GLOBAL SOLUTIONS JOURNAL ∙ ISSUE 5 BEYOND GREENWASHING: INSTRUMENTS TO FIGHT CLIMATE CHANGE AND PROTECT THE PLANET’S RESOURCES

cording to 2017 data, the US still produces that a low-carbon transition could require Realizing the twice as much as carbon dioxide per capita $3.5 trillion in energy sector investments as China and nearly nine times as much every year for decades – twice the current as India, highlighting the increased envi- rate. Under the agency’s scenario, in order low-carbon future ronmental impact of higher standards of for carbon emissions to stabilize by 2050, living. All of this means the Paris Climate nearly 95% of the electricity supply must Agreement’s goal of limiting the global be low carbon, 70% of new cars must be What role for central banks and monetary temperature increase to 1.5 degrees Cel- electric, and the carbon-dioxide intensity sius could be a pipe dream if energy in- of the building sector must fall by 80%. authorities? vestments worldwide do not change. For markets to anticipate and smooth The economy-wide changes needed to the transition to a low-carbon world, they attain a low-carbon future are enormous: need information, proper risk manage- a massive reallocation of capital is need- ment and coherent, credible public-policy The author: ABSTRACT ed, which presents unprecedent risks and frameworks. That could be strengthened Placing both advanced and developing opportunities to the financial system. The by central banks and monetary authori- Venkatachalam countries on a low-carbon path requires International Energy Agency estimates ties. Anbumozhi an unprecedented shift in private invest- Senior Energy Economist, ments and new financing models. The ERIA financial sector will have to play a cen- tral role in this low-carbon transforma- tion, while avoiding destabilizing effects Figure 1: Annual CO emissions per country (tons of CO , 2017) on economic systems. Central banks and 2 2 other financial institutions are ready to use their extensive knowledge in lending, investment, and smart advisory services to achieve the low-carbon targets expressed in the Paris Agreement. With support from central banks, commercial and national The institution: development banks can offer diverse fi- nancing products with maximum impact and appropriate risk management. Despite increased calls to reduce global carbon emissions in light of climate change, energy-related carbon dioxide The Economic Research Institute for ASEAN emissions worldwide rose 1.7% last year, and East Asia is an international organization hitting a record high (IEA, 2018). It is the providing research and policy support to the fastest rate of growth since 2013. While East Asia region and the ASEAN and EAS emissions declined in Europe, they were summit process. It was established in Jakarta, up in big G20 economies like the US, China Indonesia at the third East Asia Summit in 2007, serving 16 member countries of the and India (Fig 1). Coal, especially in Asia, region, providing policy recommendation for played a significant role in the increase. At further economic integration in the East Asia the same time, it is worth noting that ac-

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CLIMATE CHANGE, A LOW-CARBON the financial sector are closely linked to which will be written off the balance sheets system, while avoiding excessive economic FUTURE AND LIABILITY AND adjustments in real sectors and can be of the companies that own them. Other losses and financial instability. REGULATORY RISKS triggered by: physical assets that could become strand- The investment community faces several • mandatory or voluntary changes in ed include part of the fossil fuel-driven ROLE OF CENTRAL BANKS IN kinds of risks as a result of such market- emission-control policies that companies electricity-generation capacity stock, resi- CATALYSING PRIVATE FINANCE FOR A based and regulatory actions. Regulatory need to comply with, possibly entailing ad- dential housing, real estate, transportation LOW-CARBON TRANSITION risk is most relevant to the financial sec- ditional costs; infrastructure and other forms of carbon- Dikau and Volz (2018) distinguished between tor, followed by liability or litigation risk, • declining profitability and cash flows intensive industrial technology (Anbumozhi central banks’ responses to environmen- and finally, reputational risk. These risks of projects underwritten by financial insti- et al, 2018). Such asset stranding will not tal externalities affecting their traditional are interlinked and interdependent and tutions, resulting from higher capital and only lead to economic losses and unem- core responsibility of safeguarding mac- may encompass physical risks from the operating expenditures required to miti- ployment, but will also affect the market roeconomic and financial stability, and an adverse impacts of climate change such gate and adapt to climate change; valuation of the companies that own the activist role for central banks in supporting as natural disasters. Anbumozhi (2017) • low-carbon technologies and innova- assets, thus negatively impacting their in- the development of a low-carbon economy. identified three risk categories for G20 tions that render previous technologies or vestors, and potentially triggering cascade They also took climate risk into account in economies: (i) Physical risks include the products financed by financial institutions effects throughout the deeply intercon- the design of monetary policy and financial impact on insurance liabilities and finan- obsolete; and nected financial system (Table 1). regulation in the pursuit of the traditional cial assets that result from climate- and • a shift by consumers away from high Hence, the changing role of central goals of price and financial stability. This weather-related events such as floods and carbon-emitting products. banks and monetary authorities is to find can be described as the passive aspect of storms which damage property or disrupt a gradually shrinking window of opportu- green central banking because, in pursuing trade. The consequences are the greatest nity that would allow societies to achieve a their established goals, central banks may for the insurance sector, but also extend »The economy- rapid transition to a low-carbon economic need to incorporate environmental factors more broadly. (ii) Liability risks occur when parties that have suffered loss or damage wide changes from the effects of climate change seek compensation from parties they hold re- need to attain Table 1: The trade-offs in transition to a low-carbon future sponsible. Such claims could come dec- ades in the future, creating liabilities for a low-carbon fossil-fuel extractors and emitters and No low-carbon Rapid or orderly Abrupt transition their insurers. (iii) Transition risks are the future are transition transition financial risks that could result from the Stranded physical process of adjustment towards a lower- enormous.« assets (e.g., fossil- carbon economy. Changes in policy, tech- fuel reserves) and Minimal stranding Short term No stranded assets stranded financial nology, and physical risks could prompt a of assets assets (e.g., loss in reassessment of the value of a large range Whether driven by unanticipated poli- market valuation of assets as costs and opportunities be- cies, technological developments or mar- and cascade effects) come apparent. Particularly rapid repric- ket preferences, the shift to a low-carbon ing could threaten financial stability. future will cause a system-wide societal Climate-induced Minimal climate- No significant damages to When financial institutions are unpre- adjustment, during which certain sectors induced damages climate-induced Long term productive assets, to physical and damages to physical pared to assess or respond to the low- are likely to lose out. For example, respect- climate-related financial assets and financial assets carbon risks described above, they may ing the 2O C threshold in temperatures will financial losses face additional legal risks from inaction require a large portion of existing reserves (OECD, 2016). Further, transition risks in of coal, oil and gas to remain in the ground,

