By World Infrastructure Journal-
We face a fast de-globalising world at a time when climate change requires globalised solutions. Politicians frequently pull us one way, real world demands often pull us in the other. Finance sits in the middle of this debate but not always comfortably.
There are frequent calls for the finance industry to do more, or criticism that its actions do not meet its words. In reality, the finance community has done a remarkable job forging a global consensus on Environmental, Social and Governance (ESG) standards as governments and regulators play catch up, but there is still more to do. Fortunately the outlook for maintaining a global consensus is good, but nothing should be taken for granted.
Climate change is inextricably linked to economic development and how we power our economies. Financial institutions are an integral part of economic infrastructure and how we fuel the industrial system. Finance’s uncomfortable place at the centre of the world’s economic system is reinforced by the fact that it is probably the most globalised of industries, and its role directing and allocating the flow of capital is critical in tackling a range of issues, one of which being global warming.
The finance industry is of course not the prime generator of carbon emissions, but is instead the global facilitator, regularly a financier or shareholder in those industries directly responsible. Regulators and public opinion have naturally identified the finance infrastructure as a means of exerting pressure through the pivotal role around the allocation of capital flows through a closely regulated industry.
Capital flows take many forms but the principal machinery of global capital flow includes the lending of funds through banks on the one hand and allocating vast flows of private and public savings through investment management of debt and equity portfolios on the other. Add to these free-spending central banks and the picture is almost complete. Directing these flows to achieve a desirable climate related outcome is an essential step in bringing discipline to the search for solutions.
Solutions and challenges
Our de-globalising world requires, nevertheless, a consistent globalised approach to finance standards and capital flows. In the absence of regulation thus far, both lenders and investors have already spent time and energy working on standards and definitions. These efforts have borne fruit in so far as the approach to ESG standards is remarkably consistent with a high level of international alignment. But these actions can only go so far. Now governments and regulators are set to build on this.
There remain plenty of challenges facing the finance industry. Firstly, a lack of a global and comprehensive system of ESG categorisation and measurement to better set benchmarks and standards. This is being worked on. Second, while there is huge demand for ESG investments, there is a significantly smaller volume of potential supply with little compulsion for capital raisers to adopt green standards as yet. Finally there is the need for the finance sector to continue to support legacy ‘brown’ industries in the interests of jobs and the overall economy. This is not always welcomed.
On the first challenge, standards in the forms of ‘taxonomies’ are being drawn up. There is a clear requirement for a globally consistent, not regionally determined regimen to have maximum impact. Absence of clear definitions and measurement fuels cynicism around green standards and stoke fears of ‘greenwashing’ (where capital raisers don the mantle of green, but without the tangible commitment to deliver on their promises). The lack of clarity on standards and the costs of complying continue to put off many raisers of capital, partly accounting for the lack of green/ESG compliant demand to meet fast growing capital supply.
Concerning legacy lending, there needs to be clearer pathways for legacy industries to transition to a greener future as well as a recognition that banks have a responsibility to allocate funds to support customers and economies. Moreover, although regulators and rating agencies see increased links between credit quality and environmental risks, greenness and credit riskiness are two very separate considerations. As regulators toy with the idea of lowering capital charges for ESG lending or investment, this will need to be carefully balanced.
Alert now to the risks of global warning, many governments are making welcome commitments to ‘net-zero’ targets. Without plans to achieve this, these might end up as empty promises. The UK’s commitment should not be underestimated, but it is also widely acknowledged that the emerging economies and China are where the key changes will need to occur. Despite the prevailing geopolitical trends, the need for global responses cannot be overstated with cooperation on the international scale vital in order to effectively fight the climate crisis.
Tim Skeet - Career Banker in the City
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