SECTOR NOTE

Climate change and the banking industry

by Emma Rachmaninov, Anthea Bowater, Maisie Heath and Reena Parmar, Freshfields Bruckhaus Deringer LLP

Status: Law stated as at 05-Jun-2023 | Jurisdiction: European Union, United Kingdom

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A sector note setting out the key considerations arising for the banking industry concerning
climate change, as well as a discussion of sustainable finance offerings in the industry. This sector
note focuses primarily on UK law and provides a high-level overview of EU law, where it may be of
relevance to UK banks.

Scope of this note specific industries. Owing to this position, the banking
industry has become a focus for those advocating
This note sets out the key considerations arising for climate change action, who say that the industry should
the banking industry in relation to climate change, restrict or stop financing for sectors that contribute
including: materially to climate change.
• The banking industry’s direct and indirect impact on Most banking industry participants measure the direct
climate change. impact of their own operations on climate change and
• Existing and anticipated climate change law and either consider their operations to be net zero already or
regulation that specifically relates to the banking have plans in place to become net zero.
industry. The more challenging aspect for banking industry
• Key risks identified in banks’ climate change participants is the indirect impact of their operations
disclosures. or the emissions they finance. CDP Worldwide,
which is responsible for a global disclosure system
• Emerging trends and the industry’s reaction to
to help investors, companies and cities manage their
climate change.
environmental impact, estimated that, based on
The note also includes discussion of the growing disclosures in 2020, emissions arising from banks’
number of sustainable finance offerings from the financing activities were approximately 700 times
industry. higher than their direct operational emissions.
For an overview of: Steps are being taken to establish consistent ways
• The key climate change legislation that can impact of measuring financed emissions. For example, the
businesses more generally, see Practice note, Climate Partnership for Carbon Accounting Financials (PCAF) has
change issues for companies. established a global accounting and reporting standard
for measuring and disclosing emissions financed via
• Practical Law’s resources on climate change, see various asset classes including listed equity and corporate
Climate change toolkit. bonds, business loans and unlisted equity, project
• Practical Law’s resources on the climate-related finance, commercial real estate, mortgages and motor
and environmental disclosures required as part of vehicle loans. The PCAF approach has wide support
annual corporate reporting, see Climate-related and across the banking industry, with many of the largest
environmental disclosures toolkit. UK-based banks now referring to the PCAF guidance
in their disclosures. Some UK-based banks have also
developed their own methodologies for measuring the
The banking industry’s direct and emissions they finance (for example, Barclays has created
indirect impact on climate change a system for measuring and tracking financed emissions
at a portfolio level against Paris Agreement goals) and
The banking industry is in a unique position to
have acknowledged the areas of their business that
influence the transition to a low-carbon economy.
are particularly carbon-intensive in terms of emissions
Financing companies gives it a degree of control over
financed. Banks look at new business opportunities with
the allocation of capital both towards and away from

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 Climate change and the banking industry

a view to reducing their exposure to carbon-intensive • The FCA’s sustainability disclosure requirements (SDR)
industries by measuring their carbon content, reducing (see Sustainability Disclosure Requirements below).
the share of coal in the financed energy mix and by
• The FCA’s work on driving positive sustainable change
setting reduction objectives. For example, in September in financial services firms, considering culture,
2022, six large lenders to the global steel industry signed governance, remuneration and incentives, and
the Sustainable STEEL Principles agreement, which competence (DP23/1) (see The FCA’s work on driving
establishes a methodology for banks to measure and positive sustainable change below).
report the emissions associated with their steel loan
portfolios relative to net zero pathways. • The development of mandatory transition plans (see
Development of mandatory transition plans).
Banks are also offering greener investment opportunities
such as green loans or green bonds to corporate and Managing financial risks
retail investors and providing sustainable investment
opportunities to the clients of their asset management Both UK-based financial regulators, the PRA and
arms. For more information, see Green loans: checklist the Financial Conduct Authority (FCA), specifically
and Increase in sustainable finance products being recognise that climate change is a potential material
offered by industry participants. financial risk. In April 2019, the PRA issued a supervisory
statement setting out its high-level expectations on
While climate change is generally considered to be climate change for certain firms it regulates, including
an important subject in its own right in the banking banks and building societies (see PRA: Supervisory
industry, it is sometimes considered together with Statement 3/19: Enhancing banks’ and insurers’
other environmental, social and governance (ESG) approaches to managing the financial risks from climate
or sustainable finance considerations (and the terms change (15 April 2019)). In July 2020, it wrote to those
ESG, sustainable finance and green finance are often firms clarifying some of the expectations. Firms were
used interchangeably). For further information on ESG expected to have their climate-related financial risk
generally, see Environmental, social and governance plans fully embedded by the end of 2021 (see PRA:
(ESG) toolkit: UK. Dear CEO letter: Managing climate-related financial
risk – thematic feedback from the PRA’s review of firms’
Existing and anticipated law and SS3/19 plans and clarifications of expectations (1 July
2020)). In brief, the PRA expects firms to:
regulation relating to climate
• Embed consideration of climate change risks in their
change governance arrangements, including by dedicating
As with many industries, the banking industry is affected adequate resources and expertise to these risks and
by a range of climate-related law and regulatory measures. by allocating responsibility to the relevant senior
Key areas of existing and developing regulation in this area management function.
include: • Incorporate climate change risks into existing
• Financial risk requirements from the UK Prudential financial risk management practice, including by
Regulatory Authority (PRA) (see Managing financial updating their existing risk management policies,
risks below). monitoring and reporting, and by having a credible
plan in place for managing exposures.
• Amendments to the Listing Rules to align with the
Task Force on Climate-related Financial Disclosures • Use scenario analysis to inform their strategy and risk
(TCFD) recommendations, as well as other assessment (including shorter-term analysis within
measures requiring disclosures against the TCFD a firm’s business planning horizon and longer-term
recommendations (see Amendments to Listing Rules analysis, in the order of decades, on a range of
for TCFD disclosure below). different climate pathways).

