There is an opportunity to present a refreshed, united front on the way to use the totality of global finance to stop greenhouse gas emissions. The re-emphasis would be on:
This article sets out how we might create an internationally-recognised financial architecture framework which governments should aspire to implement nationally.
UN COP is the Conference of the Parties to the United Nations Framework Convention on Climate Change (UNFCCC), commonly referred to as the UNFCCC COP. This annual gathering focuses on global efforts to address climate change and implement measures outlined in the UNFCCC, such as reducing greenhouse gas emissions, adapting to the impacts of climate change, and providing financial and technological support to developing countries.
The ultimate objective of the Framework Convention, as stated in 1992, is “stabilization of greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic [i.e., human-caused] interference with the climate system”. Despite efforts from the first conference (COP1) held in 1995 in Berlin, annual global greenhouse gas emissions continue to rise and, though they may have stabilised on a per capita basis, show little sign of falling soon. In short, the Framework Convention is not yet working. COP28 will be held in the United Arab Emirates from Thursday, 30 November till Tuesday, 12 December 2023.
Reducing global greenhouse gas emissions requires a combination of economic and social mechanisms that drive sustainable practices and promote the transition to a low-carbon economy, such as:
A combination of these mechanisms, tailored to specific regional contexts, is typically needed to achieve significant and lasting reductions in global CO2 emissions. Additionally, policy stability, long-term planning, and consistent commitment from governments, businesses, and individuals are crucial for successful implementation.
Mechanisms 1 to 8 above are all moving ahead, yet reports conclude that the scale of finance is still paltry, e.g. “Only about 16% of climate finance needs are currently being met. To achieve net zero, public and private sector entities across the globe will need approximately $3.8 trillion in annual investment flows through 2025. But only a fraction of this capital is currently being deployed. Even when viewed with a wider lens that considers funding such as transition finance, expected needs still outweigh flows by 66%.” What Gets Measured Gets Financed: Climate Finance Funding Flows and Opportunities, Rockefeller Foundation & BCG (4 November 2022).
The third Conference of the Parties (COP3) to the United Nations Framework Convention on Climate Change (UNFCCC) took place in Kyoto, Japan, in 1997. The primary outcome of COP3 was the adoption of the Kyoto Protocol, an international treaty aimed at reducing greenhouse gas emissions and combating climate change. The key agreements reached at COP3 include:
a) Emissions Trading: Countries could engage in emissions trading schemes (ETSs), allowing them to buy and sell emissions allowances to meet their targets. This mechanism aimed to create a market for emission reductions and promote cost-effective solutions.
b) Clean Development Mechanism (CDM): Annex I countries could invest in emission reduction projects in developing countries and receive credits for those reductions. This aimed to encourage sustainable development in developing nations while helping Annex I countries meet their targets.
c) Joint Implementation (JI): Annex I countries could implement emissions reduction projects jointly and receive credits for the reductions achieved. This was meant to encourage collaboration and technology transfer between developed countries.
While the CDM and JI have struggled, credible ETSs now cover 23% of global emissions. A major breakthrough was the implementation of a Chinese ETS in 2021.
As most of these systems cover roughly 50% of their national or regional emissions, approximately 46% of emissions could be covered by achieving 100% coverage. Clearly COP28 could focus on moving to 100% coverage and 100% of nations having an ETS. Two of the larger outliers with no ETS are the USA (14% of global emissions) and India (7%).
ETSs can and do work, as shown round the world, once the permit issuance is restricted and the markets enforced.
Meanwhile, ESG has become, incorrectly, synonymous with preventing climate change. Rating agencies and consultancies are developing ESG scores for clients, for a wide variety of issues using a wide variety of algorithms. But as the MIT ‘Aggregate Confusion’ project found, companies could be in the top 5% on one ESG rating algorithm and the bottom 20% on another. And reputable firms like Shell find their ratings to be A from one rating agency and C+ from another. A recent issue of the Financial Times’s Responsible Investing supplement, FTfm, notes that “a lack of definitions and data is a sizeable obstacle to sustainable (ESG) investing”.
Advisors to financial services firms have been pushing ESG approaches hard, not least because ESG work generates fees. Yet the resulting clamour and confusion and costs have led to firms leaving capital markets for private sources of funding, thus negating the intended outcome that ESG strictures should increase the cost of capital for non-compliers. Good, legal, cashflow is valuable on unlisted markets too.
