How to Achieve a Green Recovery and Just Transition Post-COVID
2021, and the years to come, will be dominated by how the global economy balances recovery from COVID-19 pandemic with a shift towards a sustainable and inclusive economy. Although there is a broad consensus to turn this recovery into an opportunity and build a green and a more inclusive economy, the response to date has not yet match the scale of the challenge. Pre-COVID the global economic system was unsustainable and unequal. Moving forward the recovery needs to focus on greener outcomes, such as delivering net-zero emissions and being resilient to physical impacts of climate change. But it also needs to be just, by creating livelihoods that confront the inequalities exposed and exacerbated by the pandemic (e.g. gender, race, age and income). The pandemic brought the “S” of ESG (Environmental, Social and Corporate Governance) at the forefront and made the interdependence between “E” and “S” more prominent. The question now is how to accelerate towards a climate action while avoiding (or further widening) the social disruption that is already here.
COVID-19 has deepened – but not deflected – the financial sector's commitment to sustainability, elevated the social dimension of ESG, and resulted in unprecedented flows of capital looking to be invested. More than 110 countries today are committed to becoming carbon neutral by 2050. These countries represent 65% of the global carbon dioxide (CO2) emissions and more than 70% of the world economy. Companies which make up nearly 20% of the total global market capitalisation have committed to cut emissions at scale. The value of global assets applying ESG considerations to investment decisions has almost doubled over the last four years (and tripled over eight years) to €35 trillion in 2020. Last year was a record breaking year for green and sustainable finance, approximately €430 billion green, social and sustainability bonds were issued globally.
Several reasons contribute to these developments. On one hand, over the last years there is greater awareness and integration of ESG considerations into investment decision making. But also investors have come to realise that ESG funds offer comparable or even in some cases better performance than conventional funds. On the other hand, regulation plays an important role too. For example, the proposed amendments to MiFID II will encourage more retail flows into sustainable funds, as financial advisers will be legally bound to ask clients about their sustainability preferences.
Despite this positive progress, much more is needed. As the race to zero (emissions) is becoming the global default, the race to trillions seems to be more important. There is an investment gap of about €6.1 trillion a year globally that is required up to 2030 in order to meet climate and development objectives. More importantly, for developing countries which are currently receive an investment in the region of €50-€70 billion a year, the gap has been estimated at around €3-€4 trillion by 2030. Can such gap can be closed, and if yes how?
Given that there are no green bullets, the need for a far closer and stronger alignment of public finance with capital markets is urgently required. Private finance alone is unlikely to mobilise the necessary investments required in achieving the Paris climate goals, so public finance is essential. Focus should be given on identifying those interventions that could attract private capital by de-risking investment. Such interventions could take the form of first loss guarantees, residual value guarantees, credit enhancement guarantees, contracts for difference (CfD), or a more diverse range of investment vehicles with a right risk appetite to deploy public finance. The challenge is to use the creativity and innovation for which the financial sector is renowned, to really inform policy and make sure there are investable opportunities.
While the generation of funds for investments in green solutions is necessary, providing the right incentives for green growth are needed. One such incentive is carbon tax. In the absence of carbon price signals markets are mispricing assets, they are not fully managing risks, and they evaluate performance insufficiently (given that climate change has not been incorporated appropriately). Such market failure cannot be corrected solely by transparency and disclosure, nor by investors themselves. Carbon pricing is critical to internalising the externalities of climate change, and thus carbon taxes may be an effective tool at reducing CO2 emissions.
However, the recovery which has to be just sustainable and inclusive, it is not only about climate, and it goes well beyond that. Look for example the “vaccine nationalism” and the economic impact that can have for both developed and developing countries as well as the concerns regarding the emergence of a vaccine black market - a recent study has found that the global economy stands to lose as much as €7.8 trillion if governments fail to ensure developing economy access to COVID-19 vaccines, as much as half of which would fall on advanced economies. If the aim is to achieve an inclusive and resilient recovery that ensures protection and security against future shocks, then there is need for a new universal social contract. There is currently a breakdown in labour markets, where more than 60% of the global labor market works informally with no rights, no social protection, no rule of law, and no minimum wage. Moreover, 73% of the world’s population has little or no social protection, with the figure being even larger in developing countries.
Education has certainly an important role to play. The skills that got us here may not get us where we need to go. Thus, it is vital to integrate climate science and social metrics into everyday financial decision making, and deepen the skills and capacity of financial professionals who will support investors through a just climate transition. Last year, the UK government in collaboration with the Green Finance Institute and 12 leading financial professional bodies, launched the world’s first Green Finance Education Charter in an effort to ensure that those working in the industry get the right training. As climate change poses significant systemic risks to the stability of the financial sector, the "educational opportunity" that COVID offers should not go missing - for example, a climate finance testing for all finance practitioners should be introduced, similar to the annual tests a banker has to pass on money laundering or sanction screening.
Last but not least, global solidarity should be re-discovered, both from a climate (e.g. sharing investment, technological and intellectual property transfer, environmental partnership) and an economic point of view (e.g. sharing wealth, debt relief, liquidity swaps or special drawing rights). This requires a collective international effort and commitment. The upcoming United Nations Climate Change Conference (COP26), taking place later this year, presents a first-hand opportunity. With the US back on board the momentum is there for global leaders to act fast in ensuring a green recovery.
The silver lining of COVID crisis is a wake-up call, which should be translated into tangible actions. Everyone has a role to play. From governments in helping through fiscal advantages and limiting the subsidies to channel assets into the real economy, to regulators and policymakers in implementing a global carbon pricing system, to the financial sector in accelerating change through channeling capital into projects that will facilitate the green at the fair position.
Written by Dr. Apostolos Thomadakis
Dr. Apostolos Thomadakis is Researcher at the European Capital Markets Institute (ECMI), an independent research institute run by the Centre for European Policy Studies (CEPS).