• The Bank of England (BoE) Climate Biennial • Develop an approach to disclosure of these
Exploratory Scenario (see The BoE Climate Biennial risks, which includes engaging with TCFD
Exploratory Scenario below). recommendations. See Practice note, Task Force
on Climate-related Financial Disclosures (TCFD):
• The EU Sustainable Finance Disclosure Regulation recommendations for disclosing climate-related
((EU) 2019/2088) (SFDR) and the Taxonomy Regulation financial information: overview.
((EU) 2020/852) (see The EU’s Sustainable Finance
Disclosure Regulation and Taxonomy Regulation In implementing these expectations, the PRA expects
below). firms to take a proportionate approach that reflects
their exposure to climate-related financial risk and the
• The UK Stewardship Code (see The UK Stewardship complexity of their operations.
Code below).

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 Climate change and the banking industry

In 2022, the PRA’s supervisory approach shifted from See, for further information, Practice note, TCFD
assessing implementation to actively supervising against recommendations: climate-related financial disclosures
the expectations set out in SS3/19. In October 2022, for premium listed and standard listed companies
the PRA published a further Dear CEO letter on climate (LR 9.8.6R(8) and LR 14.3.27R).
change, setting out the capabilities it expects firms to be
Further, since 1 January 2022, rules are in force (subject
able to demonstrate and examples of effective practices,
to phased implementation) for asset managers (as well
as well as its observations on where firms are (see
as life insurers and pension providers) to make TCFD-
PRA: Dear CEO letter: Thematic feedback on the PRA’s
aligned disclosures at an entity, product and portfolio
supervision of climate-related financial risk and the
level. See Practice note, Climate-related disclosures and
Bank of England’s Climate Biennial Exploratory Scenario
ESG: FCA requirements and expectations.
exercise (21 October 2022)). For a checklist to help banks
respond to this Dear CEO letter, see Checklist, PRA A further requirement has been introduced for
supervision of climate-related financial risks. the inclusion of a non-financial and sustainability
information statement in the strategic report of certain
For more information about the PRA’s expectations
UK companies, including banking companies of a
of banks in respect of managing climate-related
certain size, in relation to financial years beginning on
financial risks and how it supervises firms generally,
or after 6 April 2022. See Practice note, Strategic report:
see Practice notes, Managing climate-related financial
non-financial and sustainability information statement:
risks: PRA requirements and expectations and PRA
financial years beginning on or after 6 April 2022:
supervisory model.
Companies required to include an NFSI statement in
their strategic report.
Amendments to Listing Rules
For further information on TCFD disclosures by other
for TCFD disclosure
entities, see Practice note, TCFD recommendations:
The TCFD recommendations aim to provide a climate-related financial disclosures for premium listed
standardised approach to climate-related financial and standard listed companies (LR 9.8.6R(8) and LR
reporting, so that risks and opportunities can be 14.3.27R): Mandatory TCFD disclosures by other entities.
categorised consistently, and organisations across
different sectors and jurisdictions can be compared. The BoE Climate Biennial Exploratory
The TCFD recommendations comprise overarching
recommendations and specific recommended disclosures
Scenario
in relation to governance, strategy, risk management, The BoE also conducted its biennial exploratory
and metrics and targets. The TCFD recommendations are scenario (BES) during 2021 with seven large UK banks
intended to improve and increase reporting of climate- and building societies (as well as certain insurers).
related financial information (see Practice note, Task The BES intended to test the resilience of those banks’
Force on Climate-related Financial Disclosures (TCFD): business models and the financial system to climate-
What are the TCFD recommendations?). related risks, and the scale of the adjustment that will
be needed in future for the sector to remain resilient.
Some banks are either listed companies or within listed
The BoE sought to measure the impact of the BES on
groups and, as such, the FCA’s Listing Rules apply
those banks’ end-2020 balance sheets with a focus on
to them or their group holding companies. The FCA
the credit risk exposure of the banking book to large
amended its Listing Rules to require companies with
corporate counterparties. A second round of the BES
a premium listing to make disclosures in line with the
was announced in February 2022 to further explore
TCFD’s recommendations or explain why they are not
participants’ strategic responses to the scenarios
able to do so, which applies for accounting periods
published as part of the first round. The results of
beginning on or after January 2021.
the exercise were published in May 2022 (see Legal
The requirement also applies in relation to accounting update, BoE announces results of 2021 Climate Biennial
periods beginning on or after 1 January 2022 in respect of: Exploratory Scenario). The BoE found that, while UK
banks (and insurers) were making good progress in
• Companies with a standard listing of equity shares.
some aspects of managing climate risk, much more
• Companies with standard listed shares other than work was needed in understanding and managing
equity shares. their exposures. It highlighted, in particular, the lack of
• Standard listed issuers of global depositary receipts available data to understand climate risk.
(GDRs) representing equity shares. While the main aim of this exercise is to inform the
It excludes investment entities and shell companies Financial Policy Committee’s (FPC’s) approach to
(such as special purpose acquisition companies (SPACs)). system-wide policy issues and the PRA’s approach

