Wielding the Weapon of Finance Against Climate Change

The French Prime Minister’s policy institute France Stratégie takes a look at what’s at stake and some of the proposals on the table to give green finance the momentum it needs.

For more than two decades scientists have been warning that if average global temperatures rise even less than 2°C above pre-industrial levels, dangerous climate change could ensue. The International Panel on Climate Change (IPCC) has concurred that global warming must not exceed this level by 2100.

Faced with the unrelenting evidence of the mounting perils of a warmer planet Earth, world leaders committed to limiting warming to 2°C at the 16^th Conference of the Parties (COP16) to the United Nations Framework Convention on Climate Change (UNFCC) at Cancun in 2010.

The Climate Vulnerable Forum (CVF), a broad coalition of 43 of the planet’s countries most vulnerable to the effects of rising temperatures, has gone even further. At the outset of the COP21, they issued a call to fully decarbonize the economy and transition to 100% renewable energy by 2050 to keep warming within a limit of 1.5°C above pre-industrial levels. Both France and Germany have publicly backed the proposal.

Amidst the urgency, earlier this year two International Monetary Fund (IMF) economists hurled a rock into the mire of statistics and facts surrounding climate change. They put the difference between what consumers pay for energy and the supply costs and the damage energy consumption inflicts on people and the environment at a whopping USD 5.3 trillion (see Figure 1 below).

These direct and indirect subsidies, as the authors term them, represent no less than 6.5% of global GDP. Moreover, using World Health Organization (WHO) figures from 2013, the IMF economists point out they amount to even more than the 6% of GDP the world spends on healthcare.

Sources: International Energy Agency; Organisation for Economic Co-operation and Development; and IMF staff estimates.

Staggering costs

To be clear, the lion’s share of this sum consists of negative externalities, i.e. the global and local consequences of the use of fossil fuels. The costs incurred due to poor air quality, illness and global warming alone come to USD 4 billion.

For its part, the International Energy Agency estimates that as of 2013 fossil fuel subsidies worldwide amounted to USD 548 billion.

Astronomical figures aside, there is no longer any doubt that a changing climate is leading to more natural disasters, agricultural crises and a higher incidence of disease. As the World Bank reaffirmed in November 2015, poor people are bearing the brunt of these so-called climate-related shocks. It estimates if action is not taken more than 100 million additional people could be indigent by 2030.

Indeed, fighting to temper a warming planet is part and parcel of the UN’s recently adopted 17 Sustainable Development Goals (SDGs). The highly ambitious goals aim to “free the human race from the tyranny of poverty and want and to heal and secure our planet.”

The United Nations Conference on Trade and Development (UNCTAD) has put the investment needs of implementing the SDGs at about USD 3.9 trillion per year, mainly for infrastructure, food security, health, education and climate change mitigation and adaptation. It estimates current investment to be around USD 1.4 trillion, leaving a gargantuan gap of roughly USD 2.5 trillion.

According to UNCTAD, climate change mitigation and adaptation alone will require on average roughly USD 800 billion per year, with an estimated gap of roughly USD 600 billion.

Given these figures, the OECD estimate of USD 62 billion developed countries raised in 2014 to help developing countries fight climate change as pledged in Copenhagen comes across as chump change (they committed in 2009 to USD 100 billion a year by 2020). That said, it is clear public money alone will not be able to plug the gap.

Divest and invest

The investment gap and the massive costs of our current energy regime underscore the clear need for carbon to be priced effectively. In other words, when it becomes expensive to pollute, money will be shifted towards clean fuels and the green investments needed to move towards a low-carbon economy.

The term stranded carbon assets has come to refer to fossil fuels that are expected to lose value as their true cost becomes apparent due to environmental damage, regulations, social norms, technological change or litigation.

Earlier this year, Mark Carney, the Governor of the Bank of England, stated that if the IPCC’s estimate of the amount of carbon that can be burnt before global temperatures begin to exceed the 2°C threshold (i.e. the “carbon budget”) is correct, “it would render the vast majority of reserves ‘stranded’”.

Abyd Karmali, the managing director of climate finance at Bank of America’s investment arm recently commented that his bank’s exposure to renewable energy sources is now three times to that of coal, adding this is “remarkable for a conservative institution like ourselves [sic]”.

Even in the absence of a sufficiently elevated carbon price, that the true cost of carbon is high is less and less in dispute. Proof of this is the movement towards ensuring investors no longer invest in the carbon economy. To date, an estimated USD 2.6 trillion in investments worldwide has been declared carbon-free.  

Governments can move to accelerate this process, either directly through taxation or indirectly through emissions trading systems, aka cap and trade. The two can be combined as is the case in Europe, where the European Union Emissions Trading Scheme (EU ETS) coexists with carbon taxes in countries like France.

Mobilizing finance

As UNCTAD notes, the role of the private sector is fundamental and pivotal in transitioning to clean energy. But the right policies are required to drive the process. For example, by encouraging innovation and establishing standards, prices for green technologies can be reduced substantially. This has played out with solar cells in recent years.

