Irene Monasterolo of EDHEC Business School, and Stefano Battiston of the University of Zurich and Ca’ Foscari University of Venice, share a few thoughts on climate financing and risk, and the roles that multilateral development banks (MDBs), governments and the private sector should play in this space.
Q: How can MDBs play a bigger role in the green transition? Is blended finance the solution?
Stefano Battisto: The climate-finance conversation is broader than blended finance. The problem of climate change cannot be solved by blended finance alone. No financial intervention, public or private, can address climate change in the absence of credible economic and energy policies for decarbonisation.
Policy credibility makes investors’ expectations and risk assessment self-fulfilling, which in turn is key to reallocating capital into low-carbon and adaptation activities. In other words, investments in climate mitigation make financial sense especially if governments commit to an energy transition path compatible with the Paris Agreement’s goal of below two degrees Celsius.
Q: Who should have the biggest responsibility for transition finance — governments and MDBs or private sector investors?
SB: Different actors play different, yet complementary and enabling roles. It is an ecosystem where one will not succeed without the others.
Governments are to play a key role by introducing timely, credible and science-based policies for climate mitigation and adaptation. Convincing policy reforms, such as the introduction of an ambitious carbon tax (for example, more than $75/tonne) and the termination of fossil fuel subsidies, should be introduced in high-income countries because they have larger economies and financial markets. They should do so also because they are historically responsible for a larger share of carbon emissions and are a main source of financing for MDBs.
[MDBS need to recognise] that climate risks are forward-looking and that the risk of carbon-intensive projects is higher than for low-carbon ones
In turn, MDBs can use these funds to finance climate mitigation and adaptation investments in emerging and developing economies. Policy credibility is a precondition to influence investors’ expectations and stimulate capital reallocation in the transition, allowing for an orderly transition that minimises risks of socio-economic and financial instability. The policy response to the current geopolitical and energy crisis may lead to reinforced economic dependence on fossil fuels. As UN secretary-general António Guterres said at COP27, this dependence is a “highway to climate hell”.
Irene Monasterolo: MDBs are a crucial actor, but in order to fully deliver on their role for the climate, they need to revise the way they think and act on climate finance. They need a ‘theory of change’. In particular, this means recognising that climate risks are forward-looking and that in transition scenarios, the risk of carbon-intensive projects is higher than for low carbon ones.
This should be reflected into the climate financial risk assessment of projects. Many MDBs have not yet internalised this idea.
Q: What about the private sector?
SB: The private sector is also a key player. With respect to climate mitigation, firms face the challenge of reallocating their own capital expenditures. According to the International Energy Agency, in order to meet the Paris Agreement goal, capital expenditures in the energy and electricity sectors together would have to increase only moderately (from $1.6tn annually in 2019 to about $1.9tn annually in 2030). However, within private sectors, a massive shift in capital expenditures from high- to low-carbon activities is required.
Q: Should greater focus be placed on improving financial systems?
IM: There is an urgent need to redesign the financial architecture and make it fit for purpose to address the climate challenges. This implies moving away from the sectoral approach deployed so far, which has focused on specific instruments and financial innovation, and moving to a system-level approach.
Indeed, in the current conditions of high public debt and high inflation, and the uncertainty and systemic nature of climate risks, traditional financial policy responses would not work. Several countries, from high-income to emerging and developing economies, lack fiscal space or have levels of public debt that are too high to invest in climate mitigation and adaptation.
To enable countries to spend on climate action while remaining attractive for investors, the financial system needs to move from the concept of debt capacity to the concept of debt impact on the climate. In particular, it has to focus on the mid-term co-benefits of investments done today, rather than on the intertemporal discount factors that have so far inhibited investments.
In other words, countries investing today in adaptation and resilience will have lower risk in the future as they will be better able to cope with the impacts of climate change compared to those who generate less debt but also lower investments.
A longer version of this article first appeared in Sustainable Views, a new Financial Times Group title on environmental, social and governance policy and regulation.
Irene Monasterolo is a professor at EDHEC Business School and Stefano Battiston is a professor at the University of Zurich and at Ca’ Foscari, University of Venice, and IPCC lead author.