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 Climate change and the banking industry

to supervisory policy, the BoE also gave firm-specific of sustainable finance: Sustainability disclosure
feedback to participants and the PRA are using requirements (SDR).
the findings to assess firms’ progress against its
However, the SFDR remains relevant for UK firms.
expectations in this area (as set out in SS3/19). See
Practically, a UK firm may decide to voluntarily comply
Practice note, Hot topics: UK regulation of sustainable
with the SFDR because of investor pressure. In addition,
finance for more information.
UK firms marketing funds into the EU or managing EU
Scenario analysis is part of the BoE’s wider work on funds may also be within scope of the SFDR. For further
assessing regulatory capital frameworks. Its March 2023 information, see Practice notes, Sustainable finance:
report on climate-related risks and regulatory capital EU SFDR: overview: Application of the SFDR in the UK.
frameworks recognises that assessing whether banks
The Taxonomy Regulation establishes criteria
are adequately capitalised for future climate-related
for determining whether an economic activity is
losses is challenging, when identifying and measuring
environmentally sustainable. It applies to financial
climate risks has inherent difficulties, for example due
market participants as defined in the SFDR and certain
to a lack of granular data, and where methodologies in
large public-interest entities. It is intended to provide
capital frameworks may not be appropriate for climate
investors with a common language to identify to what
risks, for example because they take too short-term
degree economic activities can be considered and
an approach. The BoE recognises that further work
labelled environmentally sustainable (or “green”). It also
needs to be done, including in terms of building its
obliges the entities that are in scope to make statements
understanding of gaps and its own capabilities to assess
about how their financial products and activities align
the resilience of the financial system. No policy changes
with the taxonomy it specifies. See Practice note,
have been made at this stage, but the BoE intends to
Sustainable finance: EU Taxonomy Regulation: overview.
conduct further work to determine whether changes
to the regulatory capital frameworks are required. See As with the SFDR, the Taxonomy Regulation’s disclosure
BoE: Report on climate-related risks and the regulatory provisions entered into effect after the Brexit transition
capital frameworks (13 March 2023). period. While the majority of the Taxonomy Regulation
has been onshored in the UK, this is not the case for the
The EU’s Sustainable Finance Disclosure delegated acts adopted pursuant to the Regulation. All
provisions of the Taxonomy Regulation could still apply
Regulation and Taxonomy Regulation
to UK firms, for example, where UK firms market funds
The EU’s SFDR and its Taxonomy Regulation are into the EU.
both part of the European Commission’s package of
On 9 June 2021, HM Treasury published a press release
reforms relating to sustainable finance. See Practice
announcing the establishment of the Green Technical
note, Hot topics: EU sustainable finance regulation and
Advisory Group (GTAG), an expert group whose purpose
Practice note, EU sustainability disclosures for financial
is to provide independent advice to the government on
institutions.
the development and implementation of a UK green
The SFDR has imposed transparency and disclosure taxonomy, which will build on existing international
requirements relating to sustainability matters and taxonomies, including the EU taxonomy (see Legal update,
risks, such as climate change, on certain financial HM Treasury establishes Green Technical Advisory Group).
market participants including, for example, private The GTAG published its advice on the development of a UK
banks providing portfolio management and investment green taxonomy on 7 October 2022 (see Practice note, Hot
advice. The SFDR sets out, among other requirements, topics: UK regulation of sustainable finance: GTAG advice
the information firms must disclose and maintain on to government on UK green taxonomy). While secondary
their websites, the information that must be provided to legislation relating to the UK green taxonomy was
investors and the requirements for periodic reporting to originally due in 2022, the government has now said that it
investors. See Practice note, Sustainable finance: SFDR: expects to consult on it in autumn 2023.
overview. The SFDR entered into force on 29 December
For more information, see Practice notes, Sustainable
2019 and most of its provisions have applied since
finance: EU Taxonomy Regulation: overview: Application
10 March 2021.
of the Taxonomy Regulation in the UK and Hot topics:
The core provisions of the SFDR did not apply until after UK regulation of sustainable finance: UK green taxonomy.
the end of the Brexit transition period and it has not
been onshored in the UK. The FCA has been working The UK Stewardship Code
on its own, separate disclosure framework under a SDR
regime. See Sustainability Disclosure Requirements The UK Stewardship Code 2020 sets out responsible
below and Practice note, Hot topics: UK regulation business standards for, among others, asset owners

