Background and summary:

At COP 26 in Glasgow in 2021, Germany signed a pledge to end international finance of fossil fuels by the end of 2022, except in limited and clearly defined circumstances that are consistent with a 1.5°C warming limit and the goals of the Paris Agreement. Under the 2022 German Presidency, G7 leaders’ communiqué echoed the spirit of the Glasgow commitment. While the communiqué recognizes the exceptional circumstances stemming from the Russian invasion of Ukraine, it stresses that any temporary publicly supported investment must still be “consistent with our climate objectives and without creating lock-in effects”.

The KfW Banking Group is Germany’s main public investment and development bank and therefore falls within the scope of Germany’s Glasgow and G7 commitments. A leaked KfW Banking Group document “Paris compatible sectoral guidelines”, dated 01.09.2021, purports to lay out how the KfW Banking Group intends to steer its oil and gas sector financing towards “Paris compatibility”. The document includes a number of weaknesses in the approach and includes a large number of exceptions.  A particularly notable point is the provision to pause its efforts to meet the goals of the Paris Agreement where it explicitly says it can fund projects that are not compatible with the Paris Agreement (page 13 of the guidelines) and a general lack of consideration of the Paris alignment of counterparties.

We conclude in this assessment that these sector guidelines are not compatible with the goal and requirements of the Paris Agreement. The sector guidelines are further not consistent with the political declaration made under German 2022 G7 Presidency. Indeed implementation of these guidelines in their current form would seriously undermine the KfW’s climate efforts, undermine Germany’s commitment under the Glasgow statement, and more broadly undermine Germany’s leadership.

The KfW never made the document publicly available and it was not subject to a public consultation. The opaque process is a clear departure from common practice in public banks (multilateral, bilateral, and national) which is otherwise much more transparent and deprives the KfW of relevant external input from its stakeholders.

The following are specific points where the KfW’s proposal is particularly problematic. Generally, the KfW could vastly improve its guidance to bring it closer to alignment with the Paris Agreement by fundamentally and transparently revising its approach to ensure that every single new commitment is Paris aligned. Notably, this means a drastic reduction in fossil fuel related financing commitments, which should be subject to strict limitations according to general principles that demonstrate that there are no potential zero-carbon alternatives, that they are compatible with scenarios for 1.5°C that minimize overshoot and negative emissions, they avoid fossil-fuel lock-in, and not lead to asset stranding in a rapid decarbonization scenario. A counterparty approach should be developed for companies and financial intermediaries based on their overall climate commitments and an assessment of the extent to which such finance may undermine climate objectives. Notably, lower fossil fuel funding in one year should not justify increased fossil fuel funding thereafter.

Excessively wide-ranging provisions that enable fossil fuel financing in the name of “Energy Independence” (pages 12-13).

• The guidelines provide for a complete suspension of the “1.5°C” guidance for two years until 14.09.2024 – including projects that the KfW explicitly sees as not 1.5°C compatible. This is especially problematic because it means the KfW will postpone any leadership role for two years in the “critical decade” of climate action and the guidelines make no reference to the energy security benefits of shifting away from fossil fuel dependence or how it will promote these measures.
• The exemption language makes multiple references to wanting to have a long-term impact on gas supplies, beyond the period for which the exceptions are foreseen. These include LNG terminals with “long-term” delivery contracts to Europe, LNG tankers with “long-term, in other words for (sub-)charter contracts lasting at least five years”. No mention is made of the lock-in risk of this infrastructure or any consideration of the future expected demand in a decarbonizing Germany or Europe or that this could lead to asset stranding.

A faulty “volume” / budget approach for KfW IPEX (page 8):  

• The sector lending guidelines takes a volume / budget approach, that implicitly assumes that KfW IPEX, the international project and export branch of the bank, has a right to continue to fund a declining share of global fossil fuels investments, expressed in millions of Euros.
• The approach is highly questionable and suggests a lack of understanding of the relation of the KfW IPEX‘s investments and capital expenditure, high-emitting capital stock accumulation which is likely to lock-in continued emissions for decades, and cumulative GHG concentrations in the atmosphere.
• Of particular concern is that this sector guidelines do not foresee a complete phaseout of fossil fuel finance even in 2050. Indeed, it specifically foresees significant continued KfW IPEX fossil fuel financing far into the future (see table). This is in direct contradiction to the findings of the IPCC and the IEA.

• The rate of decline in volume of finance is steeper between 2040 and 2050 than up until 2040, putting off climate efforts to the distant future and ignoring the steeper rate of emissions reductions required during this “critical decade”. 
• Fossil fuel financing made under the “Energy Security” exception period until 14 September 2024 are not reduced from the overall funding volumes that KfW proposes to allow for itself.
• Although the KfW claims that its guidance is to bring its financing in line with 1.5°C, it is not clear what assumptions are taken or which scenario this is based on. The document does not make reference to IPCC or IEA 1.5°C scenarios except for a footnote 10 on page 4, which mentions that electrical storage batteries are important to balance electric grids and implies that the KfW’s interpretation of the IEA Net Zero Scenario underlies its guidance.
• Of further concern, the financing volume levels are semi-cumulative: the guidance explicitly says that if fossil fuel finance is lower than a certain threshold in one year, the remainder for that year can be financed over the next two years. This leads to a zero sum, where any reduction of fossil investments in one year may not lead to an overall reduction over and above the KfW’s overall claimed share. Each investment should be critically considered regardless of the volume of fossil fuel finance in previous (or future) years.

