The US went backwards on tackling climate change under President Trump. His successor Joe Biden must act quickly to make up for lost time, says Steve Waygood.

The full potential of climate finance was locked down under Trump

President Trump obstructed efforts to tackle climate change at every turn. His administration withdrew the US from the historic Paris Agreement and unwound important environmental regulation at home.

Significantly, the full potential of climate finance was also locked down under Trump. Multilateral organisations were impeded from taking firm action to address climate risk and accelerate the energy transition away from fossil fuels. Global regulatory authorities were prevented from intervening to avert the greatest of systemic threats. And – with some notable exceptions – US institutional investors and their trade bodies generally opted to act quietly on climate-related projects, if they acted at all.

For evidence of how all this induced inertia in the international financial system, one only needs to look as far as the Financial Stability Board (FSB), a consensus-based body of G20 financial regulators. Though the FSB was permitted by the Trump administration to work on climate risk, it was restricted to focusing on voluntary reporting guidance in the form of the Task Force on Climate-related Financial Disclosures (TCFD).1 While this was a positive step, voluntary reporting guidance is not commensurate with the scale of the climate crisis. It should have been creating a mandatory global regulatory framework to ensure the financial system remains stable in the face of climate change. Five years on, it should now be unfettered.

The European Commission led the world with its Sustainable Finance Action Plan

As the US dragged its feet, the European Commission led the world with its Sustainable Finance Action Plan.2 By taking a systematic approach to embedding sustainability in investment management, investment governance and the distribution of financial services, the plan has catapulted sustainability considerations up the agenda. But there is only so much progress Europe can make without the cooperation of the US. The pace and scale of the efforts needed to avert the chaotic economic, financial and human consequences of runaway climate change are now more daunting than ever.

Thankfully, under Trump’s successor, President-elect Joe Biden, the US has an opportunity to make up for lost time. His appointment of John Kerry as US Special Presidential Envoy for Climate is a welcome first move. Kerry signed the Paris Agreement for the US in 2016 and possesses the diplomatic nous to restore US credibility on this issue.

No more business as usual

The new administration’s immediate focus will be to address the devastating coronavirus pandemic. Rolling out a vaccine and reviving the economy will be at the top of its list of priorities.

But President Biden also needs to show urgency when it comes to tackling the climate crisis. Implied Temperature Change (ITC) is a useful climate metric, taking an entity’s assets and activities as a proxy to gauge the extent of global warming that could yet occur. The ITC of the London Stock Exchange – as good a proxy as any – demonstrates the scale of the problem; a “business as usual” scenario takes us to roughly 3.8 degrees Celsius above pre-industrial levels by the end of the century.3

This far exceeds the targets set out under the Paris Agreement, which commits signatories to the kind of rapid emissions reductions required to stabilise global warming at 1.5 degrees, and no more than two degrees. In other words, despite more than 2,000 global policy and regulatory interventions on climate change, we are still on course for disaster.4

There comes a point at which there is too much risk in the system and the price of the insurance premium is simply too high to be affordable

At 3.8 degrees, flood risk, drought risk and crop failure will be materially worse. All commercial business lines would be tested under these conditions, particularly the business model for general insurance (especially home and crop insurance). There comes a point at which there is too much risk in the system and the price of the insurance premium is simply too high to be affordable.5

The science tells us long-term business models will face an existential crisis by the end of the century, unless the global economy moves onto a 1.5 degrees trajectory. The science also tells us the world cannot wait until the end of the century to act. Meeting the Paris Agreement target requires a 7.6 per cent reduction in global greenhouse gas emissions per annum from 2020 onwards.6 Reducing emissions at this speed is a hugely daunting challenge, but it is still within reach technologically, provided the right government policies are in place to correct market failure.

Fortunately, there is a new level of recognition of climate risk among central bank governors and prudential regulators,7 finance ministers8 and the C-Suite of many large, systemically important financial institutions, providing a strong basis for coordinated global action. The key question for the Biden administration is how to work with key stakeholders to pull all these elements together.

