By Sean Kidney, CEO, Climate Bonds Initiative

The world of finance is increasingly ready to reallocate the flow of capital. In this post for the Sustainable Finance Leadership series, Sean Kidney sets out eight steps to drive change in global capital and channel trillions towards investment in the green, resilient and inclusive economy of the future. 

Our world in 2020 has been scarred by both the COVID-19 pandemic and the ever-increasing devastation from climate change. At the beginning of the year I was in Australia, as unprecedented bushfires fires raged across the country. I was haunted by the story of a volunteer firefighter walking through vast areas of burnt-out forest surveying the damage; he had been so traumatised by the screaming of dying animals that he was receiving post-traumatic stress counselling.

Welcome to the world of climate disruption. Greening the financial system can’t prevent the coming disruption, but it can help us avoid the deepest and deadliest of wounds to our planetary ecosystems. 

The Intergovernmental Panel on Climate Change tells us we have 10 years to cut emissions by half — that’s by 7.6% per year over the decade — to limit global warming to 1.5˚C, thus avoiding utterly catastrophic climate change. Even in this brutal and extraordinary year of the COVID pandemic, we expect emissions to reduce by just 8%, following an estimated increase of 0.6% in 2019. Positive structural change is needed.

We understand the pathways to change and action has started

We know what to do: we need to switch rapidly to clean energy, low-carbon transport, sustainable agriculture, and so on. There are few technical barriers. Scientists and technologists long ago mapped out the pathways to change; the world knows what transition looks like; our constraints have been in political economy not technology.

There is a capital expenditure challenge: countries need to invest (yes, invest) more than US$90 trillion in shifting the global economy to being zero-carbon and climate-resilient in the next 30 years, with some 70% of that investment required in emerging economies.

The good news is that we have the capital. There is more capital washing around the planet now than ever before, largely in the hands of institutional investors, and large slabs of it are currently stuck in zero or even negative interest rate instruments, like German or Japanese bonds. That capital needs to get to work so it can pay the pensions of the future; and the bonus is that investors generally understand the need to be green.

There is some proof of this: the green bonds market has grown rapidly in recent years, with investor demand continuing to be far greater than for non-green bonds. It now stands at roughly US$1 trillion outstanding. The market is also evolving rapidly into a wider system of sustainable debt, with rising issuance of social bonds as well as new pandemic bonds this year.

There have been other wins. The cost of solar and wind has come down drastically, thanks to action in Germany and then China, so that fossil fuels are already often uncompetitive. We are now seeing the same change with electric vehicles, fuelled by China’s aggressive policies on this front.

Governments are starting the act. The European Commission President’s announced target of 55% emission cuts by 2030 in the EU is the first time a major economy has positively responded to the IPCC’s 2018 call for global action. Thirty per cent of the EU’s €740bn Recovery and Resilience Facility will go to green priorities – with €250bn of this boost neatly financed by green bonds.

Eight next steps

What I have described above is only a beginning. Here are the next steps different actors can take to shift our world:

1. Get tough on transition. It is time to tackle the rapid transition of the hard-to-decarbonise sectors, like steel, shipping, cement and aviation. Practical solutions are available; countries need regulatory action and capital that backs up pathways for change. The  Financing Credible Transitions White Paper produced by Climate Bonds with Credit Suisse sets out five principles that should guide the setting of thresholds and trajectories for these sectors.

2. Shift focus to resilience. The world has left its run on reducing emissions so late that we cannot now avoid volatile climate change, and indeed are beginning to experience it; the remaining challenge is to avoid catastrophic climate change. So, we need also to address resilience in our societies, preparing them for a changed world. 

In the coldest phase of the ‘Little Ice Age’, in the 1600s, one-third of the world’s population was lost to pandemics, war and famine arising from a 2˚C fall in temperatures in Europe and North America. If we act now, we can avoid similarly drastic losses. Every piece of infrastructure must be designed for inherent resilience, to withstand a harsher environment with changes to rainfall and increased heatwave and flood risk. The COVID-19 pandemic also teaches us that we must act urgently on social, economic and health system resilience. The UN Sustainable Development Goals provide a map of what we need to address.  

3. Simplify the guidance for what needs to be done. That is what the EU taxonomy for sustainable activities is about: a shopping list for the future. The clearer the guidance is on what needs to be done (and the less those actions are at risk of policy impact in the future), the more investors and corporates will act – and the more incentives can be provided. And it is desirable that countries around the world use a shared set of definitions so investors can easily find climate-proof investment opportunities. Governments, multilateral development banks and investors can then work from a common base in framing markets.

4. Investors: do more than just invest. Institutional investors can apply pressure on companies to climate-proof their strategies through initiatives like Climate Action 100+ and the UN Net Zero Asset Owner Alliance. They can press governments to create brand new investment opportunities in climate and transition that give the impetus to shift capital to green.

Also, investors can urge governments to take the policy steps needed to avoid the catastrophic climate change that would lead to increased volatility and large-scale portfolio value destruction, as foreshadowed in the Principles for Responsible Investment’s inevitable policy response (IPR) scenarios. Those of us in developed countries need to understand that the biggest investment opportunities will be in emerging markets. The challenge is to design and supply the technical and financial solutions that will support and enable green national economic development paths while earning the necessary returns.

5. Central banks: go beyond thought leadership. The finance system regulatory agenda must be about more than just increasing transparency. It is about changing structural system incentives. For historical reasons, the financial sector playing field is currently tilted drastically to benefit dirty investments like oil and gas. There is an urgent need to tilt the field towards green, to get the financial system to shift sufficiently rapidly to reduce the worst risk of forward instability from climate impacts.

6. Governments: engineer change. The pandemic has shown how governments can act in ways unimaginable just a year ago. We now need the same ambition and sense of purpose to decarbonise our economies. Larger economies like the EU and China are starting to frame the direction of technological development in key industrial sectors; more is required from other major economies. There is no technical or even cost reason why we cannot dramatically reduce emissions in concrete, plastics, chemicals, shipping, mining, steel and even transport, like fast rail along the United States’ northeast corridor.  

7. National Treasuries: issue sovereign green bonds. This single step will galvanise markets while providing liquidity and benchmark pricing for green capital markets. The Climate Bonds Initiative would like to see more countries issue sovereign green bonds and scale-up their sovereign issuance, as the EU has done with its 30% commitment. Why not have nations increasingly using sovereign green bonds to finance public spending needs to meet COP26 targets and 2030 goals? 

8. Banks: the bridge between capital and green. The banking sector has the vital role of engineering and structuring deals to help manage the myriad risks in scaling up finance to the crucial milestone of U$1 trillion in annual green investment and then accelerating up to US$5 trillion-plus of green investments every year. Ideas need to be seeded in development banks who can pick up green risk, lobby governments on the fiscally efficient measures they can take to ensure deals get done, and help capital create a future that will deliver sustainable returns as well as sustainable societies.

Greening global finance is often talked about as being a partnership or a set of steps. But it is more than that: it is also a shift in direction and purpose, a recognition that the global financial system and its actors at every level, public and private, must come together to deliver on transition, zero emissions and sustainable development. Let’s make it so.

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