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 Climate change and the banking industry

and asset managers, as well as the service providers disclosure requirements (SDR) and labelling regime:
who support them. It applies, therefore, to banks’ asset New anti-greenwashing rule.
management and private bank divisions. Although
adherence to the Code is voluntary, it is widely The FCA’s work on driving positive
supported. Principle 7 of the Code requires signatories
sustainable change
to systematically integrate stewardship in investment
decisions, including material ESG issues and climate The FCA has recognised the evolving nature of work
change, to fulfil their responsibilities. In practical terms, on many different aspects of sustainability and is
the Code also provides a basis for asset managers who encouraging dialogue on sustainability-related
hold shares in listed banking entities to apply pressure governance, incentives and competence. In February
to those entities to have regard to material ESG issues 2023 the FCA published a discussion paper setting
(including climate change). For further information, see out the various existing initiatives in these areas, and
Practice note, UK Stewardship Code 2020. posing questions about firms’ current arrangements
and views on future regulation. The feedback will help
Sustainability disclosure requirements the FCA to decide on its future regulatory approach. The
paper recognises that attention is turning to areas of
In light of the increasing importance of providing the sustainability other than climate, which include human
market with accurate and high quality information about rights, diversity and biodiversity.
sustainability-related matters, the FCA has developed
its SDR regime. The SDR will bring together existing For further information, see Practice note, Hot topics:
sustainability-related disclosure requirements under UK regulation of sustainable finance: Discussion paper
one integrated framework, including the existing TCFD- on finance for positive sustainable change.
aligned disclosure requirements (which are to be made
fully mandatory across the UK economy by 2025 and Development of mandatory transition
which are already expected of PRA-supervised financial plans
services firms), and will include a number of new
requirements. This includes a requirement for creators There is no mandatory requirement at present for
of investment products to report on the products’ all companies to publish a net zero transition plan
sustainability impact and relevant financial risks and (TP). However, while the TCFD disclosures required of
opportunities. This information will form the basis of a premium and standard listed companies (on a comply
new sustainable investment labelling regime that will or explain basis, see Amendments to Listing Rules
make it easier for consumers to navigate the range of for TCFD disclosure) do not require the publication of
investment products available to them. The introduction a TP, a TP is an expectation of reporting against TCFD
of such measures was driven by concerns about claims recommendations.
that firms are making about the green credentials of HM Treasury launched the Transition Plan Taskforce
their investment products, and the associated harm (TPT) in April 2022, with the aim of developing a “gold
to consumers and damage to consumer trust in the standard” for transition plans and the TPT opened its
market. Through the development of different labels draft recommendations for consultation at COP 27 in
for different products according to their sustainability November 2022. The FCA has been involved in the work
objectives and features, the FCA hopes to provide of the TPT and has made clear that they “intend to draw
greater transparency and consistency for consumers. on” the outputs once they have been finalised in relation
The consultation period ended on 25 January 2023, to strengthening disclosure requirements for listed
and the FCA intends to publish final rules and a policy companies and regulated firms.
statement in Q3 2023.
For further information on the recommendations for
For further information, see Practice note, Hot topics: certain UK companies to publish a net zero transition
proposed FCA sustainability disclosure requirements plan, see Practice note, Net zero transition plans for
(SDR) and labelling regime. UK companies.
The FCA is also proposing a general “anti-
greenwashing” rule for all regulated firms, forming Key risks identified in banks’
part of the ESG sourcebook. It will mean that all
FCA-regulated firms have to ensure the naming and climate change disclosures
marketing of financial products is clear, fair and not Many banks already produce a non-financial report
misleading, and consistent with the sustainability profile covering ESG matters, including climate change, and
of the product or service. For further information, see disclose in line with the recommendations of the TCFD
Practice note, Hot topics: proposed FCA sustainability (see Amendments to Listing Rules for TCFD disclosure).