Unshackling climate finance

The president-elect has been clear climate change will be a focal issue for his administration. He has pledged to reinstate the US as a signatory of the Paris Agreement on his first day in office.9 He has also spoken in support of a Green New Deal and his climate change policy reflects these commitments.10

The US now needs a strategy to finance the transition. Incorporating climate-friendly policies into a broader economic stimulus package may help win bipartisan support – an important consideration, especially if the Republicans retain a Senate majority.

The Biden administration needs a strategy to align the rest of the global financial system with rapid, coordinated climate action

But the Biden administration also needs a strategy to align the rest of the global financial system with rapid, coordinated climate action. If global capital is to move at the pace and scale required to deal with climate change, all governments need to reconsider the architecture of financial markets. With nearly $20 trillion (25 per cent of global GDP) earmarked for spending over the next 12-18 months as part of the world’s coronavirus response,11 there is now a rare window of opportunity to direct and disburse that capital in a climate-smart way.

To take advantage, Biden needs to direct his administration to focus a climate lens on prudential regulation, listing rules, accounting standards, investment standards, valuation conventions, governance codes and stewardship codes – as well as building on new interpretations of legal fiduciary duty. Many regulators are already doing this, but their efforts are piecemeal and fragmented, lacking any sense of urgency or recognition of the importance of the agenda.

The Biden administration is lucky that many of the world’s largest financial institutions are domiciled in the US. This includes the largest credit rating agencies, investment banks, investment consultants, and proxy voting advisors – all of whom wield enormous global influence. If Wall Street and its network of advisors act in a coherent way on climate change, the positive repercussions will resonate around the world.

A five-point plan for Biden’s first year

Under a Biden administration, rapid action on the climate agenda across the financial system is possible – even if the Democrats lack a Senate majority. We would like to see the president adopt a five-point plan on climate change for his first year in office:

1. Update the Paris Agreement

Biden’s first step will be to re-join the Paris Agreement on Climate Change – but he should also push to extend it. Dismayingly, there is still no accompanying global strategy to finance the Paris Agreement investment plan that covers public and private finance. This is despite the significant scale of investment and associated structural changes required across all key economic sectors.

Unless sufficient capital is mobilised, the harsh reality is that the world will fail to deliver the Paris Agreement

Unless sufficient capital is mobilised, the harsh reality is that the world will fail to deliver the Paris Agreement. Biden could take the opportunity presented by COP 26, scheduled for November 2021, to help produce a Glasgow Private Finance Accord, setting out how we will indeed make “finance flows consistent with a pathway towards low greenhouse gas emissions and climate resilient development”, as Article 2.1.c of the Paris Agreement puts it.

He could also use the platform provided by COP 26 to help create a new collaborative mechanism, the International Platform on Climate Finance (IPCF), to help governments map out how to put finance flows on a sustainable trajectory and coordinate national capital-raising plans with potential funders.

2. Include green policies in an economic stimulus package

The Biden team aims to implement a coronavirus relief package to support the US economy through the pandemic. It is crucial that this stimulus plan is climate-friendly: clean-energy subsidies could be used to direct investment towards renewables and accelerate the shift in capital expenditures towards lower-carbon energy assets. If stimulus measures focus on job creation in new climate-smart infrastructure, the Biden administration may be able to find common ground with a Republican-held Senate and get the plan through Congress.

3. Deploy the US Treasury and set a carbon price

Governments must apply a meaningful carbon price to ensure companies causing climate change are made to pay for it. Pricing carbon is significantly – but not uniquely – the role of finance ministries and, in the US, the Department of the Treasury.

A market failure as big as climate change requires multiple measures, so it is worth noting there will not be one price on carbon. Internalising the externality at source – in other words, enshrining the “polluter pays” principle – requires an innovative mixture of fiscal measures, market mechanisms, regulations and standards the Treasury could coordinate across the economy.

