G20 must 'reset' global economy to fund low-carbon development
Financing a timely, inclusive greening of the world economy is the greatest collective challenge facing world leaders
By Ma Jun and Simon Zadek
The G20's core objective is to promote strong, sustainable and balanced economic growth, but this requires greening the global economy.
Over the coming 15 years, the world will need to invest around US$ 90 trillion in infrastructure. Much of this investment will need to be "greened" to secure an orderly transition to a sustainable economy. The United Nations Conference for Trade and Development estimates that about US $5 trillion to $7 trillion annually will be needed to finance the realization of the Sustainable Development Goals promoted by the UN in developing countries, which includes infrastructure development, poverty eradication and other key goals core to sustainable development.
Successful economies in the 21st century will protect and even replenish the planet's ecosystems, reversing century-old economic norms that justified extensive environmental damage as societies developed.
The environment was seen as a "luxury good," paid for by societies only when they became rich. Such norms explain why the dramatic rise in global income, eighty-fold in real terms in the last century, has led directly to a decline in environmental capital — the world's stocks of natural assets such as geology, soil, air, water and all living things — in 116 out of 140 countries, according to the United Nations Environment Program (UNEP). Around 1 in 8 premature deaths globally are caused by air pollution; greenhouse-gas emissions add energy to the Earth's atmosphere at a rate equivalent to the detonation of four nuclear bombs every second; almost 22 million people were displaced in at least 119 countries by natural disasters in 2013; and 21 of the world's 37 largest aquifers have passed their sustainability tipping point.
China has followed this conventional pathway throughout its recent industrial development, experiencing catastrophic air pollution and extensive contamination and depletion of both land and water, with tragic consequences for human health and safety. China now understands the urgent need to care for the environment well in advance of its becoming a wealthy society. This is an unprecedented task, requiring an estimated additional annual investment in China of US$ 600 billion to finance remediation, protection and low-carbon, natural capital-saving industries such as renewable energy and electric vehicles.
Other major developing economies, similarly, from Brazil to India, and from Kenya and South Africa to Indonesia and Mexico, are now grappling with the comparable challenge of "going green" before they become materially prosperous. As Dr. Rathin Roy, director of the National Institute of Public Finance and Policy, concluded, "From India onwards, all developing countries will have to industrialize without recourse to growing fossil-fuel consumption. No country has done this before."
Developed economies are also facing intense pressures to deal with their global environmental footprints. Most of their own rivers and land are no longer polluted. But their global investments and supply chains create extensive environmental harm, just as their carbon-intensive lifestyles and economies contribute disproportionately to climate change.
Transitioning to a green, global economy provides immediate business and economic opportunities, as well as being an existential imperative. For example, renewables represented approximately 62.5 percent of net additions to global power capacity in 2015, and the market size of electric vehicles expanded 60 percent in 2014. The need to ensure environmental security is driving technology and business innovation, which in turn is driving up productivity in key sectors and providing new employment opportunities as fossil-fuel-intensive and polluting industries decline.
Financing a timely, inclusive green transition is our greatest, collective, economic challenge.
Public finance has an important role to play. However, this role will be limited by the scarcity of public funds and competing shorter-term priorities.
For China, estimates indicate that only 15 percent of its green finance needs are likely to come from public sources, with the remainder having to come from private investment. The use of innovative instruments that use public finance to crowd-in private capital will help certainly, whether through tax credits, blended financing used increasingly by development finance institutions, the deployment of sovereign wealth funds or even the use of central bank balance sheets. Deep-rooted changes will nevertheless be needed to ensure that the world's financial and capital markets are doing the right thing for savers and investors, and for wider society. As Bank of England Governor Mark Carney said, the financial system needs a "reset" if it is to be aligned to the needs of a low-carbon economy that delivers private financial returns while benefiting communities.
Recognizing the need to align the financial system with the needs of tomorrow's inclusive, green economy, China established a green finance work stream under its presidency of the G20. The G20's Green Finance Study Group's is co-chaired by the Peoples' Bank of China and the Bank of England, and supported by the UNEP acting as secretariat.
China's decision to include green finance in the G20 agenda was a significant innovation, particularly as it was placed in the finance track, bringing it under the authority and responsibility of finance ministers and central bank governors. Further amplifying this innovative step, three other groups associated with the G20 simultaneously initiated work on green finance: the "B20" group of companies, particularly banks and investors; the "T20" group of think tanks from across the G20; and the "C20" group of civil society organizations.
