Author: Adam Triggs, Accenture and ANU
There is currently more than $ 16 trillion in government bonds around the world that generate negative real returns. Meanwhile, the world needs at least $ 35 trillion in sustainable investment to prevent global temperatures from rising by 1.5 degrees, which the UN Intergovernmental Panel on Climate Change warns about.
To make matters worse, the significant environmental and economic benefits of sustainable practices such as reducing carbon emissions, improving land management and other good environmental practices are often not rewarded by the financial system, even though the returns to society are high.
These paradoxes are caused by the lack of markets for the environment and natural capital.
For too long, the world has relied on directionless governments and the unreliable promises of corporate social responsibility and shareholder activism to manage the environment and natural capital, and make the investments necessary to prevent climate change. It did not work.
Fortunately, there is a better way.
These missing markets are the product of poor global financial rules, insufficient data, and weak institutions. Some national governments are now starting to struggle with these things, but what they need is international cooperation.
The weight of the research shows that businesses and households that have good environmental records are better borrowers. They are less likely to default on their loans and are less likely to default on their repayments.
In a well-functioning market where these broader social and economic benefits are reasonably priced, these borrowers would receive lower interest rates, and if these loans were securitized and resold in the form of bonds, the bonds would be valued more cheaply because the underlying asset is stronger and lower safer.
This is not what we see. While there are some banks and financial institutions increasingly considering environmental sustainability, we are not seeing this to the extent that the evidence would recommend, especially in developing countries.
The rules that inhibit sustainable investing around the world are the Basel III global capital rules and the national financial rules they want to implement. Among other things, these regulations require banks to keep high quality assets on their balance sheets to protect them from shocks. But the rules on the quality of these assets fail to take into account the fact that green credit is safer than green credit. The result is that the world’s banks are not holding or issuing enough green bonds, resulting in less sustainable investments.
It gets worse. The failure of these rules to adequately price environmental risks undermines the stability of the financial system, as it means that there are endemic risks on bank balance sheets and throughout the financial system that we do not consider. For example, a borrower who is forced to undertake a costly environmental remediation could quickly run into financial trouble – a shock that is then transmitted to the lender and any financial assets underpinned by that original loan.
Another factor holding back sustainable investment is the lack of data. There are a number of organizations that provide environmental assessments for companies. This data is vital for the markets to properly price in to environmental risks. However, these organizations often offer different environmental ratings for the same companies, making such pricing difficult.
The ability to collect high quality data on topics such as land management and corporate environmental impact has never been easier given the availability of digital and remote sensing technologies. But in countries where such technologies are not available and companies do not yet provide comprehensive environmental assessments, it becomes very difficult for the markets to price in these risks.
How can we get the national financial authorities to work towards a global financial system that values natural capital appropriately (reduced CO2 emissions, environmental sustainability)? In China, Europe and elsewhere, authorities have begun to actively formulate national approaches to the problem, but the global nature of capital markets and environmental challenges call for a global solution.
China’s central bank governor Yi Gang has announced that the People’s Bank of China (PBOC) is working with the European Union to achieve a convergence of taxonomies for green investments in the two markets, with the aim of implementing a commonly recognized classification system for corporate environment certificates by the end of this year.
APEC is a platform from which these problems can be addressed. As a framework for cooperation, more than a negotiating forum, it can help find practical areas of cooperation, particularly between the United States and China, and build broader consensus for mutual benefit. APEC also provides a practical, private-sector-led way to take action against climate change that supports agriculture, stimulates investment and strengthens financial stability; something that can help draw more unruly governments into the tent.
Sustainable investment is a practical area in which China and the United States can work together on a common priority. It’s an issue the PBOC has been working on for a number of years, it has political appeal on both sides of the island in the United States, and is something that resonates with APEC governments who favor technology- and privately-led approaches to climate change .
One of the challenges is to ensure that credit is provided for the correct time period. It can take decades for the economic benefits of sustainable investments like improved land management to pay off. The government’s job is to ensure that the institutions are in place to stimulate natural capital markets and make these markets as effective as possible.
In view of the troubled national budget and the threat of climate change, strengthening the role of private financing is no longer preferable, but has become indispensable.
Adam Triggs is a Director at Accenture Strategy, a Visiting Fellow at the ANU Crawford School of Public Policy, and a Non-Resident Fellow at the Brookings Institution.