A global agreement for sustainable finance by Fabio Panetta
With the rise of national climate commitments and the renewal of multilateralism, there is a unique opportunity to forge a global consensus on issues such as carbon pricing, green transition and sustainable finance. In each case, the European Union offers a promising model for the others.
FRANKFURT – The COVID-19 pandemic has caused the biggest drop in global economic activity on record. But the drop in carbon dioxide emissions was only temporary. Although the global CO2 emissions fell by 6.4% overall in 2020, had already started to increase in the second half of the year and have now returned to pre-crisis levels.
The fact that the extraordinary circumstances of the past year have still not brought global emissions into line with the targets set by the 2015 Paris climate agreement is a stark reminder of the scale of the challenge we face. faced. As Nobel Prize-winning economist William Nordhaus reminds us, climate change is the quintessential global externality. Its effects are spread all over the world and no country has enough incentives or capacities to solve the problem on its own. International coordination is therefore essential.
Fortunately, a return to multilateral cooperation through the G7, G20 and the Financial Stability Board offers a unique window of opportunity. Following US President Joe Biden’s decision to join the Paris Agreement, the European Union’s commitment to achieve carbon neutrality by 2050 and China’s commitment to do the same to by 2060, we may be at a turning point in global climate action.
Three priorities emerge from the international agenda. The first is the need to increase global carbon prices. Putting a higher price on carbon is the most cost-effective way to reduce emissions at the scale and at the speed needed. By internalizing the social cost of emissions – forcing emitters to pay – carbon pricing harnesses the power of markets to distance economic activities from carbon-intensive activities.
Currently, carbon prices are far too low. The International Monetary Fund calculates that the global average carbon price is only $ 2 per tonne. And, according to the World Bank, only 5% of global greenhouse gas emissions are priced within the range required to meet the goals of the Paris Agreement.
Here, advanced economies can lead by example and use the current policy window to embark on carbon price trajectories consistent with the Paris Agreement. Although small advanced economies account for only a limited share of global emissions, their adoption of decisive decarbonization measures could encourage developing countries to follow suit.
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The second priority is to use recovery from the COVID-19 pandemic to âbuild back betterâ. Decisions made now will shape the climate trajectory for decades to come. Policymakers should seize this opportunity to put the global economy on a path of sustainable growth. The EU’s stimulus package – Next Generation EU – lives up to this ambition.
The third priority goes to the heart of the financial system and the central bank: financing the green transition. Phasing out fossil fuels implies the need for massive investment, although estimates of the precise figure are subject to significant uncertainty. Beyond emissions reduction, the broader sustainability agenda, the United Nations estimates that implementing the 2030 Agenda for Sustainable Development will require global investments of $ 5-7 trillion per year. To fill this gap, it will be crucial to mobilize the resources of financial intermediaries, including banks.
Sustainable finance products – such as green loans, green and sustainable bonds, and funds with environmental, social and governance (ESG) characteristics – have grown dramatically in recent years. Unfortunately, the field suffers from information asymmetries and insufficient transparency.
To foster the growth of sustainable finance, many countries have started to develop regulatory frameworks to tackle âgreenwashingâ, and the EU is at the forefront of these efforts. Yet, in the absence of global coordination, different jurisdictions have developed different approaches and industry-based initiatives have mushroomed.
The resulting edifice of inconsistent and incomparable standards, definitions and parameters has fragmented sustainable finance markets, reducing their efficiency and limiting the cross-border availability of capital for green investment. As jurisdictions compete for funding, the risk of regulatory arbitrage and race to the bottom has increased. Left unchecked, this trend could lead to lower standards globally, increasing the likelihood of greenwashing.
But now we have the opportunity to start designing a common global approach. Sustainable finance is a top priority both for the G20 under its Italian presidency and for the G7 under its British presidency. Additionally, in a public letter shortly after its confirmation, US Treasury Secretary Janet Yellen called for an upgrade of the G20 Sustainable Finance Task Force to “reflect its importance.”
A key first step is to agree on minimum standards for corporate disclosure. If a company’s sustainability performance is unclear or unknown, it is impossible to determine the sustainability of the associated financial assets. We need to replace the current alphabet soup of reporting frameworks with a common standard. To this end, the EU’s approach – including the ongoing review of the Corporate Sustainability Financial Reporting Directive – represents an advanced benchmark towards which any international standard should aim.
For a common standard to start a race to the top, it must not fall short of international best practice. It should cover all ESG aspects of sustainability. And it should require companies to disclose not only issues that influence the value of the business, but also information about the larger environmental and social impact of the business (known as “double materiality”).
A second and even greater challenge is to ensure that countries develop consistent classifications of what is considered a sustainable investment. If an activity or asset is considered sustainable in one country but unsustainable in another, there can be no truly global sustainable finance market.
To ensure a level playing field globally, today’s leaders should aim to agree on common principles for globally functioning and consistent taxonomies. Just as governments need to be aware of the risk of carbon leakage, they need to consider the risk of carbon funding leak.
Finally, we need to ensure that all segments of financial activity remain aligned with broader climate goals. The enormous energy consumption and the associated CO2 emissions from crypto-asset mining could undermine global sustainability efforts. Bitcoin alone already consumes more electricity than the Netherlands. Controlling and limiting the environmental impact of crypto assets, including through regulation and taxation, should be part of the global debate.
Climate change and sustainability are global challenges that require global solutions – and nowhere more than in the financial sector. The current political environment offers us a rare opportunity to make substantial progress. We must not waste it.