108 109 GLOBAL SOLUTIONS JOURNAL ∙ ISSUE 5 BEYOND GREENWASHING: INSTRUMENTS TO FIGHT CLIMATE CHANGE AND PROTECT THE PLANET’S RESOURCES into existing frameworks, e.g. into macro- environmental and social (E&S) risk man- the health of individual financial institu- Differentiated capital requirements prudential frameworks, without pursuing agement standards requires financial insti- tions, and the financial system as a whole. Through capital requirements, financial a low-carbon agenda. On the other hand, tutions to incorporate E&S risk factors into Apart from enabling the evaluation of the regulators require financial institutions central banks may be mandated to actively their governance frameworks. To enforce resilience of the financial system to ad- to hold a certain percentage of capital for use the tools at their disposal to promote climate-related risk management beyond verse shocks, climate-related stress tests risk-weighted assets, which is usually ex- green investment or discourage brown in- disclosure, green E&S risk management would also be necessary to calibrate green pressed in the capital-to-risk (weighted) vestment and play a developmental role. standards may also establish E&S rules macro-prudential policy instruments and assets ratio. Capital requirements could Central banks in developing and for banks’ lending practices by requiring to allow for the incorporation of the iden- theoretically differentiate asset classes emerging economies in Asia have been at the assessment of these risks, as well as tified vulnerabilities into capital buffers, based on sustainability criteria and assign the forefront of using a broad range of in- considering the potentially harmful envi- risk weights, and caps (Amerasingh et al, higher risk weights to carbon-intensive struments to address environmental risk ronmental effects of new financial services 2017). assets in anticipation of future negative and encourage low-carbon investment. and products. Furthermore, mandatory and sudden price developments (World Since 2015, central banks in advanced green risk-management standards could Bank, 2018). economies have started to address the oblige banks to include an assessment of »When financial implications of low-carbon investment E&S risks in the loan origination process MONETARY POLICY OPERATIONS AND for monetary and financial stability. The as a criterion based on which loans are institutions are THE FINANCING OF A LOW-CARBON Bank of England has played a central role extended. This would likely also have al- FUTURE BY CENTRAL BANKS in raising awareness of the implications of locative consequences by reducing the flow unprepared There are several ways in which central low-carbon transition risks amongst cen- of finance to polluting and energy-inten- banks and monetary policy authorities can tral banks. The pioneering central banks sive firms and enhancing the financing of to assess or engage their supervisory bank with the apply the following policy instruments. greener projects (Huxham et al, 2017). low-carbon transition (table 2). First, they respond to the can favor assessment of climate-related Disclosure requirements Reserve requirements risks, both for single institutions and at Effective disclosure requirements for Reserve requirements determine the low carbon the systemic level. This is the strategy cur- banks and other financial institutions of minimum amount of reserves that com- rently implemented by some central banks low-carbon project-related risks can play a mercial banks must hold. They could be risks, they may in high-income countries. Second, they central role in ensuring that financial insti- calibrated to create incentives leading to can employ policy tools at their disposal tutions correctly price in the impact of low- the promotion of green assets or make face legal risks to mitigate climate-related risks and sup- carbon policies. TCFD disclosure require- brown lending less attractive. Differential port the development of low-carbon activi- ments are a central element of forming a reserve requirements that are linked to the from inaction.« ties. While several examples of proactive response to climate and environmental composition of banks’ portfolios, allowing behavior by central banks are available in risk, since a lack of information on the risk lower (higher) required reserve rates for emerging G20 economies, this approach exposure of financial institutions has con- portfolios skewed towards greener, less has not yet been implemented systemati- sequences for financial stability because carbon-intensive assets (brown, carbon- Countercyclical capital buffers cally. the misallocation or mispricing of assets intensive assets) could influence the allo- Countercyclical capital buffers are used may cause abrupt price corrections in fi- cation of credit and promote green invest- to mitigate the financial cycle and can be POLICY AND VOLUNTARY ACTIONS nancial markets later (FSB TCFD, 2017). ments (Ng, 2018). calibrated with regard to environmental DRIVING LOW-CARBON DISCLOSURE risks to ease the potential effect of pricing For banks, owners and managers of as- Environmental and social risk manage- Climate-related stress testing in a ‘carbon bubble’ – the expected sudden sets, the quality and availability of relevant ment standards Climate-related stress tests can fulfil the repricing of carbon-intensive assets due to information is one of the key barriers to Similar to disclosure requirements, finan- task of assessing the potential impact that stricter emission targets and environmen- incorporating climate issues into their in- cial regulation that endorses mandatory natural hazards may have on the economy, tal policy (UN Environment, 2017). vestment processes. In part to address this

