Making Climate Pledges Stick

Corporate climate pledges are on the rise. According to a recent survey from Accenture, there has been a 25% rise in the proportion of major, global companies that have committed to net zero target since December 21 (from 27% to 34%). Corporate climate pledges are statements by which a corporation commits itself to reducing its emissions or achieving net zero by a particular date. Commitment periods range from 2030 to 2050.  The need to involve corporations in the global climate effort was made clear in the Paris Agreement, which has explicitly incorporated the private sector in its governance framework (see the Global Climate Action Portal). The 2022 UNEP Emissions Gap report has highlighted the insufficiency of government climate mitigation actions, noting that ‘[p]olicies currently in place with no additional action are projected to result in global warming of 2.8°C over the twenty-first century. Implementation of unconditional and conditional NDC [nationally determined contributions] scenarios reduce this to 2.6°C and 2.4°C respectively.’ The policy conclusions are clear: ‘broad-based economy-wide transformations are required to avoid closing the window of opportunity to limit global warming to well below 2°C, preferably 1.5°C.’

While the increase in the number of corporations that are issuing climate pledges is encouraging, there are also widespread concerns about their credibility. Critics have warned that corporations may be using climate pledges as a new form of greenwash, carbonwash or climatewash. Under current law, corporations are unlikely to be penalized if they fail to comply with their future climate commitments. This regulatory gap allows firms to reap reputational benefits even if they are not truly committed to taking costly mitigation actions in the future. In our recent paper, which is forthcoming in Ecology Law Quarterly (Making Climate Pledges Stick: A Private Ordering Mechanism for Climate Commitments) we propose two new financial instruments that address the credibility problem of climate pledges.

Before describing our proposal, we would like to say a bit more about this regulatory gap. Recent regulatory developments have increased the pressure on corporations to step up their climate actions. Thus, for example, the EU has introduced stricter climate legislation, which imposes new obligations on corporations (eg, the European Climate Law, the Emissions Trading System (ETS) Directive, the Directive on the Disclosure of Non-Financial and Diversity Information and the Directive on Empowering Consumers for the Green Transition).  In the US, the SEC has issued a proposed rule on Climate-Related Disclosures for Investors that, if finalized, will require disclosure of scope 1 and 2 emissions, as well as scope 3 emissions if they comprise a large share of total corporate emissions. The proposed rule would also require corporations to disclose information on future climate commitments, in which the registrant will need to specify how it intends to meet its climate targets. Even if the final rule is scaled back, it is likely to increase the pressure on corporate climate disclosures. However, neither EU nor US regulations will provide the means to ensure that corporations comply with their long-term pledges. 

Increasingly the oversight of climate pledges has moved into the hands of private governance initiatives, which provide a framework through which companies can submit their pledges. The major players in this area include the Science Based Targets initiative (SBTi), the Climate Pledge, the Pledge to Net Zero and the Climate Neutral Now scheme. In addition, the Race to Zero initiative provides meta-regulatory oversight for some of these schemes. These initiatives complement the existing global regulatory framework, but they are overall not sufficiently robust to compensate for the weaknesses of government regulatory systems.

Finally, consumer protection laws and exposure to tort liability provide some incentives for corporations to ensure the credibility of their climate pledges, but as with the other public and private governance frameworks, these incentives are weak when it comes to long-term climate commitments. Most of the greenwashing litigation in the US and Europe has focused on specific product or service claims. The aspirational and contingent nature of climate pledges complicates efforts to prove that a specific pledge constitutes strategic greenwashing. To succeed with such a claim, complainants typically need to demonstrate that the firm knew, when it issued the pledge, that it would not be able to fulfill its provisions. This is very hard to prove.

