector has begun the transition to financing a carbon-free economy. This is true in both equity and debt markets. Equity Markets The Carbon Disclosure Project (CDP) is an independent not-for-profit organization aiming to create a lasting relationship between shareholders and corporations regarding the implications for shareholder value and commercial operations presented by climate change. Its goal is to facilitate a dialogue, supported by quality information, from which a rational response to climate change will emerge. CDP provides a coordinating secretariat for institutional investors with a combined $57 trillion of assets under management. On their behalf it seeks information on the business risks and opportunities presented by climate change and greenhouse gas emissions data from the world’s largest companies (3,000 in 2008). Over eight years, the CDP has become the gold standard for carbon disclosure methodology and process. Ethical Funds is a Founding Member of the CDP and a sponsor of CDP Canada. Debt Markets In Canada, the Big Five banks have also started to take action by improving their credit risk assessment processes. As key lenders of capital to companies that have significant environmental impacts, this aspect of finance is crucial for the purposes of tackling climate change. It is early days, but the banks are taking steps to learn about the challenges, develop new climate risk-specific policies, and build internal capacities. The key question: how are they doing so far? Ethical Funds and the banks For several years, Ethical Funds has been in dialogue with Canada’s banks on lending practices. Our goal has been to encourage the banks to assess, mitigate, and minimize the adverse environmental and social impacts of the companies receiving loans. The effort was spawned in 2001 by concerns raised over the participation of major project finance banks in underwriting the Three Gorges Dam in China. This project is now recognized by the Chinese government as posing severe environmental and social challenges throughout the Yangtze River basin. These challenges could have been mitigated—and the project potentially stopped—had there been a full consideration of the risks posed by the dam. To address the apparent gap in the banks’ risk assessment process, socially responsible investors, non-governmental organizations, and the major project finance banks worked toward the establishment of what’s now embodied by the Equator Principles: a set of procedures for identifying, evaluating, and mitigating environmental risks associated with project finance. Today, the Equator Principles cover more than 80% of global project finance. Ethical Funds was part of this process of development, initially via our dialogue with Citigroup and other US banks. In 2002, we began to ask Canada’s major banks to adopt the Equator Principles. By 2007, this project was complete: all five major Canadian banks had signed on. In 2004, the dialogue with Canada’s banks began to shift to more sector-specific metrics for assessing climate-related credit risk. This led to discussions about the risks posed by climate change and the presence of large emitters of greenhouse gases in the banks’ lending books. Sustainability Perspectives – Credit Risk, Biodiversity, and Climate Change Page 3 Evaluating the “Big Five” For this report we draw upon 25 climate-specific indicators found in our Corporate Sustainability Scorecard. These indicators are based on emerging trends and best practices undertaken by leading banks. Our methodology has a Canadian twist. We focus not just on carbon emissions management but also on efforts to preserve biodiversity generally—and Canada’s boreal forest specifically. Evidence to date indicates that climate stabilization can’t be achieved without the conservation of forests. Forest growth has the greatest potential to reduce the concentration of atmospheric carbon dioxide over the next quarter century. The boreal forest found in Russia, United States, Canada, and Scandinavia supports nearly 50% of the world’s remaining intact forests and is the world’s most important carbon storehouse. Because of the high concentration of carbon in its peat soils and wetlands, the boreal holds 22% of the total carbon stored on the earth’s land surface and almost twice as much carbon per unit as tropical forests. Lobbying for land-use planning: The Boreal Leadership Council Canada’s boreal region contains one-quarter of the world’s remaining original forests, and is one of the largest intact forest ecosystems left on Earth. It is home to a rich array of wildlife including migratory songbirds, waterfowl, bears, wolves, and the world’s largest caribou herds. Development pressures are immense and land-use planning that recognizes environmental and social factors is the exception not the norm.