Green currency

Global warming has now become a major challenge for our societies. According to the World Meteorological Organization, the last three years have been the “hottest on record” and the pace of global warming is “exceptional” for the United Nations. According to the Institute For Climate Economics, greenhouse gas emissions have increased by 70% since 1970. And the outlook is not very encouraging: among 4 scenarios considered by the Intergovernmental Panel on Climate Change (IPCC), only the most optimistic estimates that there is more than a one in two chance that the increase in global temperature will not exceed 2 degrees by 2100.

It is accepted that greenhouse gases cannot be reduced if all political, economic and citizen actors do not unite. The very ambitious COP 21 illustrated this perfectly. Indeed, the participation in this conference of many companies, banks and members of civil society, as well as the commitments made by States, highlighted the need for a collective approach. In a system driven by increasing capital movements, finance, in the broad sense, defined as “all activities that make possible and organize the financing of economic agents”, is an essential means of achieving the ambitious objectives set by the 196 delegations meeting in Paris at the end of 2015. In recent years, government and economic actors have called “climate finance” this part of finance, one of whose objectives is to contribute to the fight against climate change.

But what exactly does this cover? climate finance ? Who are the stakeholders, what are their objectives? How have financiers come to take the environmental dimension into account in their activities as insurers, lenders or investors?

The book by Pierre Ducret and Maria Scolan answers these many questions in detail. Without naivety, but with optimism, the authors provide an overview of recent developments in finance associated with climate issues and insist on the need to continue to act quickly and forcefully.

Fragile development and many challenges

Climate finance, according to the authors, “aims to finance the transition to a carbon-neutral and climate-resilient economy” (p. 16). This very general meaning allows P. Ducret and M. Scolan to study the full diversity of private financial actors (banks, insurers, investors, pension funds, companies, etc.) involved in financing the energy transition, but also the public policies implemented by governments to develop and redirect financing towards the latter. Faced with the heterogeneity of actors with sometimes contradictory objectives, the authors’ aim is to analyze the advances that contribute to taking the climate challenge into account in financial choices.

First, the authors introduce and motivate the development of climate finance based on a rapid mapping of greenhouse gas emission sources and then the different forms of financing projects participating in the transition to a carbon-neutral economy, such as public-private partnerships, self-financing, specialized funds, or even innovation financing and venture capital. Then, tracing the birth and development of environmental financing since the Earth Summit in 1992 in Rio, they show the progress of certain political and economic actors in taking into account the climate issue. In 2006, the Stern report (an economist commissioned by the United Kingdom government) called for action on climate as quickly as possible by increasing financing, before the cost of the transition becomes inaccessible. The successive agreements of Copenhagen in 2009 and Rio+20 in 2012 gradually made it possible to formalize the concept of green growth, which combines support for economic growth and preservation of the environment, and to guide countries with divergent interests towards common objectives. However, the authors rightly highlight the weakness of investments supporting the energy transition, with the International Energy Agency noting in 2014 that

The energy scenario based on current trends will fail to achieve the climate stabilization goal. (p. 44)

Furthermore, financing for adaptation to climate change, the needs of which are significant in developing countries (more than 70 billion euros per year) is not a priority and represents only 20% of total financing.

The authors then list the different public policies aimed at promoting the financing of the transition: regulations, incentives to support renewable energies, transparency obligations, carbon pricing which introduces the idea that the polluter must pay for the CO2 that it emits. Above all, they offer a detailed analysis of a measure supported by many economists and financial circles: the establishment of a global carbon price and tradable emission rights. These mechanisms make it possible to “increase the competitiveness of low-carbon activities” (p. 76) and to redirect investments. The main obstacle encountered by these mechanisms is the economic disparities between countries, and the fact that they have divergent objectives and ambitions in terms of reducing greenhouse gases (p. 81). Can the United States and Chad pay the same price for a ton of carbon? If so, how can we create clear redistribution mechanisms accepted by all parties? While the theory seems attractive, political and economic realities show the limits of such a model. Although imperfect, the carbon price remains useful, among other incentives, in the fight against global warming.