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Table 2: Interventions by central banks and financial regulators in support of private deficiency, the Financial Stability Board closing organizations will also benefit financing of the low-carbon transition Task Force on Financial Disclosure (FSB from the process, gaining a better under- TCFD) issued its final report in June 2017, standing of the real financial implications providing recommendations on low-car- of climate-related risks and their potential bon project-related financial disclosures impacts on business models, strategy, and Approach Concept Current application that are applicable to organizations across cash flows. sectors and jurisdictions. If adopted widely, The TCFD highlights scenario analysis Assessment of Apply methodologies to De Nederlandsche the recommendations will normalize and as its preferred tool for producing for- climate-related identify and measure Bank improve the standards of corporate low- ward-looking information with respect to risks climate-related risks Bank of England carbon risk disclosures, allowing investors assessing climate risks and opportunities Task Force to better assess their own climate-related in a way that enhances the robustness and Disclosure of Develop standard methods on Climate- portfolio risk and provide this information flexibility of strategic plans. It also believes climate-related of climate-related risk related Financial to their clients and beneficiaries. The FSB such information is important for investors risks reporting Disclosures TCFD report knitted existing frameworks and other stakeholders in understanding into a single framework for disclosure on how vulnerable individual organizations Use prudential regulatory the assessment and management of cli- are to climate-related risks, and how such People’s Bank of Low carbon- tools, e.g., reserve and mate-related risks and opportunities and vulnerabilities might be addressed. China aligned prudential capital requirements to encouraged board-level engagement with Banco Central do regulation policy banks lending to low-carbon the issue. It strongly recommended using Brasil projects scenario analysis techniques as part of the »Disclosing process. The framework contains the fol- Provide additional/subsidized lowing key elements (FSB TCFD 2017): organizations Green central bank Bank of Japan liquidity to banks lending to • adoptable by all organizations; financing Bangladesh Bank low-carbon activities • included in financial filings; will gain • designed to solicit decision-useful, Impose a minimum Reserve Bank of forward-looking information on financial a better Lending quotas proportion of bank lending to India impacts; and flow to low-carbon sectors Bank of Indonesia • strong focus on risks and opportuni- understanding ties related to the transition to a lower- Include low-carbon criteria carbon economy. of the financial Inclusion of low- in the evaluation of overall State Bank of The recommendations focus on four carbon criteria in risk of an asset purchased or Vietnam key themes that are aligned with how or- implications of monetary policy accepted as collateral ganizations operate: governance, strategy, risk management, and metrics and tar- climate-related Purchase green assets as gets. The themes are fleshed out with rec- Green quantitative European risks.« part of quantitative easing ommended disclosures that organizations easing Investment Bank programs should include in their financial filings in each of the four areas, to provide investors and other stakeholders with information CONCLUSION that helps them understand the reporting G20 policymakers now face the challeng- organization’s assessment of its climate- ing task of ensuring a structural shift to a related risks and opportunities. The dis- low-carbon economy while concurrently

