A Climate-Friendly Financial System
There is no doubt that avoiding the worst effects of climate change will require action on an unprecedented scale – starting immediately. That action must include governments worldwide doing what it takes to ensure that both public and private financial flows support the climate agenda.
BEIJING/FRANKFURT – The climate conference now underway in Katowice, Poland, has been billed as the most consequential since the 2015 summit, which produced the Paris climate agreement. Amid unprecedented public concern over the threat posed by climate change – fueled by an alarming recent report by the United Nations Intergovernmental Panel on Climate Change (IPCC), not to mention devastating natural disasters around the world – negotiators are seeking to establish a set of rules for meeting the Paris commitments. But, as is so often the case, success will depend on finance.
The world’s advanced economies have made major financial commitments in previous climate negotiations. Yet it is far from certain that they will fulfill their promises, beginning with the provision of $100 billion annually to developing countries by 2020. According to the UN Framework Convention on Climate Change’s Standing Committee on Finance (SCF), public finance from developed to developing countries to support climate-change mitigation and adaptation amounted to $57 billion in 2016. When taking account of private finance mobilized by public support, flows reached over $70 billion in 2016.
However, that is a small fraction of the $2.4 trillion that the world needs to invest in clean energy every year between now and 2035 to keep global temperatures within 1.5°C of pre-industrial levels, as calculated by the IPCC. Whether rich countries honor climate financing commitments made in previous negotiations, and the degree to which developing countries can accept flexibility in how financial flows are measured, will be key to advancing the climate talks at this critical time. But, above all, climate risk and consideration of long-term sustainability will need to be embedded in the world’s financial system – from banks, asset owners, and managers to insurance companies and the capital markets that facilitate financial actors’ transactions.
The good news is that the world is already moving in this direction, thanks partly to the Task Force on Climate-related Financial Disclosures, formed in 2015 by the Financial Stability Board and the G20 Sustainable Finance Study Group. Already, the task force has done much to encourage financial institutions and companies to understand, assess, and disclose the extent of the climate risks they face.
These frameworks and tools are gaining traction and inspiring concrete actions. The China-United Kingdom Green Finance Taskforce, for example, has established a group of British and Chinese financial institutions to pilot TCFD reporting. It has also developed a set of “Green Investment Principles” to promote low-carbon investments in the region comprising China’s Belt and Road Initiative.
Then there is Climate Action 100+, an investor-led initiative that seeks to motivate companies to achieve the Paris agreement’s goals by improving corporate governance on climate change, curbing emissions, and strengthening climate-related financial disclosures. So far, 310 investors with more than $32 trillion in assets under management have signed on to the initiative.
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While market-based initiatives are important drivers of innovation, governments and regulators also have a crucial role to play in activating green finance and ensuring that climate risks are measured and reported accurately. Here, steps taken by the European Union and China to steer finance toward low-carbon assets stand out.
The EU’s Action Plan for a greener and cleaner economy has spurred an ambitious agenda to advance the transition to a sustainable financial system. Draft regulations are designed to encourage financial actors to assess and disclose sustainability risk, while moving toward the establishment of common standards to promote the financial instruments – such as green bonds – that can help direct funding to environment-friendly projects and companies. EU finance ministers have also just agreed to begin requiring banks to disclose environmental, social, and governance (ESG) risks within three years.
As for China, in 2016 the State Council announced a set of comprehensive guidelines for green finance, and the central bank and some local governments have introduced monetary and fiscal incentives for green loans and bonds. Moreover, the Asset Management Association of the China Securities Regulatory Commission recently released green investment guidelines for the asset-management industry, calling for ESG considerations to be integrated into institutional investors’ decision-making. The CSRC has also announced a plan to require all listed companies to disclose environmental information by 2020.
At the international level, there is the Central Banks and Supervisors Network for Greening the Financial System. Created at the end of last year, the NGFS brings together financial regulators and central banks from 21 countries – including France, China, and Germany – that recognize the threat to financial stability posed by climate change, and the need to assess and manage that risk, in part through prudential supervision. A central element of such risk management is for banks and investors to shift their portfolios away from high-emitting companies and projects, toward low-carbon assets.
As the IPCC’s recent report makes plain, avoiding the worst effects of climate change will require action on an unprecedented scale – starting immediately. Policymakers in national capitals must ensure that both public and private financial flows align with the climate agenda, and that the right conditions are created to make the global financial sector the facilitator of, rather than a barrier to, a low-carbon future.