Climate-Aligned Financial Flows

Working group III of the UN Intergovernmental Panel on Climate Change yesterday presented their latest report at a media conference in Bern. The report aims to provide science-based information on policy options and their consequences to policymakers worldwide. Stefano Battiston, associate professor of sustainable finance and networks at the UZH Department of Banking and Finance and professor of economic policy at Ca’ Foscari University of Venice, is one of the lead authors of the chapter on investment and finance.

The latest report by the UN Intergovernmental Panel on Climate Change (IPCC) clearly shows that rapid action is needed to stop global warming. While some sectors have reduced their CO2 emissions in the eight years since the last report, these reductions are far from sufficient to keep global warming to between 1.5 and 2 degrees by 2050 compared to the pre-industrial level. Meanwhile, most countries have committed to this goal, set by the Paris climate agreement in 2016. However, only 18 countries have effectively reduced their CO2 emissions in consumption and production in recent years. Some have invested in the production of solar and wind energy, others are pioneers in e-mobility.

Zero greenhouse gases

But global warming of a maximum of 2 degrees can only be achieved if all countries massively increase their overall investments in climate protection, and in all sectors: industry, energy supply, transport, agriculture and buildings. Global emissions of greenhouse gases such as CO2 must be drastically reduced, if possible to zero.

In addition, as they absorb greenhouse gases, natural carbon sinks such as oceans, forests and moorland must be preserved and strengthened⁠.

Role of finance

Financial flows can also help mitigate the climate crisis. To do this, they should go toward economic activities with low greenhouse gas emissions and sustainable development. However, the financial sector is still a long way from making climate-neutral investments, because it continues to fund numerous activities that cause high CO2 emissions, such as the manufacture of concrete, airplanes and cars with combustion engines, or the intensive use of forests and soil, thus making a significant contribution to global warming. However, it can now be shown that staying in the status quo harbors considerable risks. The reputation of the financial sector suffers as a result, and investments in technologies that are not climate-aligned can become more expensive in the medium term than switching to investments in CO2-neutral products.

Diverted cash flows

The 6th IPCC report includes a chapter that deals specifically with the effects of investments and financing on global warming. One of the 15 main authors of this chapter is UZH associate professor Stefano Battiston from the Department of Banking and Finance, who specializes in sustainable financing and networks. UZH News spoke with him about the importance of financial markets when it comes to climate change.

 

_{Stefano Battiston (Image: zVg)}

Stefano Battiston, what role does money play in global warming?

Stefano Battiston: A key role. Economic activities such as mobility, building, heating, industrial and agricultural production are responsible for greenhouse gas emissions at varying levels, depending on the technologies used. The activities and technologies we invest in are therefore central to combating global warming. This is why the IPCC has devoted a chapter to the subject of financing and investments in its report. It’s the first time we’ve had a chapter on finance since the Paris climate agreement, which explicitly mentioned the role of financial flows in mitigating climate change back in 2015.

What is meant by climate-aligned investments?

This refers to investments in activities that mitigate global warming by substantially reducing the emission of greenhouse gases compared to equivalent activities. This can be, for example, investments in power plants that produce electricity from renewable sources, or in agricultural practices that limit CO2 and methane emission in food production, or in CO2-neutral mobility such as the production of electric cars.

Banks have been offering sustainable investment funds for a few years now. Is it safe to invest in these funds if you want to fight climate change?

There are indeed numerous financial offers with the “sustainable” label. But not all of them are sustainable in the sense of limiting global warming. Several rating agencies have specialized in measuring the sustainability of companies in relation to environment, social and governance (ESG) parameters. But the way these rating agencies assign their scores is rarely disclosed, and so it varies. It may be that a natural gas or oil company gets a high ESG score even though its product contributes to global warming – for example because, compared to other oil companies, it has created good working conditions, or it has adopted measures to prevent oil spills.

Are there any good alternatives?

To increase transparency in the broad field of so-called sustainable investment offers, the EU adopted a taxonomy for sustainable activities in 2020. This classification system lists the criteria that sustainable investments must satisfy in order to be climate-aligned. For example, in the electric power industry, there is a limit of 100g of CO2 per kWh produced. For cars, there is a limit of 30g per km over the whole production life cycle – at the moment, only fully electric cars satisfy this limit. No fossil fuel activity is included in this taxonomy – although there is an ongoing debate regarding natural gas during the transition period until fossil fuels can be phased out entirely.

What role do central banks play in climate change?

Many central banks have recognized that climate change can impact price stability and the stability of the financial system, which is typically their primary objective. This is also the case for the Swiss National Bank (SNB), which recently joined the Network for Greening the Financial System, an international platform of financial authorities dealing with sustainable finance. Central banks can encourage the private financial sector to assess the financial risks of their investments in activities that contribute to climate change. This in turn encourages investors to shift toward low-carbon activities.

FINMA and the SNB have conducted a pilot project to identify and measure risk concentrations at Switzerland's systemically important banks with respect to transition risks, i.e. the risk associated with a low-carbon transition occurring in a delayed and sudden way.

Does only big money (stock exchanges, commodity trading, central banks) really matter when it comes to combating climate change, or can small-time investors also make a difference?

Individuals do play an important role. For instance, as consumers, we can very well exert influence. We can decide if our bank savings are invested in high or low carbon activities – although banks could make this decision easier and more transparent. We can also decide how climate-aligned our lifestyle is, how we travel and commute, how energy-efficient the home appliances are that we buy, how sustainable our food is, and whether we want to buy new clothes every few months.

However, it’s difficult for individuals to make a meaningful impact without an appropriate combination of fiscal policies, market solutions and regulations that include carbon tax, removal of fossil fuel subsidies, public investments in research and development, support for firms in decarbonization, and regulations on greenhouse gas disclosure.

Original Story Source: University of Zurich