The current incomplete and ambiguous regulatory landscape creates a challenge for firms that are genuinely committed to fulfilling their pledges: how to distinguish themselves from greenwashers, given the ability of the latter to represent themselves as ‘true-greens’, by producing ‘false’ signals through the issuance of non-credible climate pledges. A possible solution to this communication dilemma lies in the idea of costly signaling which was developed (independently) by the biologist Amotz Zahavi and the economist Michael Spence. A credible costly signal is one that has a differential cost structure such that the costs of producing the signal are higher for an untruthful signaler than for an honest one. When the differential cost condition is satisfied, a separating equilibrium emerges that distinguishes the two types: in our case, between truly climate-committed firms and carbonwashers. We argue that the instruments we propose have these properties and can thus solve a significant lacuna in the current governance framework of climate pledges.

In the context of this short post, we can only provide a brief sketch of the two instruments. Interested readers are invited to read our paper for the complete description. Our instruments address the future enforcement problem by creating a compliance mechanism that will come into effect concurrently with the creation of the climate pledge and by establishing an entity that will be motivated and able to enforce the pledge. The core idea is simple: as part of the process of issuing a climate pledge the company will also create a non-revocable future commitment in which it obligates itself to purchase and retire carbon credits in the amount of the difference between its accumulated carbon reduction target and what it has achieved in practice. To ensure a significant contribution to the climate crisis, the target should be articulated in accumulated reduction units and not as a discrete measure (percentage reduction relative to base line) due to the importance of cumulative emissions. Although other authors have noted the problem of a potential gap between firms’ promises and actual performance, they have not developed concrete mechanisms through which corporations could credibly commit ex-ante to close the temporal commitment-performance gap. The contractual instruments we propose effectuate a binding carbon forward contract to solve this problem.  We propose two credible mechanisms through which this forward contract can be enforced years into the future.

The first instrument we propose is based on the concept of a letter of credit (which we call carbon letter of credit or CarbonLC). The basic idea is as follows: the corporation (the applicant) will sign a CarbonLC with an issuing bank, according to which the bank will commit to purchase at the end of the contract carbon credits in an amount equal to the difference between the pre-determined carbon reduction target and the actual accumulated emissions reductions achieved by the firm.  Another approach to creating a credible carbon future commitment is to incorporate the commitment into a specially designed green bond. We call this instrument a Climate Pledge Green Bond (CPGB). An irrevocable future commitment can be incorporated into a green bond in at least two ways. The first is to include a commitment to sign a CarbonLC as part of the bond’s covenants. A second option is to incorporate into the green bond a climate mitigation plan that includes a commitment to close the potential commitment-performance gap. Both the CarbonLC and the CPGB operate as a kind of insurance: they provide coverage for the risk that the pledging company will fail to deliver on its promise. To cover the risk of non-compliance, the pledging company will have to provide security for the issuing bank (in the case of CarbonLC) or the debtors (in the case of CPGB).

The instruments we propose facilitate the emergence of a separating equilibrium that can distinguish between truly sustainable firms from greenwashers, due to their differential cost structure. The cost of issuing a CarbonLC or a Climate Pledge Green Bond would be much higher for greenwashers than for sustainable firms, due to the higher risk of non-compliance of the former type of firms. Truly sustainable firms will be able to produce a more credible mitigation plan than greenwashers. Sustainable firms will be motivated to bear the costs associated with producing the costly signal both because it will allow them to reap reputational benefits and because it will provide them better access to green finance. It is in this context also that the linkage between the future commitment and project finance aspects of the two instruments becomes clearer. The financial institution behind the CarbonLC or the CPGB can link the coverage it provides to the firm’s future commitment and the dedicated climate funding it will provide to the firm. By reducing the risk of non-compliance, such linkage can allow the financial institution to charge lower fees and demand less collateral from the pledging firm, thus making our instruments financially viable. Figure 1 below elaborates on the contractual structure of CarbonLC.

Oren Perez is the head of Bar-Ilan University Multidisciplinary School for Environment and Sustainability and Professor of Law at BIU Faculty of Law.

Michael P. Vandenbergh is a Professor and David Daniels Allen Distinguished Chair in Law, Director, Climate Change Research Network, and Co-Director, Energy, Environment and Land Use Program at Vanderbilt University Law School.