A carbon tax would provide a floor to the carbon price and generate revenues to finance the energy transition

Chief among the required fiscal measures is a material carbon tax, which would provide a floor to the carbon price and generate revenues to finance support for individuals, households and communities during the energy transition.

It is positive that Biden has already pledged to “apply a carbon adjustment fee against countries that are failing to meet their climate and environmental obligations”.12 This is analogous to the EU’s proposed Carbon Border Adjustment tax. If the EU and the US both introduce a carbon border adjustment, suddenly every country in the world effectively has a carbon price – the level of which is determined by the intensity of their trade with the EU and US.

The Treasury should also provide financial support for cutting-edge innovation in renewable energy, particularly energy storage technology, by rapidly redeploying subsidies away from further fossil fuel extraction. The transition could be further supported by deploying proceeds from the issuance of sovereign green bonds.

4. Focus the Fed

While national climate action could be accelerated with a price on carbon, the need for bold action does not end at the Treasury. It is high time to revisit monetary policy, which is the remit of the Federal Reserve. There have been some welcome changes in this direction. On November 11, the Fed’s Vice Chair for Supervision said it has requested membership of The Network of Central Banks and Supervisors for Greening the Financial System (NGFS).13 This is a positive sign of intent, but should be just the beginning.

Reforming QE to better align limitless bond purchase programmes with climate targets is a pressing issue

The most pressing issue is to reform quantitative easing (QE) to better align these limitless bond purchase programmes with climate targets. Since the financial crisis, major companies have materially benefited from unprecedented bond-buying programmes amounting to tens of trillions of dollars, which have significantly cut the cost of borrowing. In the first three quarters of 2020, global corporate bond issuance hit a record $21.8 trillion, according to Standard & Poor’s data.14

Of the $9.7 trillion of investment-grade bonds from non-financial corporates, 41.2 per cent ($4 trillion) was issued by companies in the automobile and transportation, chemicals, metals and mining, oil and gas and utility sectors. QE and historically low interest rates have allowed these firms to borrow, invest and grow more cheaply.15 This has distorted markets and increased climate risk. QE needs to be refocused through a climate lens, with industries of the future receiving preferential treatment. QE should require TCFD reporting and be focused only on issuers with transition plans.

5. Empower global financial regulatory authorities

The US government needs to work with and empower regulators around the world to drive the energy transition. Biden can signal to global financial regulators and standards bodies that climate change should be on their agendas, including at the International Organization of Securities Commissions, which is increasingly doing good work on stock exchange listing rules;16 the Organisation for Economic Cooperation and Development, which could help re-write fiduciary duty definitions to include climate change risk considerations; and the International Accounting Standards Board, which appears to want to develop sustainable accounting standards.17

The FSB needs to go beyond TCFD and tackle the fundamentals of prudential regulation

The FSB, meanwhile, needs to go beyond TCFD and tackle the fundamentals of prudential regulation – particularly the way it exacerbates the climate crisis by driving down the cost of capital of unsustainable businesses.

By ignoring the most profound impacts of climate change, risk management suffers from a “tragedy of the horizon”. This is not a theoretical concern; it is happening today among all those financial institutions conducting stress tests that typically only look 30 years out. It is the latter part of this century when the physical risks will manifest at an existential scale.

Biden could also work with other members of the G20 to push the FSB to examine how business risk management, actuarial risk management and portfolio risk management practices within banks, insurers and asset managers impair climate-aware decision making. The FSB could be tasked with developing alternative risk management and regulatory frameworks that are fit for purpose within the context of climate risks, now that these hazards are much better understood across markets.