Lack of consideration of counterparty alignment, in particular with regard to trade finance, corporate finance, and intermediated finance

• The guidance makes multiple references to corporate finance and the extent to which it applies to such finance or not. It abstains from any consideration of the climate objectives of counterparties – or the lack thereof. No consideration is made of the overall potential impact of “green" project finance on the overall cost of capital of a company and if a specific financial commitment may indirectly subsidize investments not in line with 1.5°C.
• The guidance specifically does not cover corporate finance for electricity utilities, regardless of their capex planning and whether that is primarily in coal or other areas that might otherwise be on an exclusion list. Therefore, although the KfW would not invest in various kinds of power production, it could finance the exact same activities if it was through a company where the exact use of funds is not defined in the financing agreement (Page 4).
• The guidance specifically does not cover finance for which the end use of the finance is not known, and specifically does not apply to finance flowing through intermediaries where the end use of the finance is not known (page 4).
• In footnote 28 on page 9 referring to general corporate finance in industrialized countries after 2045, a distinction is made between two categories of companies: companies with a turnover ≥ 50% in oil and gas and companies with ≥ 50% in other areas aside from oil and gas. First, it is not clear if a company with exactly 50% turnover in oil and gas is covered by the guidance, as the statement is contradictory. Second it is clear that financing a company with even anything close to 50% in turnover anywhere close to 2045 is clearly not 1.5°C or Paris aligned.

Exclusion list insufficient and includes multiple loopholes

• The guidelines lay out a number of investments which are excluded from KfW Banking Group finance which primarily focus on up and some midstream oil and gas project types. While the exclusion list makes sense, the KfW should explicitly exclude more mid- and downstream activities from their financing eligibility, especially where technologically mature clean alternatives exist taking careful consideration of what can be considered consistent with sectoral decarbonization pathways, and avoid carbon lock-in, and stranded asset risk. The KfW could use best practice among public banks as a basis for discussion for a revised exclusion list, notably policies of the European Investment Bank (EIB) or the Agence française de développement (AFD). The proposed KfW guidelines further include multiple explicit exceptions which significantly weaken the guidance and it is not clear to what extent the exclusion list will lead to a reduction in overall finance flowing towards fossil fuels.
• The document mentions a number of oil and gas project types which are eligible for KfW financing subject to limitations (page 6-7). The details of any such limitations is not clear, though reference is made to other guidance chapters which were not included in the leak (page 8).

Broad exception to application of any restriction in cases of reputational risk

• The guidelines allow the KfW to finance projects where the bank perceives that their cancellation could result in reputational risk to the bank (further guidance expected in 2023). Although further guidance is foreseen, such reputational risk is vague, and there is no mention with regard to reputational risk of continuing to finance fossil fuels and undermining the Paris Agreement.

Arbitrary and oversimplistic distinction between industrialized countries and developing countries and emerging economies (pages 9-10)

• The guidance foresees phased limitations for various fossil fuel finance, which are marginally stricter for industrialized countries than for developing countries and emerging economies. This categorization ignores the actual development status of countries, the extent to which KfW finance may undermine the climate objectives of developing countries including their Nationally Determined Contributions or Long-Term Strategies. Further, no mention is made about opportunities to support countries to leapfrog towards clean energy alternatives or support them in a transition away from fossil fuel dependence. This approach is likely to lead to dangerous fossil fuel lock-in – especially in countries on the DAC list or runs the danger of counterparties in developing countries going further into debt in future stranded assets.

Overly optimistic approach to “sustainable biomass”

• The proposed biomass sustainability requirements are not sufficient, and the categorization of biomass is problematic for several reasons and includes multiple loopholes, for example that biomass power plants smaller than or equal to 20 MW need no sustainability certification.
• Further, power plants that claim to use biomass consisting of byproducts or waste products which do not have any other use are eligible for finance without any certification for example saw dust or rice husks, although it is not clear if any checks will be made on such claims.
• Further, the guidance allows for financing when the companies supplying the biomass comply with environmental and social standards such as those of the IFC and these standards apply to their supply chains. Although the IFC Environmental and Social Sustainability Performance Standards include a standard on biodiversity and sustainable management of living natural resources, these are not specifically aimed to the Paris aligned certification of biomass or its supply chain. Biomass is considered certified if 50% of the origin area is certified, although an action plan should be established for areas not covered by certification.

Recommendations:

To bring its lending activity into line with the Paris Agreement, the Glasgow Statement, and Germany’s 2022 G7 political commitments, the KfW should:

1. Revise the approach to ensure every new commitment is Paris aligned, considering global, sectoral and national decarbonisation pathways as well as transition and lock in risks.
2. Develop a robust counterparty approach based on their climate commitments and an assessment of the counterparties ability and progress to implement its commitments.
3. Expand exclusion lists for project finance to cover more mid- and downstream activities, using best practices from other public development banks like the European Investment Bank (EIB) or the Agence française de développement (AFD) as a starting point.
4. Reconsider the distinction between industrialized countries and developing countries/emerging economies, taking into account development status, climate objectives, and clean energy opportunities.

Overall, the KfW Banking Group's guidelines should undergo a fundamental and transparent revision to align with the Paris Agreement and ensure Germany's commitment to climate leadership.