Taxonomic confusions have led to perverse roadmaps and blockages. The threat of litigation has led firms, e.g. major insurers, US-listed companies, to drop the targets altogether.
Social and governance issues are tangentially related to greenhouse gas emissions. Within ‘E’, there are many components that have market failures where ESG monitoring may help, e.g. forestry, water, biodiversity. However, ETSs can and do work. Perhaps the chant should be, “Take the ‘C’ out of ‘ESG’.
This paper’s proposal is to prepare for COP28 by submitting a much clearer financial compact combined with some straight talking, about carbon only. “We, the global financial services industry, can stop greenhouse gas emissions using markets, if governments commit to:
Perhaps call this ‘All-In Finance Against Carbon’ or ‘Extreme Finance To Save The Planet’. Behind this idea would be a ‘template’ for governments to use to ensure that their financial architecture meets the requirements for delivering net-zero 2050, e.g.:
The diagram below attempts to summarise how this financial architecture might fit together.
Clearly, if there is interest in an All-In Finance Against Carbon compact, then there is much discussion ahead of COP28 and during the COP28 year. A sticking point will be those who wish to bring in many of the other ‘E’ items. While supporting the goals of wider sustainable finance, the sub-set of anti-carbon finance is the goal of the All-In Finance Against Carbon. Discussions would need to work towards:
Much has been made of the fact that 2024 is the 80th anniversary of Bretton Woods, where the world agreed on a new international monetary system. Some of the principles of Bretton Woods might have analogues that apply to this global crisis:
CFCs were solved by banning them. But there were existing alternatives to CFCs. SOX and NOX were solved largely by financial markets using markets, as there still needed to be some emissions. Greenhouse gases, as agreed at COP3, fall into a category similar to SOX and NOX – markets can fix this problem.
An All-In Finance Against Carbon compact is an ambitious goal. Frustration at the lack of progress and the numerous result-free jobs-for-the-ESG-boys-and-girls should lead to a desire to use grown-up, hard finance to solve the resource allocation and pollutant problems it has solved elsewhere.
Aviva Investor’s report, “Act Now: A Climate Emergency Roadmap for the International Financial Architecture” (October 2022), provides a summary and roadmap for transforming the international financial system to effectively address the challenges posed by climate change. The key points covered in the document are as follows:
a) Climate Risk Assessment: Encouraging financial institutions to integrate climate risk assessments into their decision-making processes and disclosure frameworks. This includes assessing both physical and transition risks associated with climate change.
b) Macroprudential Regulation: Strengthening the role of regulators in addressing climate-related risks and incorporating climate stress testing into prudential frameworks to ensure financial stability.
c) Green Investment: Mobilizing capital towards green investments and sustainable projects by leveraging public and private finance. The document suggests measures such as green bonds, sustainable finance initiatives, and innovative financing mechanisms.
d) Carbon Pricing: Promoting the adoption of carbon pricing mechanisms globally to internalize the costs of carbon emissions and drive the transition to a low-carbon economy.
e) Sustainable Development: Integrating sustainability considerations into development finance and ensuring that infrastructure projects align with climate and environmental objectives.
f) International Cooperation: Enhancing international cooperation and coordination among financial institutions, governments, and regulatory bodies to address climate change collectively. This includes harmonizing standards, sharing best practices, and fostering information exchange.
Overall, the document provides a comprehensive overview of the need for and potential steps to transform the international financial architecture to effectively address the climate emergency. It emphasizes the urgency of taking action and the importance of cooperation among global stakeholders to tackle climate-related risks and promote sustainable development.
The principles used at the 1944 Bretton Woods Conference in New Hampshire, laid the foundation for the post-World War II international monetary system. The conference aimed to establish a framework for economic cooperation and stability among nations. The key principles adopted at Bretton Woods were:
10.Sovereign Autonomy: While promoting international economic cooperation, the Bretton Woods principles also respected the sovereignty of member nations. Countries retained control over their domestic monetary and fiscal policies while recognizing the need for coordination and consultation to maintain stability and avoid disruptive economic practices.
The principles agreed upon at the Bretton Woods Conference provided the framework for international economic cooperation and monetary stability for several decades.