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14 November 2016, Gateway House

Will Marrakech move the money?

Making the climate change transition involves an unprecedented reallocation of capital – and the task is to build the financial architecture that can deliver these flows within deadline. COP-22 has to raise more, cheaper and better quality finance for climate action.

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Government officials, meeting in Marrakech for the annual climate negotiations (COP-22, 7-18 November 2016), have reason to have a spring in their step. Last year’s Paris Agreement came into effect in record time, having been reinforced by a domino of measures to cut greenhouse gas emissions from chemicals, aviation and shipping. Yet beneath the smiles, there remains the hard reality: the measures currently in place are simply not adequate to hold global warming to below 2oC, ideally to just 1.5oC above pre-industrial levels. According to UN Environment, today’s commitments will reduce emissions by no more than a third of the levels required by 2030, risking warming of up to 3.4 oC.

Finance is a key lever to close this gap – and one of the significant innovations of the Paris Agreement was to introduce a new international objective of ‘making financial flows consistent with low greenhouse gas emissions and climate-resilient development’. This means rethinking how the $300 trillion worth of assets within the global financial system can now generate value within a limited carbon budget and an increasingly disrupted ecosystem.

At the heart of the challenge is how to mobilise far more, cheaper and better quality finance for climate action, particularly in the developing world. We now know that the transition does not require additional costs compared to the status quo. But it does involve a fundamental two-fold reallocation of finance both from high- to low-carbon assets and from vulnerable to resilient investments. Climate solutions invariably mean replacing the consumption of natural resources with human ingenuity and technology. From a financial perspective, this implies a more capital intensive system, one that is balanced by far lower operating costs, particularly in terms of energy use. This is the reason why the cost of capital is one of the main variables that will determine whether the transition will take place in time.

There are positive signs of momentum visible across the world’s financial system.  Actions that were unthinkable a few years ago are now being taken. Industrialised countries have just published a roadmap for mobilising $100 billion in annual flows to developing countries by 2020 – a pledge that was first made in 2009.

Latest estimates suggest that actual flows of climate finance into developing countries rose from $52 billion in 2013 to $62 billion in 2014. The new Green Climate Fund has just taken decisions to commit $1 billion this year to developing countries.

Over in the investment world, institutions with over $10 trillion in assets have committed to publish a ‘carbon footprint’ of their portfolio – and a leading group is going further by taking action to decarbonise $600 billion worth of assets.

The ‘green bond’ market is booming, with issuance so far this year of $65 billion, up from barely $11 billion in 2013. Investors want to buy green assets, and countries such as China, India, Morocco, and Nigeria, see green bonds as offering a new tool to finance their ambitions for sustainable development. And some of the world’s leading financial centres, such as Hong Kong, London and Paris are now involved in a race to claim their share of the green finance prize.

Important financial actors, such as central banks and regulators, that were once absent from the scene have also been stirred to action. In September, the People’s Bank of China and six other financial agencies published a 35-point set of guidelines for ‘greening the financial system’.

The Bank of England undertook the first review of the implications of climate change for the financial system: this was one factor that led to the establishment of a new Task Force under the Financial Stability Board to set out a roadmap for consistent climate disclosure, thereby enabling business and investors to make informed decisions. For the first time, G20 finance ministries and central banks this year recognised the need to ‘scale up green finance’, identifying a set of steps to mobilise private capital.

In all, UN Environment has estimated that the number of policy and regulatory measures to promote more sustainable finance has doubled to over 200 in the past five years.

This unprecedented momentum, however, is still far from ensuring that the world’s financial flows become ‘climate consistent’. To take one indicator: only 0.4% of the assets of the world’s top 500 asset owners have been identified in low-carbon investments.

The reasons for this are not a mystery. Public finance for climate action may be growing, but remains insufficient, both in terms of volume and allocation: only a fraction is supporting developing countries to adapt to climate shocks, for example. In the wider financial system, the costs of carbon pollution are still not reflected in market prices – and in many countries, are actually rewarded through the continued use of fossil fuel subsidies. Currently, financial institutions are not evaluated for the climate performance of their decisions. Furthermore, the short-termism of capital markets can mean that the strategic shifts required for climate transition appear to be always over the horizon.

The theme of the Marrakech conference is to move from the high-level commitments made in Paris to action on the ground. There is now real appetite across the financial system to bring together the policy frameworks and market innovation needed to drive this transformation. A vital starting point is to ensure that each country’s policies for financial sector development are in tune with its climate plans (known in UN parlance as the ‘nationally determined contributions’). As part of this, countries can identify the key financial policy levers that could scale up green finance and avoid stranded assets. These can include efforts to create new markets (such as for green bonds), improve capital market disclosure and strengthen risk analysis by banks, insurers and investors. One area of increasing interest concerns the implications of climate factors for the capital requirements of banks and insurers.

The strategic use of public finance needs to reinforce these steps to get the financial architecture right. Here, developing countries need greater visibility over the steps that industrialised countries will take to deliver the precious $100 billion through to 2020 and beyond, particularly to withstand mounting climate shocks.

The gulf between ‘high finance’ and the real world facing small enterprises and households also has to be bridged. Here, fintech innovations, such as peer-to-peer finance, could help to substantially improve access to capital. Ultimately, a climate finance dashboard will be needed to track the performance of the world’s capital stocks and flows so that decarbonisation and resilience are the norm. Setting in motion actions such as these would ensure that Marrakech becomes known for really moving the money.

Nick Robins is Co-Director, Inquiry into the Design of a Sustainable Financial System, United Nations Environment Programme (UNEP).

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