Monday, November 24, 2014
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Greening Financial Reform

SEOUL – Trillions of dollars in “green finance” – that is, low-carbon, resource-efficient investment – are needed annually to prevent climate change and natural constraints from stalling the global economy and threatening the livelihoods of billions of people. But investors remain resolutely brown and dirty, unwilling to bet on a sustainable future. Now, given an increased focus on regulatory reform, policymakers must seize the opportunity to chart a new course.

Given the low cost of capital and the need to stimulate the global economy, now is the ideal time to invest in the infrastructure needed to support sustainable growth. But prolonged economic recession in developed countries, together with the rise of cheap shale gas, has undermined investment in clean technologies.

While investment in renewable energy is higher in emerging economies, it remains inadequate to support a sustainable future. Even in China, where green initiatives have gained significant attention in recent years, investment in renewables – high by international standards – is dwarfed by investment in coal-generated energy.

Moreover, “climate finance” – advanced countries’ contribution to developing countries’ emissions-reduction and climate-adaptation efforts – remains pitifully small, with efforts to persuade investors and advanced-country taxpayers to contribute more having delivered only small returns. As a result, innovative financing mechanisms like the Green Climate Fund are struggling to get off the ground, and have yet to offer a vision for unlocking capital at scale.

Clearly, policymakers need to develop more effective ways to boost green investment – a point that was emphasized at the recent Global Green Growth Summit in South Korea. Efforts to entice investors under “business as usual” conditions, which provide only modest incentives to pursue projects that strengthen economic sustainability, are no longer tenable. Investors need to be motivated to assume responsibility for their investments’ environmental impact and to adopt a longer-term view in their risk assessments.

Given that financial intermediaries’ job is to invest in the future, linking financial-market reform to green growth should be an obvious step. Indeed, in the run-up to last year’s Rio+20 summit, the United Nations Secretary-General’s High-Level Panel on Global Sustainability highlighted the need to “green” financial-market reform. But this far-sighted message was lost amid general disappointment with the panel and a focus among some developing-country leaders on seeking higher contributions from developed-country taxpayers.

Policymakers should embrace the green mission and adjust their reform efforts accordingly.

Several regulatory actions would drive progress in this area:

· Investors should be required to disclose fully the carbon and natural-resource pricing in their asset valuation, so that it is consistent with the principles of material-risk reporting, and intended beneficiaries are informed about how their money is being used. A carbon-price floor could also be established.

· Rating agencies should be required to integrate carbon and natural-resource intensity (emissions per unit of output) into corporate and sovereign credit ratings.

· Given that investment in renewables is effectively guaranteed by government electricity-purchase agreements, the Bank of International Settlements should allow such investment to count against the new global capital-holding requirements established under Basel III.

· Global leaders should launch an inquiry to determine the best way to build long-term environmental considerations into the legal architecture governing fiduciary duties, especially for private institutional investors, but also for policy-directed banks and sovereign wealth funds.

· Financial regulators should extend their macro-prudential mandates to include the impact of financial markets on the broader economic and natural environment within which they operate – and upon which they depend for their long-term performance and survival.

To be sure, implementing such reforms will not be easy. In order to minimize the risk of unintended consequences, regulatory changes should be straightforward and enforceable – tough criteria, given the complexity and dynamism of financial markets. But pursuit of perfection should not be allowed to impede progress, especially in an environment in which American and British regulators, in particular, are already struggling against a fierce headwind of lobbying by financial firms and threats by them to relocate, much like today’s corporate-tax optimizers.

In fact, emerging-economy policymakers could take the lead in advancing financial-market reforms aimed at encouraging green finance. Investor-based assessments, such as the China Banking Regulatory Commission’s Green Credit Guidelines, have proved useful in overcoming policy-enforcement challenges in the real economy.

Developing-country financial regulators have already taken steps to direct investment toward their countries’ most pressing needs. Bangladesh’s central bank, for example, has introduced rules to encourage financial inclusion, including requirements that banks use a percentage of their disbursements to strengthen agricultural and rural credit lines.

Furthermore, incumbent business interests in developing countries, unlike their counterparts in the developed world, tend to lack the power to block innovation. South Africa has adopted the King III Code of Governance Principles, which requires firms to integrate their financial and sustainability reporting, and a revision of the Pension Funds Act establishes guidelines for consideration of environmental and social outcomes in investment decisions. In many developed countries, such measures would have been (and still are) impossible to enact.

Limiting regulatory reform to preventing a repetition of past crises is an incomplete, potentially damaging approach, akin to driving with both eyes focused on the rear-view mirror. Today’s financial-market reform must also look ahead, in order to avoid the potential crises of tomorrow.

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    1. Portrait of Christopher T. Mahoney

      CommentedChristopher T. Mahoney

      There are many options for contra-cyclical nonproductive investment. FDR's was for people to dig holes and fill them up again, plus dams. Keynes's idea was digging for gold. My own idea is building beautiful buildings, which Prince Charles also advocates. But "climate finance"? That is an income transfer, which is just not happening. If Germany won't bail out Cyprus, and if America won't bail out Detroit, why would you think that we would like to subsidize unproductive investment in foreign countries?

    2. CommentedOli Ver

      Are there any economists with the ability to see the connection between 20th century global growth fueled by cheaply available fossil fuel and 21st century non-growth engendered by the end of cheaply available fossil fuels? If economics was a real science, its adherents would take account of the Second Law of Thermodynamics and put aside this continuous shrill call for growth fueled by renewable energy, or any other miraculous technological replacement fuel. The sums don't (and will never) add up in terms of EROEI. Yes, of course, we can keep up the pretense, if it makes people feel better. But the cold hard reality is that we can either cut down our consumption of energy by colossal amounts in order to perpetuate our species in a negligible-growth world, or temporarily carry on living under the clouds of hopium that ignores real science.

        Portrait of Christopher T. Mahoney

        CommentedChristopher T. Mahoney

        I kind of like the idea of impoverishing billions of people in the pursuit of a desire to change the course of nature. Perhaps if we would all protest enough, the Sun will relent and allow the planets to cool--but not too much!

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