The former member of the European Parliament Pascal Canfin and economist Alain Grandjean identified four key areas for climate finance in the report Mobiliser les financements pour le climat they submitted to the French President in the run-up to COP21. They are the carbon price, resilient low-carbon infrastructure, mobilizing development banks and financial regulation.

They called for monitoring the financing of the decarbonized economy, particularly through a carbon price signal and reforming financial and monetary regulation to foster investment in green technologies.

It is clear it is incumbent on financial regulatory bodies to ensure transparency of information. Along these lines, the Financial Stability Board (FSB) has made a proposal to the G20 to create an industry-led disclosure task force modelled on the successful Enhanced Disclosure Task Force (EDTF) set up at the onset of the 2008-09 global financial crisis. It would allow the financial sector to take account of climate-related risks by providing information to lenders, insurers, investors and other stakeholders.

This initiative is echoed in France’s recently passed law on the energy transition, which requires institutional investors to publish information on their exposure to climate risks and how they are contributing to limiting climate warming and transitioning to cleaner energy.

The law also focuses on ensuring buildings are energy efficient, a major challenge for developed countries given the low demand for new infrastructure when compared to developing nations. France aims to reach the goal of 500 000 extensive renovations per year by 2017, for example.

Along these lines, Michel Lepetit, CEO of the banking consultancy Global Warming SAS, has put forth a plan to create an agency devoted to financing the energy efficiency of public buildings. This requires substantial capital and financial tools adapted to renovating rather than construction, which predominates today. The proposal is somewhat similar to the UK’s Green Investment Bank, created in 2012 by the UK government to spur private investment in environmental sustainability.

Monetary tools

Faced with the increasing urgency of our environmental predicament, there are calls for developing financial measures that will have more of a direct and immediate impact than carbon pricing and disclosure of information related to climate risks and action.

French economists Michel Aglietta, Etienne Espagne and Baptiste Perrissin-Fabert have developed a monetary proposal based on carbon certificates. Companies with a green project would receive certificates matching the value of the project’s reduction in emissions. They could then redeem them at commercial banks against loans to cover part of the project’s total costs.

The institution responsible for backing and refinancing the certificates – e.g. a central bank – would provide the commercial banks with financing on par with the value of the certificates collected. In their proposal the European Central Bank (ECB) could fulfil this role and finance the certificates as part of its Quantitative Easing (QE) policy launched at the beginning of 2015.

The bet would be that the inevitable rise in the price of carbon would make the vetted green projects profitable, resulting in a healthy return on investment.

Another innovative monetary proposal concerns linking public debt to carbon dioxide emissions. Economist Abdeldjellil Bouzidi and executive chairman of think tank Z/Yen Michael Mainelli propose creating government bonds, with interest rates linked to CO₂ reduction targets. The more a government reduces CO₂ emissions, the less interest it would pay. They contend the bonds “could allow long-term investors, such as insurance companies or pension funds, to hedge their climate risk” to which they are likely over-exposed.

Colin Hines, environmental activist and convenor of the UK’s Green New Deal Group, has proposed that the ECB buy bonds from the European Investment Bank (EIB) within its QE programme, targeting green investments in countries most vulnerable to risks related to climate change.

Political economist Matthias Kroll also sees central banks as playing a crucial role in financing action to stymie warming temperatures. He points out that monetary authorities around the world have been buying bonds to create new liquidity to stave off the effects of the financial crisis, so why shouldn’t they do the same to fight climate change? To do so, he posits they would buy green bonds issued by the UNFCCC’s Green Climate Fund (GCF), thereby financing concrete green investment projects.

Moreover, he specifies the green bonds would have maturities of at least 100 years and would bear small, if any, interest rates. They would thus become permanent assets of central banks. He calculates the US Federal Reserve and the ECB could potentially buy green bonds totalling USD 250 billion per year without causing inflation.

The UNFCCC is clearly taking green bonds seriously. It recently partnered with the UK-based Climate Bonds Initiative to showcase all labelled green bonds issued by companies, cities, municipalities and banks on its Non-State Actor Zone for Climate Action (NAZCA) platform.

As Matthew Arndt, head of environmental, climate and social policy projects directorate at the EIB, recently pointed out at the COP21, any proposal put to a financial institution has to be both simple and credible, with all risk fully covered (e.g. when converting carbon certificates into bonds).

Beyond the different economic tools to incite investment, creating a legal framework ensuring countries uphold their commitments to fight climate change is also crucial. Law professor Mireille Delmas-Marty has emphasized the importance of creating a mechanism for resolving disputes related to states’ responsibilities in addressing climate change.

All of these proposals represent an attempt to remedy the seemingly dire predicament we find ourselves in. Though some are more feasible than others, they all point to a tipping point in the role finance can play in the fight against climate change. If the political will can be mustered in Paris, finance may well be set to fulfil its promise as a powerful weapon in the struggle to halt the rise in global temperatures.

Authors: Pierre Douillard, Policy Analyst, France Stratégie and Richard Venturi, Journalist, France Stratégie