What policies are needed to accelerate the transition to a Green and Sustainable economy ?

Setting the scene for COP 29

In my capacity of Vice Chair of the Finance Committee of Business at OECD (BIAC) , I had the priviledge to attend the Forum on Green Finance and Investment organised by OECD - OCDE in Paris on October 15-16th 2024.

Here are my take-aways of a very inspiring conference, at the cutting edge of the global policy debates, and setting the scene for the COP 29 debates.

1. Acceleration is urgent, and this requires a change in behaviour NOW. We have only 4 years of carbon budget left at current pace of emissions. New infrastructures built in 2025 will last until 2050, so there is no room for polluting infrastructure. MSCI reports that the implied temperature of the worldwide equity index is a 3° increase. At current pace, the world is heading toward a delayed and disorderly transition. Climate adaptation is also taking centerstage, as the impacts are being felt on a daily basis. How many people will afford adaptation spending ? What will be the impact on migration and on geopolitical consequences?
2. Transition plans are now recognized as a central tool in the ESG framework, which is a very positive development. However, there is still a long way to go. There is still a suspicion that transition plans may be an excuse for delaying change. There is a clear need for improving the credibility of transition plans, which requires a definition of their content, a monitoring of their implementation, and potential sanctions. Voluntary frameworks are clearly insufficient. The EU is leading in including transition plans in its legal framework, while the regulations are still in implementation phase, and benefits are yet to be reaped. Multiple initiatives are developing and should be streamlined at EU level: the Platform on Sustainable Finance, EFRAG, ESMA, EBA, ECB are all working on transition plans, with different and overlapping mandates. As per the AEFR - Association Europe - Finances - Régulations report on Transition plans, which I co-authored, a company should have only ONE transition plan, with possible additional building blocks, for example on risk management. Streamlining those initiatives is essential, before they are set in stone in legislative texts. At international level, many frameworks also flourish (G20 SFWG, IPSF, GFANZ, NGFS, ...), and should converge under the authority of the G20.
3. Transition must be a whole-of-economy approach. Financial institutions can and should engage with clients, but cannot drive the industrial transformation. While Net-Zero commitments have been taken by financial institutions representing about half of worldwide financial assets, their strategies have relied so far mostly on sector policies, client engagement and increase in green finance. This is still insufficient to align the portfolios, and financial institutions need sectoral pathways. Ultimately, what is needed is a transition plan for countries (a developed version of NDCs) which would translate into a pipeline of projects. Investors are ready to step in. Indeed, the goal is not to decarbonize the portfolios, it is to finance the decarbonation of the economy. Exclusion policies would lead to risk shifting to non regulated investors, with little impact on overall emissions. In China and in Japan, transition is driven by a set of sectoral industry plans, with various constraints and/or incentives such as tax benefits, promotional loans, etc... These transition pathways provide to companies a clear roadmap to develop their research and development programs and investments. In turn, financial institutions finance those projects. In a sense, the US Inflation Reduction Act has followed the same route by injecting money in specific industries, and providing tax credit. The EU has chosen a more indirect route through regulation, rather than incentives...
4. Mandatory disclosure is necessary, but it is not enough. Disclosure is a mean to an end, and market discipline is not working on climate issue, as there is no differenciation in pricing (yet?). This being said, the impact of disclosure is also inside the company: 2 years after the first disclosure, GHG emissions of disclosing companies are on average reduced by 7/10%: what you can measure, you can manage! ISSB standards are increasingly recognized as the "global baseline", but implementation in jurisdictions is still early stage, and generally diverges from the standard. Close monitoring is needed to enable interoperability. At the same time we need to be pragmatic and data will never be perfect. Scope 3 is mentioned as one of the main area of confusion, while it represents often 80% of total emissions. We are still at a point where no international standard setter has been mandated to develop clear methodologies to ensure credibility and comparability of this essential metric. Net Zero is also an issue, as what the planet needs is to reduce emissions, not compensate them by planting trees...
5. Risk Management is necessary but it is not enough. Financial models have underlying assumptions (such as Discounted Cash Flows which assume a continuous growth and a terminal value), which does not take into account externalities. How can we price the priceless (but not worthless)? Fundamental work is needed to look at risk differently, so that individual decisions can be informed by more holistic models. This is essential to solve the current conundrum faced by asset managers, with diverging incentives between financial return and sustainability. Carbon pricing was not seen as a favoured solution, also due to the political sensitivity of imposing such costs. The potential Central Bank lever was mentioned, not so much through dual interest rates, but rather by differentiating collateral policies, which would at least have a signalling effect on the market. Many underline that regulation should not lead to risk aversion, as the key is to green the brown. Lower insurability of physical risk is another manifestation of the inadequacy of risk pricing.
6. Emerging Markets and Developing Economies are the most impacted and are moving fast to establish rules. Capacity building needs are huge, with an estimate of 100 000 green finance specialists needed to implement the transformation. Needless to say, the 100bn/year commitment is slow to materialize, especially compared to the massive COVID recovery plans. Cost of capital in EMDEs is 120bps higher than in developed economies, and their investment needs are huge, while emissions have been mainly generated by the North (and China). Some interesting initiatives were showcased, such as Indonesia JETP platform to pool smaller projects into bankable investments for international investors. But we cannot ignore that overall EMDE see significant outflows in recent years, given their sensitivity to US monetary policy. Blended finance has been discussed for a decade or more, and fails to scale up. Initiaves are fragmented, involve huge labour costs and delays, they need to be made more effective.
7. While the conference was very focused and constructive, ...the elephant was not in the room. There was very little recognition of the current pushback, the potential impact of US elections, and of political shifts in European countries. To maintain acceptability, the balance between burden and benefits must be improved. The implementation of the very complex set of EU legislative texts needs to be gradual, and the texts themselves must be rationalized, as they were developed in parallel, including SFDR, Benchmark, Taxonomy, CRR, ESG rating etc...) A more pragmatic approach is needed, for SMEs, and for retail investors.

In short, we need less focus on regulation, and more focus on action !