Smart finance for low-carbon transition

Transition to carbon neutrality represents a significant economic challenge

In the 2015 Paris agreement, the shared realisation that climate change is having increasingly significant effects led the international community to affirm its long-term objective: to keep the rise in global average temperature below two degrees Celsius. If the transition to a carbon neutral world seems achievable from a technological perspective, its scale should not be underestimated.

The low carbon transition represents a significant economic challenge, requiring the complementary actions of public authorities, economic actors and financial institutions.

On the public side, policies are needed to put a price on carbon, such as cap and trade or a carbon tax, as well as an overall framework that fosters long-term decisions. Public authorities have an imperative to align their policies with the Paris agreement, from phasing out implicit fossil fuel subsidies to prioritising transition-related issues in research and development programmes.

Transition-conscious companies must develop or seek out technologies and deploy new solutions and products. They must adapt productive capital to economy-wide carbon neutrality. This is only marginally about more investment; it is fundamentally about different investment. Every company needs to embed a climate change perspective into its decision-making, or risk contributing to the build-up of ‘stranded’ assets that will become uneconomical as more countries pursue low-carbon policies.

While it cannot achieve much on its own, a financial system that takes account of climate change-related issues not only could contribute directly to financing the low carbon transition and to managing risks; it would also amplify the policy signal. Developing smarter finance matters for the transition beyond mere financing.

‘Green’ or ‘sustainable finance’ agendas are being designed and implemented in a growing number of jurisdictions. France has been at the forefront by introducing policies that promote better integration of sustainability throughout the economy. To enable the financial sector to price climate change-related risks and grasp opportunities, corporate disclosure has been strengthened.

To nudge appropriation, accelerate innovation and disseminate best practice, institutional investors and asset managers are required to report on how they integrate environmental, social and governance issues into their investment strategies. To improve climate change-related risk management, the prudential supervisor is engaging with supervisees.

To contribute to deepening the green bond market, France’s debt management office is issuing green bonds. To ensure that retail investors can find robust ‘green’ or ‘sustainable’ products, dedicated labels have been developed.

These policies are proving effective. The reporting requirements have contributed to the management of more than 90% of the domestic insurance sector assets to incorporate climate change concerns.

The integration of climate change issues in the dialogue between regulators and companies has been one of the factors behind French banks’ leadership in this field among their European peers. The involvement of the debt management office in the green bond market contributed to a renewed interest for these bonds among issuers and enabled them to formalise their commitment to this market.

The key to such developments may be to foster the adoption of climate change policies and emphasise each economic participant’s personal responsibility in devising the right course of action. Smart regulation can help the advent of smarter finance, and policy can contribute to developing markets and strengthening their integrity. But eventually, ensuring that finance is contributing to a ‘good society’ rests on a culture of doing what’s right. This requires everyone in the financial sector, whether in private firms or public authorities, understanding the role they are expected to fulfil.

Jean Boissinot is Director of Financial Stability at the French Treasury. This article first appeared in OMFIF’s fifth annual Global Public Investor devoted to public sector asset ownership and management, and governance and asset allocation for official institutions around the world. GPI 2018 is now available to download for free

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