COP26 has passed. The public and private sectors, as well as the media around the world, are eagerly evaluating its achievements or lack thereof. The climate talks in Glasgow witnessed first-hand the passion of young people demanding that governments act with greater urgency, while their national representatives worked overtime to find common ground on the details of the ‘OK.
COP26 did not unveil a treaty comparable to the 2015 Paris Agreement, but urged countries to take action to keep the global temperature rise at 1.5 degrees Celsius until the end of the century. . Leaders of developing countries have asked for $ 1 trillion over the next three decades from developed countries to embrace and mitigate climate change. Advanced countries, whose generations-passed carbon pollution has caused the problem, have accepted this funding commitment for developing countries with the goal of ultimately achieving net zero emissions by 2050. Net zero is when a country’s carbon emissions are offset by removing equivalent carbon from the atmosphere, so that the resulting emissions are zero.
The Glasgow Climate Pact has put in place measures allowing countries to improve their climate targets next year and gradually reduce coal-fired electricity; and he resolved the key rules of the Paris Agreement. It has failed in other areas, such as insufficient provisions on carbon markets, social protection and alignment of public investments. Outside of the negotiations, COP26 made encouraging commitments to reduce methane emissions, stop and reverse deforestation, and align private investment with net zero.
Climate finance is the thorniest point of contention between developed and developing countries. Since most Nationally Determined Contributions (NDCs) are conditional, they are subject to an availability of $ 1,000 billion. Developing countries are grappling with a long-term debt and liquidity crisis, made worse by the pandemic Covid-19 crisis. When they met in Glasgow, all parties were concerned about where the money would come from to meet the most ambitious climate goals.
Raising $ 1 trillion every year seems like a daunting task. But the preparation for COP26 was marked by extraordinary support from the global financial industry. The world’s biggest investors have called for a strong, transparent and fair climate deal, promising they will make money flow. And banks have pledged to find ways to promote and funnel tens of billions into low-carbon investments.
But private funding will not flow in a vacuum. There is a close relationship between how incentives are managed and increasing climate investments. Thus, the public sector must focus on the efficiency of the financial sector to support the channeling of private savings into investments that will not only give investors a return in the short term, but will ensure that those returns are economically viable in the long term. . The development of a targeted financial industry is essential for the realization of $ 1 trillion of clean investments.
The good news is that the financial sector has no shortage of savings to invest. Globally, some $ 300 trillion is represented in capital markets, just over half of commercial banks, the rest of insurance companies and institutional investors. In the face of this, the net $ 1 trillion seems quite modest. But financial markets still don’t have enough money to support a net zero economy.
One reason is that the motivation for private financing of low carbon infrastructure is not strong. If a carbon-intensive investment outperforms a clean, green alternative, investors cannot ignore the business case for making a profit. That’s why more than 300 financial institutions urged world leaders to reach agreement at COP26 on climate finance. They are willing to pay a price for carbon if it makes their investment relatively more attractive. These institutions did not suddenly become climate activists. They have gradually understood that if the climate is not stable, the economy in which they invest will be threatened.
In addition, most private investments in climate change mitigation in developing countries in Asia are not made by financial institutions but by large corporations. And most of the time, they don’t come to their bankers but pay new investments with retained earnings. Huge economic rewards could be obtained if they are geared towards low carbon investments by setting the price of carbon in the markets.
A new impetus is also emerging in the Asian bond and stock markets in favor of environmental, social and governance (ESG) investments. For example, the signatories of the Principles of Responsible Investment (PRI) represented $ 50 billion in 2020-2021. The green bond market, where countries and companies borrow for climate projects, grew 12% in Asia during the 2020 pandemic.
Although a lot of activity takes place in financial systems, it is a long way to mobilize the own $ 1 trillion. A major cause is that financial institutions themselves are not well structured to accelerate financial flows in the right direction. Inadvertently, they favor high carbon investments over low carbon investments. For example, the rating agencies that determine whether a bond is investable do not consider the risk beyond three years. Thus, a bond backed by a power plant powered by fossil fuels may receive the same rating as a renewable energy plant powered by solar or wind energy.
The same is true for accounting standards. Even if they say they are cautious, they do not question the value of stranded assets. The risk measures used to manage banks are retrospective and ill-suited to predict future climate risks. Investment institutions, which owe a fiduciary duty of care to their stakeholders, often ignore the effects of climate change on the population for whom investment decisions are made. Shareholders, citizens and policy makers need to ensure that financial systems are fit for purpose of achieving net zero goals. In short, significant and coordinated efforts are needed to constrain future investments in climate change mitigation and adaptation.
Here are some possible initiatives that are successful in several countries: ensure that credit agencies offer ratings that incorporate long-term climate risks into their assessments; encourage companies to openly report on their carbon intensity and agree to declare their improvement plans; create reporting standards for all companies that can raise funds through public exchanges; get banks and financial institutions to manage and minimize value at risk through proper screening and make them more secure, and steer them away from carbon intensive activities. Trustees of investment funds could be encouraged to accept fiduciary responsibility; equity investors to integrate climate considerations into their engagement with companies and their voting for boards of directors; insurance companies to help identify and build climate resilience; sound standards and a taxonomy to be developed for green bonds and similar financial products. Donors, public and multilateral banks must significantly increase their climate portfolios and step up their efforts to help countries reach net zero. Each of these is just one of many small steps. But taken together, they would put the world on a very different path by mobilizing $ 1 trillion of their own.
The author is Director of Research, Strategy and Innovation at the Institute of Economic Research for ASEAN and East Asia (ERIA).
The opinions expressed are purely those of the author and can in no way be taken as an official position of ERIA.