A sustainable future

The world needs to harness the innovative power of finance to power a transition towards a more sustainable future. For this to happen, we need multilateral organisations, global regulatory authorities and key US institutional investors to treat climate change like the emergency it is. The Biden administration has a key role to play in this process. The EU is making overtures in this direction, calling for a transatlantic agenda for co-operation, including to “Jointly design a global regulatory framework for sustainable finance”.18

Under a new US administration, these goals are achievable after years of obstruction and foot-dragging on climate change

Over the longer term, the Biden administration should go further and work with academia and the finance industry to reconsider some of the assumptions that underpin modern capitalism. The influential dogma of modern portfolio theory, for example, does not take the long-term risks of climate change into account; it fails to recognise that returns generated unsustainably in any given time period will reduce potential returns in the future. Similarly, the discounted cashflow model, which forms the basis for all fundamental investment analysis, encourages short-termism and ignores climate externalities. The US Department of Labor has issued a final injunction19 against subordinating financial returns to non-material ESG issues. But no one can deny the corollary: Knowable material risks, whatever their origin or character, must be taken into account.20

For now, the five steps outlined above would be a good place to start. Under a new US administration, these goals are achievable after years of obstruction and foot-dragging on climate change.

Unlike Trump, Biden understands the scale of the climate threat; as vice president, he served under Barack Obama, who famously told the UN Climate Summit in 2014 that “ours is the first generation to feel the effects of climate change – and the last to be able to do anything about it”.21 With President Biden in post, there is fresh hope this might happen.

References

  1. The author is a member of the Task Force
  2. The author was a member of the EU High Level Expert Group on Sustainable Finance
  3. ‘Adapting to 4°C of global warming’. Speech by Emma Howard Boyd, Chair of the Environment Agency, at the Committee on Climate Change’s “Adapting to 3°C+ of global warming” conference (13.10.2020).
  4. ‘Grantham Research Institute on Climate Change and the Environment’, 2020
  5. This is the ‘hothouse earth’ scenario, described by Will Steffen et al., ‘Trajectories of the earth system in the Anthropocene’, PNAS, August 14, 2018
  6. ‘Emissions Gap Report 2019’, UN Environment Programme, November 26, 2019
  7. The Network of Central Banks and Supervisors for Greening the Financial System (NGFS) has 77 central bank and prudential regulator members and 13 observer organisations. NGFS, November 23, 2020
  8. Launched in 2018, the Coalition of Finance Ministers for Climate Action brings together fiscal and economic policymakers from over 50 countries. Finance Ministers for Climate Action, 2020
  9. Leslie Hook, ‘Biden shift on climate change welcomed by world leaders’, Financial Times, November 8, 2020
  10. ‘Climate change’, Biden-Harris Transition, 2020
  11. ‘Wood Mackenzie energy transition outlook 2020: Highlights’, Wood Mackenzie, September 14, 2020
  12. ‘The Biden plan to ensure the future is “made in all of America” by all of America’s workers’, Battle for the Soul of the Nation, 2020
  13. ‘Fed Set to join NGFS, the Climate Change Club for Central Banks’, Bloomberg, November 10, 2020
  14. ‘Credit trends: State of play: record issuance lifts global corporate debt by 6%’, S&P Global Ratings, November 10, 2020
  15. Frank van Lerven and Josh Ryan-Collins, ‘Central banks, climate change and the transition to a low-carbon economy,’ New Economics Foundation, 2017
  16. ‘Sustainable finance and the role of securities regulators and IOSCO: Final report’, The International Organization of Securities Commissions (IOSCO), 2020
  17. Michael Izza, ‘Accounting for climate change: new IASB Guidance’, ICAEW, June 16, 2020
  18. ‘Joint communication to the European Parliament, The European Union and The Council: A new EU-US agenda for global change’, European Commission and High Representative of the Union for Foreign Affairs and Security Policy, December 2, 2020
  19. ‘U.S. Department of Labor announces final rule to protect Americans’ retirement investments’, U.S. Department of Labor, October 30, 2020
  20. ‘U.S. Department of Labor proposes new rule that may impact ERISA plans and fund sponsors pursuing ESG’, Linklaters, July 9, 2020
  21. ‘Remarks by the President at U.N. Climate Change Summit’, The White House President Barack Obama, September 23, 2014

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