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 Climate change and the banking industry

In line with TCFD guidance, risks are generally operational continuity by damaging offices and data
categorised as either: centres. Banks may also suffer reputational harm if
their clients and customers perceive them to have
• Transition risks (see Transition risks below).
mismanaged physical risks or if they fail to provide
• Physical risks (see Physical risks below). adequate support to communities and customers
• Connected risks (see Connected risks below). affected by extreme weather events.

For more information on non-financial reporting and Banks may also be vulnerable to fluctuations in
climate risks, see Practice note, Narrative reporting: commodity and other asset prices caused by extreme
climate-related and environmental disclosures in annual weather events. If customers’ income or profitability is
company reports: overview and Climate change toolkit: reduced, banks will be exposed to a greater risk of credit
Summary of risks. losses. Further, rising sea levels and increased flood
risk or increasing forest fires could increase the risk of
customer default. In particular, the cost of damage to
Transition risks residential or commercial property may leave borrowers
Transition risks identified in TCFD reports include policy, unable to meet mortgage payments.
regulatory and legal changes initiated as a response
to climate change, as well as technology shifts and Connected risks
changing market demand. Specific examples include:
Connected risks are second-order risks arising
• Rapid policy or regulatory changes, for example in from transition or physical risks. Examples include
relation to carbon taxes, which could lead to the recessionary pressures and reputational risk if a bank’s
increased credit risk of clients and counterparties. clients include those that have the potential to cause or
• Credit risk in sectors particularly vulnerable to climate contribute to significant adverse impacts on the climate.
change (for example, aviation, oil and gas), where In modelling these risks, banks use different quantitative
clients or counterparties may fail to fully honour their
and qualitative methodologies to calculate a
obligations to the bank (see Sector note, Climate
counterparty credit risk that incorporates data from
change and the oil & gas industry).
physical, transition and connected-risk scorecards. For
• Market risk resulting from changes in market conditions example, banks assess their counterparty’s reliance on
adversely impacting the value of assets or liabilities non-green energy, or their strategy to protect physical
(including “green swans” or sudden market shifts). assets from future physical risks, as well as transition
• An increased risk of potential climate-related initiatives for a more sustainable operating model. The
litigation, including in relation to stranded assets, main issue is the lack of reliable and objective data that
acute climate events or resulting market price would enable comparisons between counterparties.
declines. This type of risk (liability risk) is often In the PRA’s Dear CEO letter of October 2022, it noted
categorised as a stand-alone category of risk, along that, in general, banks did not have a complete picture
with transition, connected and physical risks, see
of counterparties’ exposures or transition plans and had
Climate-related activism and litigation in the
faced challenges in procuring this information. It noted
banking industry below.
that some banks were developing their counterparty
engagement processes to collect this data. See PRA:
Physical risks Dear CEO Letter (21 October 2022).
Physical risks identified in TCFD reports include risks
from extreme weather events (classified as acute
physical risks) and longer-term shifts in climate
The industry’s reaction to climate
patterns, such as sustained higher temperatures or change and emerging trends
sea-level rise (termed chronic physical risks). The banking industry’s response to climate change and
Such events or patterns could affect supply and emerging trends in the industry include:
demand, which could impact on market prices in • The climate goals and commitments being made
susceptible sectors or countries, resulting in market by industry participants (see Climate goals and
risk. In particular, extreme weather events may present commitments below).
operational issues relating to property owned by the
bank and ongoing business continuity. • The increase in sustainability-linked products being
offered by industry participants (see Increase in
For example, extreme weather events pose a risk sustainable finance products being offered by
to banks’ infrastructure and could jeopardise their industry participants below).

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 Climate change and the banking industry

• Industry groups and reports (see Industry groups and longer finance development of new oil and gas fields
reports below). (11 May 2023)).

