Today’s financial system is not ready yet.
The decision by China and the United States to jointly ratify the Paris Agreement on climate change on the eve of the Chinese-hosted G20 Leaders Summit earlier this month, was simply great news. It is a huge signal from the world’s two largest economies that the low-carbon transition is not just environmentally necessary, but now lies at the heart of their future prosperity.
The news out of China is even bigger than meets the eye. In addition to ratifying the Paris Agreement, G20 Summit host President Xi Jingping headed to Hangzhou after just presiding over the decision to introduce new guidelines for establishing a green financial system. The decision consists of 35 measures to boost capital flows to green industries and constrain finance to polluting projects. The goal is to mobilise the US$600 billion needed each year to realise China’s goal of becoming an ecological civilization – an ambition amounting to trillions of yuan.
These decisions go hand in hand. It is no surprise that one of the three goals of the Paris Agreement is to ensure that investment, lending and insurance decisions take climate risks fully into account. What is needed are the global frameworks and national climate plans to reset the incentives for the unprecedented investment that’s needed for zero-carbon energy, climate resilient infrastructure, retooling of the agricultural system and protecting vulnerable communities and nations.
Government money is of course vital, particularly to generate financing so that developing countries can meet climate change goals. But the bulk of the funding for climate action and building a green economy more broadly will come from private sources. According to UNCTAD’s World Investment Report (2014), somewhere between $5 trillion and $7 trillion each year to deliver sustainable development worldwide. This is a large sum – but set against the $300 trillion of assets in the world’s financial system, the issue is not an absolute shortage of funds. The question is one of allocation.
Today’s financial system is not yet fit to supply the investment required – a reason why China has introduced its comprehensive greening strategy. A range of barriers stand in the way: mispriced environmental risks, short-term investment horizons, under-developed capital markets for green assets (such as clean energy), and perverse incentives (biased investment decisions in favor of short-term returns over long-term value creation), and misguided subsidies (continued fossil fuel subsidies).
Moves are afoot to fix these weaknesses, blending market leadership with national action and new forms of international cooperation. Institutional investors worth $10 trillion are measuring the carbon footprint of their portfolios. The bond market focused on emissions-reducing technologies has grown to $46 billion in issuance this year – with China’s new green bond regulations driving $8 billion alone in the first quarter. In parallel, fintech innovations in Kenya are enabling poorer communities without consumer credit ratings to purchase clean energy on a pay-as-you-go basis. And stock exchanges with 70% of market capitalization have now committed to sustainability disclosure.
China is also not alone in introducing rules that seek to align the financial system with the climate and sustainability challenge. France’s recently passed Energy Transition Law requires major businesses – including financial institutions – to get serious about measuring, managing and reporting the implications of climate change. The Bank of England has kicked off a domino of assessments across Europe looking at the threats that climate change poses to key sectors, such as insurance. Building on these national measures, the world’s club of central bankers, the Financial Stability Board, has launched a task force, chaired by former New York mayor and financial data titan Michael Bloomberg, to set out a consistent framework for transparent climate disclosure.
Such developments are but the early stages in a broader transformation of the financial system. More is expected. Under China’s presidency, the G20 has established a Green Finance Study Group (GFSD). Chaired by the People’s Bank of China and the Bank of England, the GFSG is mandated to develop options to mobilise green finance through financial market reforms and development. At the conclusion of the G20 Leaders Summit, world leaders released the first-ever policy document on greening financial systems endorsed by all G20 members.
Take as a whole, the decisions of the United States and China display a seriousness towards achieving what Mark Carney, Governor of the Bank of England has labeled a “reset” of the financial system. So let us enjoy the momentum generated by this ratification, but “follow the money” – whether in yuan, dollars or pounds – must surely be our mantra from now on.
Simon Zadek and Nick Robins are co-directors of the United Nations Environment Programme (UNEP) Inquiry, which works to advance systematic action to align the financial system and sustainable development.