Finance

The limits of climate finance

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Alas, the Glasgow COP26 summit promises to be disappointing. Hopes that emerging markets, which emit much of the world’s greenhouse gases, will announce ambitious proposals have been dashed. The plans of China, India and Brazil are all disappointing. Nothing indicates that this COP will be the one that will kill the coal, as wished by Great Britain, host country. World leaders have yet to agree to stop subsidizing fossil fuels.

The GFANZ example

But climate finance is an area where enthusiasm is growing. Financial institutions representing nearly $9 trillion in assets have pledged to eliminate deforestation from their investment portfolios. The most striking announcement came from the Glasgow Financial Alliance for Net Zero (GFANZ), a coalition co-chaired by former Bank of England Governor Mark Carney.

“The Glasgow Financial Alliance for Net Zero (GFANZ), which includes asset owners, asset managers, banks and insurers, holds $130 trillion in assets. They will strive to achieve zero emissions from their lending and investing activities by 2050”

Its members, which include asset owners, asset managers, banks and insurers, hold approximately $130 trillion in assets. They will strive to reduce emissions from their lending and investment activities to zero by 2050. Can the financial sector really save the world?

Polluting states and calculation of the carbon footprint

In principle, it has a huge role to play. Shifting the economy from fossil fuels to clean energy sources requires a vast reallocation of capital. By 2030, approximately $4 trillion per year will be needed in clean energy, three times more than current levels. Spending on fossil fuels must decrease. In an ideal world, institutional investors would have an incentive to reduce emissions, and these owners and financiers would control the global assets driving the emissions. Asset owners would have both the motivation and the means to reinvent the economy.

The reality of green investing falls far short of this ideal. The first problem is coverage. ‘The Economist’ estimates that listed companies that are not controlled by governments account for only 14-32% of global emissions. State-controlled companies, such as Coal India or Saudi Aramco, the world’s largest oil producer, are a big part of the problem, and they are not subject to the influence of institutional money managers and bankers in the world. private sector.

“State-controlled companies such as Coal India or Saudi Aramco are a big part of the problem, and they are not subject to the influence of institutional money managers and private sector bankers”

A second problem is that of measurement. There is still no way to accurately assess the carbon footprint of a portfolio without double counting. The emissions from a barrel of oil can appear in the carbon footprint of companies that drill, those that refine and those that burn oil. The methodologies for attributing emissions to financial flows are even more vague. How should shareholders, lenders and insurers share the emissions from a coal-fired power plant, for example?

The hot potato of polluting assets

The third problem is that of incentives. Private finance companies aim to maximize risk-adjusted profits for their customers and owners. This is not very compatible with reducing carbon emissions. The easiest way to reduce the carbon footprint of a diversified portfolio is to sell the portion invested in polluting assets and put the proceeds of the sale into companies that have never emitted a lot of carbon, such as Facebook by example. Together, the five largest U.S. tech companies have a carbon intensity (emissions per unit of sale) of around 3% of the S&P500 average.

“Private finance companies aim to maximize risk-adjusted profits for their customers and owners. This is not very compatible with reducing carbon emissions”

Highly polluting businesses or assets often find new owners. If you can get rid of the stigma, it can be profitable to own assets that can legally generate untaxed externalities – in this case, pollution. As shareholders urge the oil majors to clean up, the oilfields they sell are being bought up by private equity firms and hedge funds, away from the public eye. The promises do not change the fact that companies have little reason to invest billions of dollars in green technologies whose risk-adjusted returns remain poor.

Essential carbon tax

What should be done ? A tune-up can be helpful. Measurements need to be improved. The European Union is making carbon reporting mandatory for companies; the United States is considering doing the same. Some accounting bodies want to standardize how climate metrics are disclosed. Asset holders, such as pension funds, should keep their investments in polluting companies and use them to contribute to change. Institutional investors must also develop their venture capital activities to finance new technologies, such as green cement.

Pledges like GFANZ’s are good insofar as they follow through, but the world needs a generalized price on carbon for finance to work wonders. This would target all companies, not just those controlled by certain institutional investors. The will to avoid this tax would strengthen efforts to reduce emissions. Companies and governments would be encouraged to tackle the questions of who pollutes and who should pay. It is essential that a carbon price aligns the profit incentive with the objective of reducing greenhouse gases. The role of the financial system would then be to amplify the signal sent by the price of carbon. This combination would be a powerful engine for changing the way economies work.

The Economist

© 2021 The Economist Newspaper Limited. All rights reserved. Source The Economist, translation The new Economist, published under license. The article in the original version: www.economist.com.

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