There is an urgent need to channel capital into sustainable infrastructure and innovation that will drive job creation. The race is on leading the way in sustainable finance between Europe and the rest of the world, writes Achim Steiner.
Achim Steiner is the Executive Director of the United Nations Environment Programme
Europe’s financial system is on the move, in perhaps an unexpected direction.
From citizen to corporation to central bank, European individuals and institutions are vigorously backing the transition to a low-carbon, green economy. Europeans themselves are placing more of their savings in assets that underpin sustainability. Europe’s financial institutions, most notably its pension funds and insurance companies, are recognizing the long-term benefits of putting sustainability at the heart of their business models. Central banks and regulators are realizing that they have critical role to make this reallocation of capital as orderly as possible.
But perhaps this is not so unexpected after all. It’s a transition that was underway, but has since accelerated in the wake of the climate agreement in Paris in December and, three months prior, international consensus on the 2030 Agenda for Sustainable Development in New York. The direction given by governments to global markets during these two summits was clear: sustainability and environmental concerns will be at the core of future development.
The shift in policy awareness across the European Union over the past year has already been striking. Far from being seen as a drag on growth, sustainability is now regarded as an essential component of a recovery process that is more stable and efficient, and better serves the real economy.
It is national institutions, such as the Bank of England, that have in many ways become part of this changing agenda. In September, Governor Mark Carney acknowledged that markets and financial policymakers suffer from a “tragedy of horizon” when faced with structural threats such as climate change. The Bank has now delivered the first assessment of what climate means for the insurance sector. As chairman of the Financial Stability Board, Carney launched a new industry-led task force to improve climate disclosure, ensuring that investors can make informed decisions.
France also has been a pioneer, delivering a pathbreaking Energy Transition law last year. An innovation of this new law is a requirement for investors to disclose how they are managing the transition. New labels are being introduced to help individual consumers choose financial products that are sustainability-oriented. Spain, Portugal and Germany offer further examples of these market transformations.
Elsewhere, Italy recently launched a national dialogue on sustainable finance and Sweden has included a new policy goal linking finance with sustainable development in its recent budget. The Dutch central bank, DNB, recently argued for a long-term view, adequate carbon pricing and more transparency.
At the Union level, action is also underway, not least as part of the Juncker Plan. More than half of the 42 projects that the European Fund for Strategic Investment approved earlier this year are in sustainability-related areas, including energy and climate action, environmental and resource efficiency, transport, and research and development.
The action plan for the Capital Markets Union recognizes the need to enable markets to provide easier and cheaper access to sustainable finance, for example, through green bonds – bonds whose proceeds are committed to investments in assets such as renewable energy and energy efficiency. European public authorities, such as the Ile de France and the EIB, have often been at the forefront of creating this new green bond market.
Market action is also striking.
At COP21 in Paris, we saw clear commitments from the finance sector to align their portfolios to a low-carbon economy that is resilient to climate shocks. Major European institutions such as Allianz, Amundi, AP4, Aviva and Axa — just to name a few in the “A’s” — are all investing a growing proportion of funds in green assets and reducing their carbon risks.
By COP21, UNEP’s Portfolio Decarbonization Coalition had seen commitments by institutional investors to decarbonize over $600 billion in assets.
All of this positive momentum is pointing in the right direction, but major gaps remain. Most financial institutions are still not fully incorporating the speed and scale of the transition that lies ahead into their activities. Many of the policy moves remain in their early stages.
Major market failures also exist. Some of these failures lie in the real economy, such as the absence of a robust carbon price in global markets. But others exist within the financial system, such as misaligned incentives that encourage short-termism, inadequate disclosure, unclear accountabilities and stunted innovation.
In a new report, UNEP’s Inquiry into a Sustainable Financial System identifies how Europe could tie together action at the national level with common frameworks across the Union.
The key elements could be summarized as the 5 Rs: reallocating capital, assessing risk, clarifying responsibility, improving reporting and delivering a strategic reset so that sustainability becomes a part of the “rules of the game” that steer the financial system.
The steps already being taken in Europe are part of a global shift, what UNEP calls a “quiet revolution”. Growing numbers of countries realise the need to link finance more clearly with social and environmental drivers of long-term prosperity.
China, for example, has made green finance part of its new 13th Five Year Plan, and is seeking to raise over US$400bn in green investments each year, most of which will have to come from financial and capital markets. As part of its G20 presidency, China has also launched a Green Finance Study Group to explore how best to mobilise private capital for the road ahead.
Europe has long been a leader in sustainable finance. Now the stakes are higher. Locally, there is an urgent need to channel capital into sustainable infrastructure and innovation that will drive job creation. The global dynamics have also shifted, with countries such as China seeing this as a strategic dimension of the next phase of its development. The race is on.