Climate goals and commitments Green investment strategies

Banks are committing to a growing number and variety In addition to restricting investments in fossil fuel
of climate-related goals and metrics. These include projects, many banks are actively directing their
measures to reduce their environmental impact through investment strategies to greener products and
net zero carbon commitments, reducing or stopping industries. In particular, investment is being channelled
funding of fossil fuel projects and directing investment into renewable energy and low-carbon vehicles, as well
to more environmentally friendly products and sectors. as to enable clients to make the low-carbon transition.
For example, in 2020 HSBC announced that, over the
next decade, it aims to provide between $750 billion
Net zero carbon emissions
and $1 trillion of financing and investment to assist in
In line with the UK’s 2050 net zero target, many the transition to lower-carbon emissions (see reuters.
UK-based banks have made commitments to become com: HSBC targets net zero emissions by 2050,
net zero (including in relation to their emissions earmarks $1 trillion green financing (9 October 2020)).
financed or “scope 3 emissions”) by 2050 or sooner.
Some UK-based banks are members of the Net Zero Increase in sustainable finance products
Banking Alliance (NZBA), which is a UN-convened being offered by industry participants
but industry-led alliance representing over 40% of
global banking assets, which have committed to align In recent years there has been huge growth in the
their lending and investment portfolios with net zero market for green and sustainable financing products.
emissions by 2050. Market participants have sought to demonstrate their
commitment and ambition to a more sustainable future,
In April 2021, the Glasgow Financial Alliance for Net by utilising an existing financing need to firstly support
Zero (GFANZ) was launched, bringing together existing and complement wider environmental strategies,
net zero finance initiatives (including the NZBA, which including climate change mitigation, and secondly to
is the banking element of GFANZ) into one forum and help drive behaviours.
working to accelerate the financial sector’s progress
towards net zero. Signatory companies are required to Banks have a key role to play in steering capital towards
show credible plans for reducing investment in high- sustainable economic activity, through lending,
carbon assets (see Practice note, Climate change and structuring, underwriting, intermediating, purchasing
sustainability work by international financial services and trading sustainable finance products such as:
authorities: tracker: Glasgow Financial Alliance for Net • Equity in corporates that meet environmental, social
Zero (GFANZ)). or governance sustainability criteria (such as FedEx
Many banks have also signed the Paris Pledge for that has set a goal of operating an all-electric, zero-
emission global pickup and delivery fleet by 2040)
Action, which allowed businesses to demonstrate their
or are ranked in sustainability indices such as the
commitment to the objectives of the 2015 Paris Climate
FTSE4Good.
Agreement.
• Green, social and sustainable bonds (GSS bonds).
Reduction in fossil fuel investing • Green and social loans (GS loans).
Some banks are beginning to take action to reduce,
• Sustainability-linked bonds (SLBs).
or entirely halt, their investment in carbon-intense or
ecologically damaging fossil fuel projects, often as • Sustainability-linked loans (SLLs).
a result of growing public pressure. For example, in
• Sustainable commercial paper.
December 2022, HSBC announced it would stop funding
new oil and gas fields that received final approval after • Green securitisation.
the end of 2021 and would expect more information • Green asset-backed financing.
from energy customers over their plans to cut emissions
(see reuters.com: HSBC to stop funding new oil and gas • Green project financing.
fields as part of policy overhaul (14 December 2022)). • Related ESG-linked derivatives.
In 2023, BNP Paribas also announced it will no longer
provide dedicated financing for the development of new Banks are also using a range of green and sustainable
oil and gas fields (see reuters.com: BNP Paribas: will no finance products to finance their lending portfolios.

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 Climate change and the banking industry

Green financial products This development may help to further energise climate
GSS bonds and GS loans are the most mature sustainable change mitigation efforts by green bond issuers that have
finance products. They are often referred to as “use a sufficient volume of climate change mitigation projects
of proceeds” financing as they require net proceeds to fund, and banks may notice interest in the green
to be used for specific green or sustainability projects bond asset class by issuers that are keen to demonstrate
(such as projects related to climate change mitigation), compliance with this new “gold standard”. For further
with associated ongoing tracking of funds and related information on the development of the EU GBS, see
reporting. This means that borrowers need to have a European Commission: EU Green Bond Standard and EU
sufficient volume of green or sustainability projects to be green bond standard (EU GBS): legislation tracker.
able to use the net proceeds of the bond or loan. See also Practice notes,
By way of example, the European Investment Bank • Green, social and sustainability bonds.
(EIB) has issued several climate awareness bonds,
• Green loans.
with net proceeds earmarked for projects contributing
to climate action in the renewable energy sector • Social loans.
(such as wind, hydro, solar and geothermal energy
• Green loans: what an in-house bank lawyer should
production targets) and the energy efficiency sector
know.
(such as building insulation and energy loss reduction
in transmission and distribution projects), as well • Green loans: checklist.
as projects related to research, development and
deployment of innovative low-carbon technologies. See Sustainability-linked finance
EIB: Climate awareness bonds. Banks have also helped to develop sustainability-
While the green bond asset class consists largely of linked finance products, which corporate borrowers
senior green bonds, this asset class has expanded with are increasingly turning towards to finance their
innovations such as green hybrid bonds and green sustainability strategy. SLBs and SLLs are highly flexible
convertible bonds. The market for “use of proceeds” financing products, as the proceeds may be used for
asset-backed or securitised bonds remains small, mainly general corporate or other specified purposes. The use
due to a lack of green underlying assets, but there are of proceeds is not restricted to specific projects (unlike
a few examples of such bonds where recourse is to a GSS bonds and GS loans) and there is no need for
group of climate-related projects such as solar leases or ongoing tracking of proceeds.
to mortgages that finance energy efficient homes. There SLBs and SLLs are forward-looking performance-based
are also examples of project bonds where proceeds are instruments that involve both:
ring-fenced for specific green projects, such as wind
farms, which can aid climate change mitigation efforts by • The selection of key performance indicators (KPIs),
which are predefined, quantifiable metrics used to
plugging the investment gap in greener infrastructure.
measure the performance of selected indicators.
A number of banks and other market participants
• The calibration of sustainability performance targets
helped to formulate the voluntary principles set out in
(SPTs), which are ambitious (beyond business-as-
the Green Bond Principles and the Green Loan Principles
usual) and measurable improvements in KPIs that a
in connection with GSS bonds and GS loans and are borrower commits to over a predefined timeline.
encouraging their use in connection with green bond
and loan issuance. While the Green Bond Principles The KPIs and SPTs are aligned to a borrower’s
are the main principles guiding the green bond market, sustainability goals, which allows them to be individually
there are other industry guidelines that may also tailored. While the regulator’s approach suggests that
be relevant, including the Climate Bonds Initiative’s banks may need to play an important role in attaching
climate bonds standard and certification scheme. See ambitious but appropriate environmental targets to
Climate Bonds Initiative: Climate bonds standard and SLBs and SLLs, considerations such as competing
certification scheme. offerings on the market and alignment with customers
need to be taken into account. Many borrowers have set
From a regulatory perspective, in July 2021 the targets to reduce the GHG or carbon emissions of their
European Commission published a proposal for the own operations. Some borrowers have gone further by
creation of an EU Green Bond Standard (EU GBS). committing to decrease such emissions in their supply
The EU GBS is intended to be a new voluntary “gold chains too. KPIs could also cover increased use of
standard” for green bonds with a common framework of renewable energy sources, energy efficiency of buildings,
rules, intended to help finance sustainable investment water usage and waste or recycling targets. A structuring
while addressing concerns around greenwashing.