112 113 GLOBAL SOLUTIONS JOURNAL ∙ ISSUE 5 BEYOND GREENWASHING: INSTRUMENTS TO FIGHT CLIMATE CHANGE AND PROTECT THE PLANET’S RESOURCES safeguarding economic prosperity and the tors should further deepen their activities stability of the financial system. Achieving in assessing climate-related financial risk With or without you this goal will require financial markets and exposures of their regulated firms, includ- institutions to start considering climate- ing what data and methods they are using related risks in their financing decisions. in assessing these risks, and take appro- How the G20 could advance global action toward G20 central bank governors and monetary priate actions if prudential risks are found authorities can contribute to this process to be material. Finally, central banks might climate-friendly sustainable development in several ways. First, they can support wish to consider whether they should ac- measures to improve financial markets’ count for climate-related factors in deter- ability to consider climate-related risks, mining the eligibility of assets for their as- e.g. better disclosure of such risks. Sec- set purchase programs or as collateral in The authors: With a collective responsibility for 80% of ond, central banks and financial regula- their market operations. Steffen Bauer global greenhouse gas emissions, while representing 80% of global wealth, the Senior Researcher for Environmental Governance and Head of Klimalog, countries of the G20 must throw their German Development Institute weight behind the implementation of both the Paris Agreement on climate change Axel Berger and the 2030 Agenda for Sustainable De- Senior Researcher for Transformation velopment. In the past, the G20 has dem- of Economic and Social Systems, onstrated it can do that. The G20 Summit German Development Institute in November 2015 in Antalya, Turkey, pro- Gabriela Iacobuta vided strong support for the climate agree- ment signed a month later at the UN Cli- Researcher for Environmental Governance, German Development mate Change Conference (COP21) in Paris. Institute In 2016 in Hangzhou, China, the G20 adopt- ed an Action Plan on the 2030 Agenda and

Anbumozhi, V., K. Kalirajan, and F. Kimura, eds. (2018), Financing for Low-Carbon Energy Transition: committed to “further align its work” with Unlocking the Potential of Private Capital. Singapore: Springer. The institution: the 2030 Agenda. Even though both agen- Anbumozhi, V., K. Kalirajan, F. Kimura, and X. Yao, eds. (2016), Investing in Low -Carbon Energy Systems: das have emerged in the multilateral con- Implications for Regional Cooperation. Singapore: Springer. text of the United Nations system, the G20 Amerasinghe, N., J. Thwaites, G. Larsen, and A. Ballesteros (2017), The Future of the Funds: Exploring the Architecture of Multilateral Climate Finance. Washington, DC: World Resources Institute. is expected to exert strong political leader- Dikau, S. and U. Volz (2018), ‘Central Banking, Climate Change and Green Finance’, ADBI Working Paper Series, ship to address global climate change and No. 867. Tokyo: Asian Development Bank Institute. to achieve sustainable development. FSB TCFD (2017), Implementing the Recommendations of the Task Force on Climate-Related Financial Disclosures. Basel: FSB Task Force on Climate-Related Financial Disclosures. Yet, since 2017 the G20 has struggled Huxham, M., U. Varadarajan, B. O’Connell, and D. Nelson (2017), Mobilising Low-Cost Institutional Investment in The German Development Institute / Deut- to provide such leadership, as support Renewable Energy: Major Barriers and Solutions to Overcome Them. San Francisco, CA: Climate Policy Initiative. sches Institut für Entwicklungspolitik (DIE) is for multilateral commitments, especially IEA (2018) World Energy Outlook, International Energy Agency, Rome. one of the leading research institutions and those involving ambitious climate actions, Ng, A.W. (2018), ‘From Sustainability Accounting to a Green Financing System: Institutional Legitimacy and think tanks for global development and inter- Market Heterogeneity in a Global Finance Centre, Journal of Cleaner Production, 195, pp.585–92. appears to be fading. Crucially, opposition national cooperation worldwide. DIE’s work to strong multilateral climate policy in the OECD (2016), Green Investment Banks: Scaling Up Private Investment in Low-Carbon, Climate-Resilient is based on the interplay between Research, Infrastructure. Paris: OECD Publishing. US and Brazil resorts to outright climate Policy Advice and Training. DIE is building UN Environment Inquiry (2017), A Review of International Financial Standards as They Relate to Sustainable denialism at the highest levels of govern- Development. Nairobi: United Nations Environment Programme. bridges between theory and practice. Research ment. These developments are challeng- World Bank (2018), Climate Change, Overview. http://www.worldbank.org/en/topic/climatechange/overview at DIE is theory-based, empirically driven and (accessed 25 December 2019). application-oriented. ing the G20, and BRICS and the G7 for that

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