China's G20 initiative on green finance benefited from initial inputs from three major sources. The first was China's Green Finance Task Force, established in early August 2014, co-convened by this article's two authors on behalf of the Chinese central bank and UNEP. This task force, comprising 45 policy, regulatory and market institutions, published a set of 14 recommendations to advance green finance, covering fiscal, standards, regulatory, judicial, and institutional innovations and instruments, many of which have now been incorporated into China's 13th Five-Year Plan (2016-20). Although exclusively China-focused, the recommendations drew heavily on international experience, and have in turn provided inspiration and guidance for subsequent green finance initiatives elsewhere in the world.
Next was the exemplary lead taken by the Bank of England in advancing a prudential review of climate-related risks to the UK's insurance sector. The review was groundbreaking in being the first such systematic assessment of climate risks undertaken by any central bank. In addition, it offered methodological innovations that have subsequently informed a generation of comparable assessments by other central banks, notably the focus on the need to transform themselves with a combination of policy, technology and business changes to mitigate risks from climate change. Building on this work, the Financial Stability Board (FSB), chaired by the Bank of England's Carney, initiated a related, international review of climate risks, which is currently being taken forward by an FSB-hosted task force on climate-related financial disclosure.
Third, the work by G20-linked committees benefited from the findings of the two-year UNEP study, titled "An Inquiry into Design Options for a Sustainable Financial System," launched at the IMF Annual Meetings in Lima, Peru, in October 2015. UNEP's inquiry documented the innovations in about 20 countries in mainstreaming green and sustainable finance through financial system development, including developed and developing country experiences, and across banking, insurance and the investment community. Such experiences, extending from enhanced disclosure requirements by stock exchanges to environmental lender liability for banks and product innovations such as green bonds, provided ready proof that actions already existed on the ground that could form the basis for the G20's deliberations.
The G20's initial assessment of international practice and options for mobilizing green finance is to be published at the G20 Summit in Hangzhou in early September, alongside a major international green finance event in Shanghai.
Over its six months of initial, intensive work, the Green Finance Study Group's G20 members have directed researchers and international organizations, including the IMF, the OECD and the World Bank Group, to assess three core aspects of the financial system — banking, bonds, and institutional investors — and two cross-cutting themes: risk assessment and impact analysis. Summarized in a number of working papers, the evidence has been drawn from market innovations, including, for example, the Industrial and Commercial Bank of China's environmental risk stress testing program and the rapid growth of the green-bond market. It also looks at regulations and standards, such as the green-credit guidelines put forward by the China Banking Regulatory Commission and innovations in investor's fiduciary duties.
Initial work undertaken by the G20 through the Green Finance Study Group has been mainly intended to map international practices, and to establish green finance as a legitimate, long-term agenda for finance ministers and central bank governors. The welcoming of the work to date clearly demonstrates success in this regard, and it is to be hoped that the work will continue under future G20 presidencies, such as Germany's in 2017 and Argentina's in 2018.
That said, a number of specific options were identified during this initial phase and set out for voluntary adoption by financial institutions and countries, and through international co-cooperation. Examples of this include: progressing green bonds as a major source of financing for green infrastructure and enterprises; capacity development, particularly of the banking community in developing countries; and improved risk models and assessment to enhance environmental risk pricing. Some other key options for development, such as the smarter use of available public finance and improved disclosure, were not included in the first year's work.
The G20 leadership's move to work on the topic of green finance, under China's presidency, has had a positive impact in terms of encouraging international dialogue, policy and market developments. Many G20 countries have advanced strategies for sustainable finance, such as Italy's sustainable financial road map, Kazakhstan's interest in establishing the Astana Financial Centre as a regional green finance hub, the green finance initiative of the UK's City of London, India's growing interest in catalyzing green finance, and the European Commission's decision to undertake a strategic review of the place of sustainable finance in the continent's capital market development plans. Green bond markets have also been further encouraged by China's focus on green finance, with Chin issuing over half of the world's green bonds in 2016. The IMF and other international organizations have become far more active in the space, as have civil society organizations and the broader research community.
Success is ultimately measured by the speed and volume of finance channeled into less-carbon and natural capital intensive assets. Today, that redeployment is accelerating, but still from a very small base. There is a long way to go. However, a critical step is to mainstream green finance by alerting and activating policy makers, regulators and standard-setters, as well as financial institutions. Considerable progress is being made on this front, and the G20's focus on green finance has contributed to this progress.
Dr. Simon Zadek is co-director of the UNEP Inquiry into Design Options for a Sustainable Financial System and DSM Senior Fellow and visiting professor at Singapore Management University.
Dr. Ma Jun is chief economist of the Research Bureau of the People's Bank of China and chairman of the China Green Finance Committee.