January 11, 2022

Estimated reading time: 6 minutes

Are financial services about to face a carbon tax?

Individuals, businesses and households the world over have recently had to deal with a rise in energy costs. The impact hasn’t been easy to bear for many – forcing policy makers to defend their actions.

Yet, in a head-spinning twist, it’s exactly price-hikes like these which could rescue the planet and humanity. Particularly when they concern carbon emissions. In this article, we’re taking a deep dive into what the upcoming carbon taxes will mean for finance, as well as how banks and FinTechs can ready themselves for a rocky future.

Conquering the climate crisis with a carbon tax

There are two main ways governments impose a carbon tax. The first is quite simple. It’s a straight-up tax per tonne of greenhouse gas emitted into the atmosphere. Finland was the very first to adopt this system, some 30+ years ago in 1990. Then, there’s the market-style set-up, which is growing more commonplace, known as an Emissions Trading Scheme (ETS). In this mandatory market, large corporations must buy their carbon allowances. If they under-emit, they can sell their leftover credits for profit. This gives sustainable firms an extra financial boost, to the detriment of their carbon-emitting counterparts.

Over the past years, both taxation systems have been ramping-up. All around the world, governments are imposing carbon taxes and ETSs with increasing urgency. Today, more than 60 international, national, and regional regimes are going strong. But at the time of writing, hardly any of them have any meaningful effect on the climate. Largely because the carbon tax is dwindling below an underwhelming $20 per tonne of carbon on average, not enough of an incentive for corporations to up-end their business models.

For most companies – especially giant corporations – emitting greenhouse gases has largely been considered “free” or a “negative externality”. So, industries such as energy, manufacturing, construction, fashion and even finance have over-emitted carbon and under-invested in sustainable alternatives for decades. But that could all be about to change, as governments fight fire with fire… Or in this case, profit with profit. Linking profitability with carbon is about to go mainstream.

Carbon will get expensive… for everyone

For the system to work, carbon emissions need to get expensive. They need to be costly enough to persuade corporations and their shareholders to make sustainable changes. Without wanting to rock the boat too much, governments have been gently warning about increasing carbon taxes for years. And now, it’s finally starting to get serious.

The Canadian government, for example, announced that its carbon tax rate will shoot up to US$135 dollars per tonne by 2030. And the super committed Norwegian government will increase its tariff nearly three-fold, pushing the cost upwards of $260 per tonne.

This will have knock-on effects. Hardest hit will be the dirty energy sector. In the US, a rather unambitious tariff of just $25 per tonne –the lower end of the carbon tax scale – would increase fuel costs by nearly 12%. A significant burden to add to the economy, especially if we’re to expect more pandemics, recessions, and natural disasters over the coming years. For finance, insurance, real estate, and rental, costs would swell by a lower but still noteworthy 0.4%.

If the cost of carbon goes up beyond $25 – in line with governmental pledges – the profitability of large-scale emitters will be severely impacted. And most likely, the brunt of this cost will need to be borne by the customer. Take heavy-hitting energy supplier Exxon Mobil for example. If the corporation was required to pay $100 per tonne of carbon for Scopes 1 and 2 emissions (those which they cause directly), that’s an additional $9.2 billion each year they must fork out. This would kick shareholders right where it hurts – in the wallet. Or it would mean the customers must shoulder an extra 20 cents per barrel of fuel. If Exxon Mobil needed to pay for Scope 3 emissions (those which they caused indirectly, such as from car fumes), customers would have to pay an extra $1.35 per barrel. Which is a moot point, because according to the researchers, a Scope 3 tax would bankrupt Exxon Mobil… not to mention it’s shareholders.

How will financial services be affected by a carbon tax?

Carbon taxes – a necessary tool to create a greener economy – will certainly affect financial services. For decades, financial services have poured money into oil investments. Since the Paris Agreement, the top 50 banks have poured $3.085 trillion into dirty energy investments. For context, the GDP of the entire UK was $2.7 trillion in 2020. Oil has played a huge part in UK institutional investing, where some years ago every £1 in £7 withdrawn by a pensioner came from British Petroleum.

As such fervent investors, traditional finance will inevitably be smacked hard with these new “greenflation” measures. Only those banks or FinTechs who ditched the dirty fuels and invested heavily in renewables early enough may come out unscathed.

But it’s not just brown energy investments that will feel the green pinch. In July 2021, the EU proposed expanding its world-leading ETS carbon market to buildings and road transport too. And from there, it wouldn’t be surprising if the likes of manufacturing, fast fashion and more joined the ranks of the carbon-taxed. Norway, for example, is extending it’s carbon charge scheme to waste and agriculture.

When it comes to green initiatives, where the EU leads, the wider world tends to follow. For the foreseeable future, the direction of travel seems to be pointing towards more widespread emissions taxing. Alongside increased climate scrutiny for financial services, the Sustainable Taxonomy and other regulations are also stamping down on bank-wide greenwashing.

The way that financial services will be impacted may be surprisingly similar to the effects felt during the COVID-19 pandemic. In that, a carbon tax could speed up the inevitable. As the lockdown accelerated digital transformation, green tariffs may fast-track soon-to-be stranded assets, such as oil.

Mitigate the the damage by staying ahead of upcoming regulations

If “green” becomes the new “cheap”, financial services will certainly get a shock. No longer will they be able to rely on the tried-and-tested global corporations for returns. And they may find that consumers turn their back on previously favourited brands which turn out – in a double whammy – to be bad for the planet and more expensive.

But this doesn’t mean there aren’t new opportunities. Far from it. Financial services are on the cusp of a new era of sustainable innovation and possibility. There are incredible projects to unlock which can open the door to a universe of potential. Staying two steps ahead of upcoming regulations will be crucial for FinTechs and financial services to surge beyond the competition and claim their place as an industry leader. Meaningful products and innovative strategies must start with climate regulation forecasting.

To ensure you don’t get left behind in the (carbon) dust, incorporate climate regulation planning into your strategy. While others are left grappling from a predictable tax, you could be in the glow of a unique economic opportunity.