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 Climate change and the banking industry

mechanism such as a coupon step-up mechanic is built executed to date, primarily where the climate action
into the terms of the SLB or SLL and this acts as an element has been embedded in an interest rate swap.
incentive for an issuer to meet its SPTs or otherwise face Often the associated financing has included a climate
the prospect of higher interest payments to investors. action element or has been for a business focused on
In the SLL market, it is fairly typical to see a two-way clean energy. For further details of these transactions
margin ratchet, with a coupon step-down mechanism and also the wider role of OTC derivatives in sustainable
that kicks in if a borrower meets its SPTs, as well as a finance, see ISDA: Overview of ESG-related derivatives
coupon step-up mechanism that applies if a borrower products and transactions and ISDA: Sustainability-
fails to meet its SPTs. linked derivatives: Where to begin?.
A number of banks helped to formulate the voluntary For further information on green finance generally, see
principles set out in the Sustainability-Linked Bond Environmental, social and governance (ESG) for finance
Principles and the Sustainability-Linked Loan Principles lawyers toolkit (UK).
and are encouraging their use by bond and loan market
participants. Climate-related activism and litigation
See also Practice note, Sustainability linked loans. in the banking industry
Over the past few years there has been an increase
Transition finance in climate activism directed at the banking industry.
Some banks have indicated that they intend to help Shareholders of listed UK-based banks have increasingly
clients in carbon-intensive sectors (such as oil, gas proposed climate-related resolutions (see Practice
and aviation) to progressively transition towards a note, Resolutions on climate change at annual general
low-carbon emission future. The International Capital meetings of FTSE 350 companies). Environmental
Market Association’s (ICMA’s) Climate Transition NGOs have run campaigns lobbying for banks to
Finance Handbook provides guidance and establishes reduce financing of fossil fuel companies and specific
common expectations for capital markets participants projects which contribute to climate change, as well
on the practices, actions and disclosures to be made as campaigns criticising the climate commitments
available when raising funds in bond markets for and goals that banks have made. There has also been
climate transition-related purposes. See Legal update, pressure from large institutional investors to focus on
Climate Transition Finance Handbook and Q&A. The climate change risks. In September 2021, ShareAction, a
Loan Market Association is also exploring the concept UK charity focused on responsible investment, published
of transition finance and how existing sustainability analysis of the climate and biodiversity practices of
frameworks can be amended to financially support a Europe’s largest banks, concluding that the industry still
company’s transition in the loans market. has much progress to make to address climate risks and
recommending strategies for investors to engage with
Sustainability-linked derivatives banks to facilitate progress. Since then, ShareAction has
Derivatives markets can also play an essential role in continued its focus on the financial sector. For example,
facilitating the transition to a sustainable economy. in February 2022, ShareAction published a further
As well as offering rate and FX hedging solutions for report criticising continued bank funding of oil and gas
sustainable finance products and offering lenders expansion, and, in February 2023, ShareAction reported
liquidity and risk solutions for such products, the market that it coordinated letters from 30 investors to Europe’s
has also started to see OTC derivatives contracts for top banks urging them to stop the direct financing of
interest rate or FX products with a specific climate action new oil and gas fields by the end of 2023.
overlay. The terms of these contracts include a specific In April 2021, the NGO ClientEarth issued proceedings
incentive to hit pre-defined climate action targets (such in the Belgian courts against the Belgian National Bank
as increased use of renewable energy sources, reduction (BNB) on the basis that the bank breached environmental
in GHG emissions or achieving a target ESG score). As and human rights laws when implementing the
with SLB and SLL financing products, this could involve Corporate Sector Purchase Programme set up by the
an adjustment to the cashflows if a particular KPI is met European Central Bank (ECB) and purchasing assets
or missed (for example, an adjustment to the spread or under it. ClientEarth alleged that the BNB’s asset
the payment of a premium or rebate) or an agreement purchases effectively direct capital into sectors which fuel
that the counterparty (such as a bank) will contribute to the climate crisis. It asked the Belgian courts to refer the
an environmental project if the obligated party hits or question of whether the ECB’s decision to establish the
misses that target. The KPIs are highly customisable and purchase programme in 2016 was valid to the European
can apply to either one or both counterparties. A small Court of Justice, and to make orders halting the BNB from
but growing number of these transactions have been

