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“Green finance” still a long way from the Paris Agreement

peter_tankov
Peter Tankov
Professor of quantitative finance at ENSAE (IP Paris)

The con­cept of green finance has been around for about 20 years, but it only became main­stream in 2015 with the adop­tion of the Paris Cli­mate Agree­ment. Its rise sym­bol­is­es the moment when finan­cial insti­tu­tions woke up to the exis­tence of cli­mate risks; an event that has been strong­ly attrib­uted to for­mer Bank of Eng­land Gov­er­nor Mark Car­ney’s ‘Tragedy of the Hori­zons’ speech. Since then, reg­u­la­tors have pushed finan­cial insti­tu­tions to recog­nise the cli­mate risks borne by their asset port­fo­lios and to com­mu­ni­cate this to investors. It hap­pened first in France, with Arti­cle 173 of the Ener­gy Tran­si­tion Act of 17 August 2015, and then on a glob­al lev­el with the rec­om­men­da­tions of the Task Force on Cli­mate-Relat­ed Finan­cial Dis­clo­sures (TCFD) cre­at­ed by the Finan­cial Sta­bil­i­ty Board – which includes 26 major cen­tral banks and inter­na­tion­al institutions.

Align­ing finance and climate

In prin­ci­ple, the pri­ma­ry objec­tive of green finance is to align finan­cial flows with cli­mate objec­tives by min­imis­ing the neg­a­tive impacts and max­imis­ing the pos­i­tive impacts of invest­ments. To do this, there is a body of dif­fer­ent tools: spe­cif­ic finan­cial prod­ucts such as green bonds, indices, the famous ‘Paris-aligned index’ and engage­ment poli­cies with com­pa­nies and poli­cies to exclude com­pa­nies that are harm­ful to the cli­mate and bio­di­ver­si­ty issues in their port­fo­lios. Final­ly, there are spe­cif­ic mar­kets: the mar­ket for CO2 emis­sions or the mar­ket for off­sets of neg­a­tive exter­nal­i­ties, for example.

The sec­ond objec­tive is to mea­sure and mit­i­gate the finan­cial risks posed by cli­mate change on the one hand and by the ener­gy tran­si­tion itself on the oth­er. The for­mer are called phys­i­cal risks such as storms or for­est fires, and the lat­ter tran­si­tion risks. Tran­si­tion risks are caused by reg­u­la­to­ry changes aimed at mit­i­gat­ing the scale and impact of cli­mate change. For exam­ple, a coal-fired pow­er plant or coal mine could become unvi­able due to the high price of car­bon price or a change in con­sumer preference.

Lack of results

Over the past 5 years, a pos­i­tive dynam­ic has been set in motion but, apart from a pause due to Covid, the glob­al emis­sions curve is not yet show­ing any sign of slow­ing down. Invest­ments in renew­able ener­gies are insuf­fi­cient to reverse the trend and the com­mit­ments made by States in the frame­work of the Paris Agree­ment are insuf­fi­cient to achieve the objec­tive of this agree­ment. Glob­al invest­ment in renew­able ener­gy was $322bn 2018 (com­pared to $933bn invest­ed in fos­sil fuels the same year)1. Mean­while to pre­vent warm­ing about 1.5°C by 2100 requires invest­ment of $797bn each year between 2016 and 2050.

The results of green finance are not yet sat­is­fac­to­ry despite the impres­sive fig­ures. This is part­ly due to the lack of invest­ment in renew­able ener­gy, espe­cial­ly in devel­op­ing coun­tries, which are still con­sid­ered risky by pri­vate investors. Fur­ther­more, the com­mit­ments made by indi­vid­ual investors or groups of investors are cur­rent­ly insuf­fi­cient to trig­ger a tran­si­tion dynam­ic and are also dif­fi­cult to eval­u­ate and compare.

Need for a glob­al effort

Europe is ahead of the game with some mod­el coun­tries in terms of reg­u­la­tion such as France, the UK and the Nether­lands. In the US, even though the exit from the Paris cli­mate agree­ment had a sig­nif­i­cant neg­a­tive media effect, the pres­ence of a cli­mate-denier as in the White House for four years has not quite reversed the estab­lished momen­tum. This is because the time for invest­ment is long, and many ini­tia­tives are tak­ing place at the cor­po­rate and state lev­el. In par­tic­u­lar, despite Pres­i­dent Don­ald Trump’s efforts to sup­port the tra­di­tion­al indus­try, 2019 saw a record num­ber (after 2015) of coal plant clo­sures. 15 GW were replaced by renew­ables and gas. It should be not­ed that the use of gas-fired pow­er plants, even if it does not allow car­bon neu­tral­i­ty and will even­tu­al­ly have to be aban­doned, is a quick way to reduce emis­sions as coal emits almost 3 times more car­bon diox­ide than methane for the same amount of ener­gy produced.

Chi­na, while still the largest emit­ter of green­house gas­es and with emis­sions still ris­ing, is also the coun­try that is invest­ing the most in renew­able ener­gy. It is com­mit­ted to achiev­ing net zero by 2060 and is at the fore­front of green finance both in terms of mar­ket devel­op­ment (“green bonds”) and par­tic­i­pa­tion in inter­na­tion­al ini­tia­tives (NGFS etc.).

Con­sumers also play a key role in the ener­gy tran­si­tion as they are the ones who ulti­mate­ly make the deci­sion to switch to elec­tric cars or ren­o­vate their homes. Green finance can help finance these projects, and this con­cerns both pub­lic and pri­vate play­ers, par­tic­u­lar­ly banks.  But also, to have an impact on the real econ­o­my, investors need to dis­en­gage them­selves from assets that are harm­ful to the cli­mate. As long as this is not the case, we can­not con­clude pos­i­tive­ly on the real impact of green finance.

At Insti­tut Poly­tech­nique de Paris, issues relat­ed to sus­tain­able devel­op­ment, ener­gy tran­si­tion and green finance are addressed at the ‘Ener­gy for Cli­mate’ Cen­tre and in par­tic­u­lar in ‘long-term sus­tain­able devel­op­ment’, of which I am co-direc­tor. This line of research aims to char­ac­terise the sus­tain­able evo­lu­tion of ener­gy and the design of ener­gy mar­kets that will accom­pa­ny the tran­si­tion to a decar­bonised econ­o­my. We are also work­ing on envi­ron­men­tal impact mea­sures and the align­ment of investors’ port­fo­lios with a tem­per­a­ture and cli­mate risk sce­nario, in par­tic­u­lar by using machine learn­ing algo­rithms and big data. We rely on inte­grat­ed eco­nom­ic-cli­mate mod­els to assess invest­ment projects in the ener­gy tran­si­tion. A final impor­tant top­ic is the inte­gra­tion of ESG cri­te­ria into port­fo­lio management.

Interview by Clément Boulle
1Glob­al Land­scape of Renew­able Ener­gy Finance, IRENA, 2020

Contributors

peter_tankov

Peter Tankov

Professor of quantitative finance at ENSAE (IP Paris)

Peter Tankov is a graduate of Ecole Polytechnique (X98). His research focuses on quantitative energy finance and green finance. He works on topics related to electricity markets, energy mix scenarios, forecasting and risk management for the renewable energy industry. Peter Tankov is a member of the scientific board of the Louis Bachelier Institute where he is also the scientific leader of the interdisciplinary research programme on green and sustainable finance. He is also on the board of the international research network GRASFI on sustainable finance.