The Quiet Revolution Needs to Deafen

Jul 11, 2017 | Green finance

30 June 2017

There are essentially 3 entry-points for climate action.

The first involves reforms to the real economy – for example, through support to renewable energy and energy efficiency, and changes in agricultural and forestry practices.

The second involves the intelligent use of limited public funds. Here the debate often revolves around the commitment by developed countries to jointly mobilise US$ 100 billion/year of climate finance by 2020 (of which approximately US$ 65 billion/year currently materialises) and the sheer complexity of international climate finance: there are over 100 international public climate funds, all with their own rules and idiosyncrasies.

A more pressing issue is actually the smart use of domestic public resources. Despite all the talk of a globalised economy, most countries rely far more on domestic resources for infrastructure investment than on international sources: almost three-quarters of global capital flows targeting climate change are raised and spent within the same country.

 

Global climate finance, showing the relative sizes of flows. Credit: UNFCCC Standing Committee on Finance

The third entry-point encompasses measures within the financial system itself.

An unprecedented reallocation of capital will be needed to realise the Paris Agreement – in the order of roughly US$ 300 billion per year over and above baseline investment. Harnessing the financial system will be a fundamental pre-requisite to mobilising investment flows of this magnitude.

As UN Environment’s Inquiry into the Design of a Sustainable Financial System observes, it is the third entry-point that has attracted least attention to date. Policy-makers are often not familiar with the intricacies of finance, and the sector is still struggling to escape from the post-2008 sentiment that “financial” and “engineering” are two words that are best kept apart.

But there are two positives that can’t be ignored. First, there is no shortage of funds that could be deployed to support climate investments: banks alone manage US$ 140 trillion of assets, with institutional investors – notably pension funds and insurance companies – responsible for another US$ 100 trillion. That such deployment isn’t currently taking place at the required scale is a lesser problem – and one that’s more easily ‘nudged’ into resolution through policy and regulatory actions – than having to conjure the funds up in the first place.

Second, the financial system is unusually dynamic and adaptive. Just look at the disruptive impact that ‘fintech’ is having on established business models. Mobile money, for example, is now available in 93 countries, at least 19 of which now have more mobile money accounts than bank accounts. Dynamic and adaptive can cut both ways, of course – think of the collateralised debt obligations, credit default swaps and other exotica that sank the global economy in 2008. But, harnessed in the right way, ‘green finance’ can live up to its name.

The UN Environment Inquiry speaks of a “quiet revolution” getting underway, with initiatives proliferating at national and international levels to better align the financial system with sustainable development needs – developing sustainability principles and definitions, improving climate disclosure standards, incorporating environmental risks into bank stress testing, developing new financial instruments and so on.

Some of the more prominent initiatives include the Carbon Tracker Initiative, the Climate Bonds Initiative, the Green Infrastructure Investment Coalition, the Sustainable Banking Network and the Sustainable Stock Exchanges Initiative. Just yesterday, the Task Force on Climate-Related Financial Disclosures issued recommendations on how companies should assess and report their climate-related risks.

Interventions are still more ad hoc and fragmented (and voluntary) than they could be, but the general direction of travel is clearly desirable.

Nonetheless, turning the quiet revolution’s volume up – ideally to 11 – is clearly going to be vital if we’re serious about tackling climate change. Amidst the complexities of climate science, integrated assessment models and the international negotiations is one hugely under-appreciated fact: the window for effective climate action is closing and it’s closing very fast.

As Mission 2020 point out, if global emissions continue to rise beyond 2020, or even remain level, the temperature goals set out in the Paris Agreement become effectively unattainable. That means we have less than 3 years to ‘bend the emissions curve’ – which, given the inexorable rise of emissions over the past 23 years since the UN Framework Convention on Climate Change came into force, rather suggests new thinking and new approaches are needed.

We are currently just scraping the surface of what’s possible in the green finance space.

Green bonds, which are rightly held up as a success story of the past 10 years, still only account for 0.1% of the US$ 100 trillion in the world’s debt capital markets: there is plenty of scope for systematic market development, building on nascent organic growth in countries such as Kenya, Morocco and Nigeria.

Green bond issuance relative to total bond issuance and potential growth scenarios. Credit: OECD

During the 2008 financial crisis, central banks deployed unconventional methods – ‘quantitative easing’ – to insulate economies from recession. There is obvious scope to shape their future asset purchases with climate goals in mind: not so much QE For People as QE for the Planet.

Or how about debt for climate swaps? Or climate policy performance bonds? Or energy savings insurance? Or layered-risk funds?

We’re back to dynamic and adaptive. Without rapid, large-scale redeployment of finance, backed up by a healthy dose of fresh thinking, we will lock ourselves into a development trajectory – or, rather, fail to escape from the current development trajectory – that is simply inconsistent with the climate goals we have set ourselves.

But there’s a catch. Speed is of the essence from a climate perspective. But abrupt change is rarely desirable from a financial perspective. In a February report that deserves to be more widely read, the European Systemic Risk Board notes that belated, sudden climate actions by financial regulators could lead to rapid repricing of carbon-intensive assets (such as oil and gas companies, and power utilities), setting off contagion in the broader financial system as the impacts propagate through the bond and leveraged loan markets, and as institutional investors’ (for instance, pension funds’) holdings lose value.

So, our collective failure to get to grips with the climate challenge over the years means that not only is the window of opportunity for meaningful action closing fast, but some of the instruments at our disposal are being rendered increasingly ineffective. This isn’t typically why climate change is referred to as a ‘wicked problem’, but it should be.