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 Climate change and the banking industry

making purchases under the programme (see Westlaw (CFRF) and Practice note, Climate-related disclosures
Edge UK: ClientEarth launches climate-based legal and ESG: FCA requirements and expectations: Role of
challenge against Belgian National Bank (14 April 2021)). Climate Financial Risk Forum).
ClientEarth’s claims were rejected at first instance and it
Internationally, the BoE is a founding member of the
appealed the decision. In November 2022, ClientEarth
Network of Central Banks and Supervisors for Greening
withdrew its case following the ECB’s announcement
the Financial System (NGFS) established at the Paris
in September 2022 of reforms to decarbonise its bond
“One Planet Summit” in December 2017. There are
buying programme. This is a good example of the
now over 120 members across the world. The NGFS
strategic objectives that claimants in climate litigation
aims to assist the financial system in providing funding
are seeking to achieve (see ECB: ECB provides details on
to low-carbon investments in line with a policy of
how it aims to decarbonise its corporate bond holdings
sustainable investment and promotes best practice as
(19 September 2022)).
well as conducting and commissioning analytical work
In February 2023, ClientEarth issued an application for on green finance.
judicial review against the FCA in the UK, arguing that
While not an industry group, it is also worth mentioning
its approval of the prospectus of an energy company was
that the UN’s Expert Group on the Net Zero Emissions
unlawful as the energy company had not made sufficient
Commitments of Non-State Entities has published a report
risk disclosures about climate change to comply with
providing guidance to businesses, financial institutions,
the Listing Rules or to fully inform investors (see Legal
cities and regions on making net-zero pledges. See Legal
update, ClientEarth seeks High Court permission for
update, UN publishes recommendations for net zero
judicial review of FCA over fossil fuel company’s climate
commitments by businesses, cities and regions.
risk disclosures in oil and gas company prospectus).
In February 2023, NGOs also brought an action
against BNP Paribas in France under the French Duty Climate change and the operation
of Vigilance law, focusing on its support of fossil fuel
projects and clients.
of the industry
The increasing focus by the industry on climate change
There have also been complaints brought against ING
is creating (and will continue to create for some time)
Bank in the Netherlands under the OECD Guidelines in
a number of complex issues for banks to consider,
relation to climate change-related matters, and some
including:
cases brought against banks in Australia relating to
non-disclosure of climate-related risk, which have all • The types of clients and projects a bank supports.
settled before trial.
• Whether a bank’s subsidiaries and companies in its
For more information, see Environmental, social and supply chain have climate change policies that are
governance (ESG) litigation risk for lenders. comparable to the bank’s own policies in relation
to climate change. (For information on parent
company liability for the environmental impacts
Industry groups and reports of their subsidiaries’ operations, see Practice note,
The most notable national industry group in relation Environmental law: overview: Parent company liability
to climate change is the Climate Financial Risk Forum for environmental damage.)
(CFRF), which is jointly convened by the PRA and • How climate change affects the bank’s hedging and
the FCA in order to advance the banking industry’s investment decisions over time.
responses to the financial risks posed by climate change.
Since June 2020, the CFRF has published a number • How climate change affects the pricing of the risks of
of guides to help the financial industry approach and investing in commodities and shares, particularly of
address climate-related financial risks. The guides companies who are seen to be contributing to climate
provide industry views on best practice associated with change.
risk management, scenario analysis, disclosures and • The impact of climate risk on banks’ own financial
innovation (see FCA: Climate Financial Risk Forum positions.

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