Emissions are increasing while transition finance plans remain in flux

ESG targets should be more than just a ‘vanity project’

The financial sector must focus on good governance and transparency as it moves forward with the sustainable transition. This was a key message at OMFIF’s Sustainable Policy Institute symposium, alongside the importance of collaboration with policy-makers to drive stronger data collection, disclosure reporting and standardisation.

A global network of public and private sector players came together to discuss central banks’ role in the net-zero transition, developments in risk understanding, transition finance and green market growth, all within the geopolitical context of war and inflation.

Barnabás Virág, deputy governor of the Magyar Nemzeti Bank, highlighted that the green issue is a priority for central banks. In the same session on central bank mandates, Clara Raposo, vice governor of Banco de Portugal, pointed to a climate-friendly stance in the euro area market. This strategy includes corporate bond assessments and central banks releasing information on their exposure to brown investments.

The consensus was that central banks should lead by example. Yet there is conflict between managing the economy, reducing inflation and ensuring the green transition. In the short term, managing inflationary shocks is the priority, but mid-term, more emphasis should be on providing preferential rates for investors looking to crowd in money for green issues, with more flexible thinking on the central bank capital positions and role in the market.

There is much work to be done on the integration of geopolitical risks and short-term volatility into stress testing and scenario analysis models, which is missing from the Network for Greening the Financial System scenarios. Livio Stracca, deputy director general of macroprudential policy and financial stability at the European Central Bank, mentioned that this is being integrated but it is particularly hard to model and capture. Long-term risk management practices, stress tests and addressing transition risks are crucial to prevent disorderly transition.

Figure 1. Financial institutions are unequipped to accurately report portfolio emissions
Do you have the correct datasets and tools to adequately report on your portfolio and assess climate impact? Share of respondents, %

Source: SPI symposium polls

There are positive developments, with the US Federal Reserve now undertaking its own stress test and substantial progress being made in the number of exercises and financial sector participants. The understanding of risk via disclosure and reporting was also discussed, with Carlo Funk, head of ESG investment strategy in Europe, Middle East and Africa at State Street Global Advisors, who flagged it as integral to investors’ decision-making. Investors should focus on material risk and good governance in disclosing activities.

Nature-based risk assessments and disclosure are also on the rise, with the work now evolving to include biodiversity and nature-based finance developments. It was highlighted that carbon pricing can support the reduction of nature-related risks, but it will take time and investment.

Carbon markets, the energy transition and scaling up capital markets were discussed on day two in high-level panels on geopolitics and transition finance. Jean-Marie Paugam, deputy director general at the World Trade Organization highlighted a global standard in carbon pricing and taxation as essential to decarbonise trade and supply chains.

He observed that the risk of fragmentation with different decarbonisation strategies and extension of green investments can lead to gross domestic product loss. Interoperability is coming in disclosure standards with the development of the International Sustainability Standards Board. But the question on carbon pricing and the effectiveness of the Carbon Border Adjustment Mechanism, along with tensions on access to resourcing, trade and the just transition, is causing economic dislocation.

This tension was raised in a second panel on transition finance, with Sheila M’Mbijjewe, deputy governor of the Central Bank of Kenya, highlighting that only 3% of global emissions come from African countries, but the continent suffers the most from climate change. A poll revealed that lack of information is the key barrier to investing in emerging markets, and speakers identified opportunities such as renewable energy resources, investable projects, development and issuance of green financial products and deepening capital market structures (Figure 2).

Figure 2. Lack of information cited as largest barrier to investment
What’s the biggest challenge to mobilising sustainable finance in emerging markets? Share of respondents, %

Source: SPI symposium polls

M’Mbijjewe noted that emerging market assessments need to be different from ‘developed’ markets, which have the problems of ‘brown’ investments. Pricing and the cost of capital is too high and there is a need for policies to stimulate competition in renewable energy. Although capital markets are not as ‘deep’, M’Mbijjewe suggested investors begin with small projects to test viability and provide the opportunity to grow.

There is a need for a clear definition of transition finance. The private sector needs government commitments and policies to invest in renewable energy, and increased collaboration in the financing of projects.

The green bond market is growing, and transition bonds have huge potential in driving industry transition. Labelling of products can improve and increase the market. Yet there is a need for credible data and key performance metrics to avoid greenwashing. Challenges remain with understanding scope 3 emissions and supply chain data and it is essential that all data are linked back to the real economy. Panellists emphasised that there is a lot of information out there and we can use estimated and modelled data to drive real economy change as disclosure requirements develop.

Desiree Fixler, former sustainability lead at DWS discussed greenwashing, mislabelling and mismarketing of financial products. She highlighted the importance of transparency and ensuring sustainability is embedded across the company, overseen by compliance, with reporting going to the chief financial officer. She warned that ESG should not be a ‘vanity project’. Emissions are going up and we are still in a critical state. Good governance and approaching the transition with humbleness will be essential.

Overall, central banks need to do more to green their own reserves and portfolios. Jurisdictions and sectors need to work together to drive better information, standards and green capital market growth. The good news is that ESG is becoming absorbed by the regular investment process and is considered ‘mainstream’. The sustainable finance market is becoming ever more sophisticated and the aspiration to meet net zero is there. Finance is being mobilised to solve the climate crisis, but there is a long way to go.

Emma McGarthy is Head, Sustainable Policy Institute, OMFIF.

The Sustainable Policy Institute’s next event will be in collaboration with the UK Transition Plan Taskforce, discussing how to drive credible climate transition plans and inform global coherence of standards. For more details and to register to attend, click here.

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