Financing the low-carbon transition

NEW YORK — If pragmatic minds prevail, governments and the private sector, working together, can usher in a low-carbon economy and help the world adapt to the climate-related transformations already under way. In fact, several developments over the past year have shed light on the role that investors and financial services can play in managing or mitigating the global systemic risks posed by climate change.

For example, in June, the United Kingdom became the first country in the world to set a national target of net-zero greenhouse-gas emissions by 2050, while also unveiling a comprehensive green-finance strategy to boost investment in sustainable infrastructure and renewable energy. The same month, Chile’s government issued a $1.4 billion green bond, joining a bull market in which sovereign and corporate green-bond issuances could top $250 billion by the end of the year.

But climate action has also run into new political obstacles this year. At the G20 summit in Osaka, representatives from the host country, Japan, appeared to downplay the importance of emissions reductions prior to and during negotiations, amid fierce resistance from the United States, Brazil, Turkey and Saudi Arabia. While the summit’s final communiqué did acknowledge the “irreversibility” of the 2015 Paris climate accord, it also offered space for the US to reiterate “its decision to withdraw from the Paris Agreement because it disadvantages American workers and taxpayers”.

The climate narrative this year has thus been marked by signs of encouraging progress alongside difficult political realities. And, in the meantime, emissions and average global temperatures have continued to rise, as have the associated financial risks.

It does not have to be this way. Sensible climate policies and a broader shift toward a low-carbon economy could drive growth and deliver benefits to societies at every stage of development. But for that to happen, policymakers and business leaders will need to focus on three key areas.

For starters, governments can do more, and at a much faster rate, to reduce their constituents’ reliance on carbon, and invest in green solutions. According to the Intergovernmental Panel on Climate Change and the UN Environment Programme, signatories to the Paris agreement are collectively far behind in limiting global warming to 2ºC above pre-industrial levels, let alone 1.5ºC, the point at which climate change will have devastating real-world effects.

One way to get back on course is through the “Paris ratchet” process, whereby governments will raise their emissions-reduction targets (officially known as “nationally determined contributions,” or NDCs) every five years, with input from the private sector and other stakeholders. Though the US is currently on track to withdraw from the Paris accord in November 2020, nearly half of US states have endorsed the agreement, and some have begun to set their own net-zero emissions targets.

The UN’s Climate Action Summit this year has been billed as an opportunity to “send strong market and political signals and inject momentum in the ‘race to the top’ among countries, companies, cities and civil society” in pursuit of the objectives enshrined in the Paris agreement and the 2030 Sustainable Development Agenda. Notably, the event includes not just national governments, but also representatives from the private sector and major cities. The government of Los Angeles, for example, has offered a visionary plan for building a sustainable future.

The second area to focus is the market: Policymakers and private-sector leaders could come together to push for a meaningful price on carbon, among other measures. Earlier this year, a group of prominent European economists issued a “plea” for carbon pricing, arguing that existing market schemes should be both strengthened and extended to include more economic sectors. At the same time, the US Climate Leadership Council, a bipartisan alliance of economists and former central-bank chiefs, has called for a carbon dividend, which would set a price on carbon but then return the fees to citizens.

Making progress toward effective carbon pricing will require a broad consensus. In the US, ten states already have active carbon-pricing programmes, so any national-level carbon-dividend or cap-and-trade scheme will need to be reconciled with these. Fortunately, the UN Global Compact reports that 1,300 companies worldwide have already incorporated a carbon price into their operations, which shows that the private sector is forging ahead in the absence of coordinated global action. And as carbon-pricing proposals garner more support, so, too, will parallel initiatives to boost investment in green infrastructure.

The third action area is investment-portfolio management. Financing an overhaul of the global economy is in large part the responsibility of asset managers and institutional investors, who are in the business of directing investment and capital on a large scale. The long-term challenge of decarbonising the economy certainly comes with risks, but it also offers opportunities for innovative investors.

To evaluate climate risks within investment portfolios, PIMCO has designed a climate-change framework that includes a Climate Macro Tracker, to follow global climate trends, as well as a Portfolio Climate Heat Map, to score investments and determine a portfolio’s net exposure to climate risks across sectors and asset classes. With these analytical tools, asset managers can determine whether an investment portfolio is aligned with the goals of the Paris agreement and with the recommendations of the Task Force on Climate-related Financial Disclosures.

We encourage asset managers, asset owners, banks and insurers to expand their thinking, policies and strategies. It is time for financial services to grapple with the true risks posed by climate change, and to seize the new business and investment opportunities that will come with a transition to a low-carbon economy.

Scott Mather is Chief Investment Officer of US Core Strategies at PIMCO. ©Project Syndicate, 2016. www.project-syndicate.org