Towards a low-carbon economy

Beyond public policies, financial players are behind several innovations that enable the financing of energy transition projects. Socially responsible investment, consisting of including environmental, social and good governance criteria (ESG) to select companies in which to invest, now represents 60% of financial assets managed in Europe and 30% worldwide. Similarly, extra-financial rating agencies have emerged, whose objective is not to directly assess the economic performance of companies, but rather their environmental, social and governance policies. Furthermore, green bonds (” green bonds “), these loans made on the stock markets which finance projects promoting the ecological transition, are growing rapidly with more than 120 billion dollars of issues in 2017 compared to 90 in 2016.

“Carbon risk” is also beginning to be integrated into the financial valuation of assets. Shares (assets) on the stock market of companies that produce fossil fuels present a carbon risk, for example, since they are likely to suddenly lose a large part of their value during the energy transition, due to regulatory changes and new environmental constraints. Asset managers are therefore increasingly tending to “limit the carbon risk of portfolios” and to “seize low-carbon transition opportunities” (p. 111) by reducing their investments in high-emitting companies and by financing “green” companies.

Innovations affect all types of financing linked to the environment: banks offer “green credits”, which make it possible to finance the renovation of housing, for example; insurance companies also offer green insurance products, whose premiums are calculated on the basis of the greenhouse gases emitted by the insured, such as car insurance ” pay as you go/drive “, which consist of charging the customer based on the kilometers he travels.

Here again, the authors insist on the need to develop these innovations and financing, the volumes of which remain low, by improving the consideration of climate risk by banks and investors, by standardizing green products, by developing securitization to refinance the risks taken (i.e. the transfer to a third party of certain risks taken by an entity, so that the latter reduces its own risk). They also propose reducing the cost of information on companies’ greenhouse gas emissions, or offering support from public authorities in the form of guarantees for example and favorable regulations. All these proposals have one objective: to reduce the cost of capital, which is still too high, on green investments.

The clock is ticking

What direction will climate finance take in the coming years? Some announcements mentioned by the authors seem encouraging: agreement at the COP 21 in Paris; involvement of banking supervisors such as Mark Carney and the Financial Stability Board; French law on energy transition; creation of a working group to improve climate-related information made public by companies, such as greenhouse gases emitted.

These recent advances are unfortunately struggling to materialize. The Norwegian pension fund cited by the authors did indeed introduce a climate-related exclusion criterion in 2015. However, the 2016 report of the ethics council of this fund explains the difficulty of evaluating this criterion due to its still vague definition and the opacity of the information provided by companies. The authors also mention the thirteenth Chinese five-year plan (2016-2020) “which will make green growth one of its five priorities” (p. 167). However, the emissions trading mechanism that has just opened in China is struggling to develop and the system is not expected to be effective until 2020, for only a third of the country’s emissions. The authors also discuss the many possibilities offered by monetary policies, citing the example of the central bank of Bangladesh which grants “preferential refinancing conditions to green bank loans” (p. 171). Here again, these many intellectually stimulating avenues seem far from seeing the light of day. The Paris Agreement has been weakened by the election of Donald Trump and the subsequent withdrawal of the United States, the second largest polluter in the world. Similarly, uncertainties remain around the ratification of the agreement by Russia (the fifth largest polluter in the world).

Progress is therefore undeniable, but is it sufficient on the time scale we have to preserve the balance of the planet? In their conclusion, the authors remain aware of the many challenges to overcome, such as the best use of public funds or carbon pricing at the local level. The essential message of this work is that it is necessary to go beyond the “tragedy of horizons”, which refers to the fact that “the greatest climate disasters will occur at a time frame that exceeds our usual decision-making horizons” (p. 178). Financiers, who assess their risks and returns over periods that are too short, do not integrate climate risk or only slightly and therefore invest too little in long-term green projects, which are necessary for the energy transition. The authors then call on public authorities to reduce the cost of capital in green investment and, thus, change the allocation of resources towards green projects.