Action is required in three key areas to mobilise private finance for climate-change goals

Richard Pereira

Richard Pereira

One of COP26’s four goals is to deliver on a commitment made by developed countries at COP15 in 2009 to mobilise at least $100bn (€86.5bn) annually in climate finance by 2020. In July 2021, the V20 group of nations most vulnerable to climate change called for developed countries to urgently meet their promise. Last month, the OECD reported that the highest level of climate finance raised was $79.6bn in 2019. This included $14bn in private finance. 

Trillions of dollars in private and public sector finance will be needed to secure global net-zero carbon emissions by 2050 and to keep 1.5ºC within reach. The global funding gap to meet UN’s Sustainable Development Goals this decade is $84-101trn. This includes $15-18trn for net-zero energy transition. It is estimated that between 2030 and 2050 over $80trn in additional climate investment is required to fund net-zero transition. 

To mobilise private finance at the scale, COP26 needs to address three key areas. 

Carbon markets
First, develop robust international carbon markets to incentivise efforts to decarbonise and mobilise negative-emissions technologies (NETs). COP26 is the moment to put into operation the Paris Agreement’s international carbon-market mechanism. Carbon markets are fragmented in terms of prices and standards. This is not conducive to mobilising private finance and it creates concerns

that carbon prices are not high enough to incentivise global emissions reduction. 

In July 2021, G20 finance ministers endorsed carbon-pricing mechanisms as part of the policy mix to achieve orderly net-zero transition. COP26 should aim to formalise G20 consensus on carbon pricing. 

Areas requiring consideration include carbon price floor arrangements; effectiveness of carbon-border adjustments; mitigation of carbon leakage risks; and non-regressive carbon tax implementation. G20 economies responsible for 78% of global emissions should agree carbon price floors to ensure carbon prices can achieve more ambitious nationally determined contributions. 

Scaling voluntary carbon markets is an important initiative to create international carbon-credit markets. High governance standards, G20 carbon pricing mechanisms and science-based carbon accounting are essential to establish trusted markets. 

Robust capital markets would accelerate decarbonisation by enabling trading of high-integrity carbon credits in transparent and liquid markets. A share of proceeds from trading activities would assist vulnerable countries to meet climate adaptation costs.

Creating markets with operational integrity will motivate the supply of NETs that create high-integrity tradeable removal carbon credits. NETs such as nature-based removal solutions, direct air carbon capture and storage, and bioenergy CCS are essential to achieve net-zero transition. These carbon-removal solutions can complement a company’s internal decarbonisation plans. The Coalition for Negative Emissions in June 2021 found the current NETs pipeline is insufficient. It highlighted an 80% shortfall in negative emissions required by 2025 to meet the 1.5°C target.

Scaling up carbon markets is an opportunity to adopt digital infrastructure to support exchange trading. Technologies employed in decentralised finance, such as distributed ledger technology, offer inherent transparency, enhanced integrity, efficient and resilient infrastructure to scale up a global network of carbon markets.

Agree on how to scale up impact
The second action is to foster consensus on sustainable-finance frameworks to scale up sustainable-impact investment. Frameworks should incorporate regulation and best practices across taxonomies, disclosure/reporting standards and benchmarks. 

The EU’s Sustainable Finance Framework and the International Platform on Sustainable Finance (IPSF) promote private-sector sustainable investment. IPSF’s work on developing a common taxonomy builds international consensus on ‘green’ taxonomies and helps to scale up cross-border green investments. COP26 should ensure that IPSF membership includes all G20 countries. This would augment the efforts of The Glasgow Financial Alliance for Net Zero (GFANZ) by enabling greener transitions with reduced ‘greenwashing’ risk. 

COP26 should agree timely implementation of new mandatory global sustainable standards. A science-based, net-zero transition cannot be achieved unless companies disclose information aligned to Task Force on Climate Related Financial Disclosures (TCFD) and adopt science-based targets. The IFRS Foundation’s proposed International Sustainability Standards Board is expected to be launched at COP26. New standards should be based on TCFD and supplemented by measures to attribute financial metrics to environmental and social outcomes created by a company. The Impact Weighted Accounts Project at Harvard Business School provides a good framework to monetise non-financial metrics in the financial statements.  

Global sustainable assets grew from $23trn in 2016 to $35trn last year. However, the total private climate finance mobilised for developing countries was only $53bn (2016-19). There is concern that many investors still approach ESG from a defensive posture. COP26 should prioritise actions to address this disconnect and scale sustainable-impact investment in climate solutions. 

Digital financial technologies can catalyse decarbonisation of the economy. The Kalifa Review of UK fintech recognised the potential for fintech solutions to support ESG. Climate fintech and climate tech goes further by embedding environmental sustainability directly within digital products to better quantify and manage climate-related risks.

The role of insurance
Action is needed to close future insurance protection gaps and increase insurance penetration to improve resilience in climate vulnerable countries. Vulnerable countries experience significant insurance protection gaps. Swiss Re Institute’s 2020 Natural Catastrophe Resilience index shows that over 90% of potential natural catastrophe losses in emerging countries are unprotected. 

In V20 economies, micro, small and medium-size enterprises (MSMEs) are important contributors to sustainable economic growth, employment and GDP. Studies show that economic recovery after natural catastrophe events is faster for countries with high insurance penetration. 

Ensuring V20 MSMEs have access to adequate insurance protection to absorb shocks is critical to resilience. The V20’s Sustainable Insurance Facility aims to climate-smart insurance solutions for MSMEs and supports the transition of vulnerable economies into climate-resilient economies. 

Investor confidence to commit long-term private climate finance to projects in emerging markets requires long-term future resilience. Climate-change risk undermines future resilience by increasing the gap between economic loss and insured loss. COP26 should prioritise closing ‘future’ insurance protection gaps to encourage private capital flows into a pipeline of investable projects in developing countries. Aligning public-private financing and risk sharing initiatives with Climate Finance Leadership Initiative investment-readiness guidelines will help scale private finance to support investment in sustainable infrastructure. 

The internet of things, AI and cloud computing offer solutions to access big data, predictive analytics and computing power to alleviate previous limitations in insurability. 

The IPCCs sixth assessment report shows the world is not on track to meet the Paris goals. There is concern that current G20 nationally determined contributions are not ambitious enough and that net-zero pledges lack policy detail. 

Francis Richard Pereira is an investment actuary and chartered accountant