Sustainable taxonomies are not yet fit for purpose

First SPI symposium challenges financial sector to do better

The inaugural Sustainable Policy Institute symposium sparked debate and encouraged discussion on how the global financial system can revolutionise finance for net zero. The two-day event explored the role of central banks in driving the sustainability agenda, the latest developments in transition tools and metrics for meeting net-zero targets and what we can expect from COP26 next week.

The symposium brought together over 700 attendees from around the world. With more than 50 speakers from central banks, multilateral institutions, sovereign funds, investors and agencies, a global network of public and private sector players came together to drive action. After each session, attendees were invited to take part in a poll to assess public opinion on key issues.

Carbon pricing is high on the global agenda and will undoubtedly be a huge discussion point at COP26. In his opening keynote address, Bo Li, deputy director of the International Monetary Fund, urged that ‘carbon pricing must rise to $75 per tonne by 2030 to achieve the 1.5°C goal’ set by the Paris agreement.

Figure 1: Poll respondents support robust carbon pricing

This was echoed in a panel discussion with Mário Centeno, governor of the Banco de Portugal, Yannis Stournaras, governor of the Bank of Greece, and Gabriel Makhlouf, governor of the Central Bank of Ireland. The governors emphasised the need for a robust carbon price to achieve net zero and described it as a core element of creating transparency in markets. Ignazio Visco, governor of the Banca d’Italia and G20 leader, pointed out that an increase in carbon pricing would cause a rise in inflation, but that this would be temporary.

Governments must take the lead in setting clear taxation, subsidisation and investment policies, as well as standardisation in disclosure and reporting. As Nathan Fabian, chief responsible investment officer of the United Nations-backed Principles for Responsible Investment, argued, investors are still not aware of the scale of change needed. However, once specific, clear goals and regulatory frameworks are set, it will be easier to set pathways for the transition.

Linked to this is the need for international co-operation, including the involvement of China, in developing standards and taxonomies. This was underlined by panellists across the symposium, with Visco praising the deeper ‘trust’ between all sides in climate talks as well as technical co-operation with agencies.

Figure 2: Current sustainable taxonomies are not fit for purpose

Many central banks are reviewing their market policy in relation to climate action. There was consensus among speakers at the symposium that mitigating climate change is within central banks’ mandates if it could impact risk and price stability. Stournaras argued there is an obligation for central banks to align monetary portfolios with sustainability, but noted the need for defined accounting principles and clear rules from the European Union’s taxonomy.

Sabine Mauderer, member of the executive board of Deutsche Bundesbank, observed that central banks bring value through ‘high credibility and outstanding analytical capacity’. She identified central banks’ major task as ‘[raising] the awareness at government level’. Their objective is to make market recommendations, maintain and safeguard price stability, use public finance prudently and reflect the clear risks of climate change in the financial market.

Figure 3: Respondents are divided over central banks’ mandates

Figure 4: No clear consensus on how central banks should manage portfolios

Central banks play a crucial role in developing risk frameworks and mitigation tools and huge strides are being made. The Central Banks and Supervisors Network for Greening the Financial System has developed stress testing and scenario analysis tools to assess transition and physical risks on balance sheets and translate climate scientist language for the financial sector. Central banks are working to imbed scenario analysis into their frameworks to set clear objectives, with notable examples from the Banque de France and Bank of England.

Sylvie Goulard, deputy governor of the Banque de France, highlighted the need for forward-looking scenarios when examining risk, and for a well-rounded view that includes biodiversity. She added that the financial sector needs to accept a level of uncertainty when integrating these tools. Forward-looking data are essential to fully understanding the extent of physical and transition risk and developing disclosure metrics, but access to quality data is a challenge. Speakers across the event highlighted the importance of interdependency and open information in maximising the use of data sets across the financial sector.

The examination of environmental, social and governance reserves and asset management, and developments in driving sustainable capital markets were major themes of the symposium. Participants highlighted the link between climate, price volatility and inflation, and the importance of screening processes and transition benchmarks in managing risk and transitioning to net zero. The debate between the exclusion of certain issuers and assets versus transition and active ownership continues to cause friction, with speakers emphasising the importance of being able to evaluate alignment potential.

There is evidently growing investor demand and developments in green bonds, with liquidity and size of transactions increasing. This is especially the case across Asia Pacific and within emerging markets. However, Chuchi Fonacier, deputy governor of the Bangko Sentral ng Pilipinas, Adrian Orr, governor of the Reserve Bank of New Zealand, and Serey Chea, director general of the National Bank of Cambodia, raised the need for more resources and green instruments in emerging markets.

The panellists argued for the importance of reserves management, ratings and credit risk in establishing sustainable financial markets. High-income countries must step up financial aid to ensure developing markets are not left behind in the green transition. This includes the need to stop driving carbon lock-in in resource-rich countries.

Patrick Harker, president of the Federal Reserve Bank of Philadelphia, echoed this in another session. He underscored the need for a just transition in greening the economic system, noting the risk of stranded capital assets when moving to alternative energy sources, which can be managed if action is taken now.

Figure 5: Monetary policy incentives are required for an effective transition

The symposium ended on a challenging note, with Kirsten Dunlop, CEO of the European Institute of Innovation and Technology’s Climate-Knowledge and Innovation Community, questioning the current global economic model and capitalistic growth. She emphasised the need for new thinking, tools, solutions and systemic innovation to truly mitigate climate change.

There is a vast amount the financial sector must change to achieve net-zero goals and turn financial flows green. Nevertheless, there are positive signs, with the NGFS making huge efforts to bridge data gaps and develop stress-testing models. As sustainable finance products and assets become more mainstream and investors increasingly engage in efforts to transition to net zero, it is imperative that the global financial sector is able to understand and mitigate climate-related financial risk.

Symposium sessions are available to watch on demand.

Emma McGarthy is Head of Policy Analysis, Sustainability, Sustainable Policy Institute.

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