Editing IPCC:AR6/WGIII/Chapter-1 (section)

=== 1.4.4 Finance and Investment ===

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Finance is both an enabler and a constraint on mitigation, and since AR5, attention to the financial sector’s role in mitigation has grown. This is partly in the context of the Paris Agreement finance articles and the Green Climate Fund, the pledge to mobilise USD100 billion yr –1 by 2020, and the Addis Abbaba Action Agenda ( [[#1.3.1|Section 1.3.1]] ). However, there is a persistent but uncertain gap in mitigation finance ( [[#Cui--2018|Cui and Huang 2018]] ) (Table 15.15.1), even though tracked climate finance overwhelmingly goes toward mitigation compared to adaptation ( [[#UNEP--2020|UNEP 2020]] ) ( [[#15.3|Section 15.3]] ; Working Group II). Green bond issuance has increased recently in parallel with efforts to reform the international financial system by supporting development of local capital markets ( [[#15.6.4|Section 15.6.4]] ).

Climate finance is a multi-actor, multi-objective domain that includes central banks, commercial banks, asset managers, underwriters, development banks, and corporate planners. Climate change presents both risks and opportunities for the financial sector. The risks include physical risks related to the impacts of climate change itself; transition risks related to the exposure to policy, technology and behavioural changes in line with a low-carbon transition; and liability risks from litigation for climate-related damages (Box 15.2). These could potentially lead to stranded assets (the loss of economic value of existing assets before the end of their useful lifetimes ( [[#Bos--2019|Bos and Gupta 2019]] ) (Sections 6.7 and 15.6.3). Such risks continue to be underestimated by financial institutions ( [[#15.6.1|Section 15.6.1]] ). The continuing expansion of fossil fuel infrastructure and insufficient transparency on how these are valued raises concerns that systemic risk may be accumulating in the financial sector in relation to a potential low-carbon transition that may already be under way ( [[#Battiston--2017|Battiston et al. 2017]] ) ( [[#15.6.3|Section 15.6.3]] ). The Financial Stability Board’s Taskforce on Climate-related Financial Disclosures’ (TCFD) recommendations on transparency aim to ensure that investors and companies consider climate change risks in their strategies and capital allocation ( [[#TCFD--2018|TCFD 2018]] ). This is helping ‘investors to reassess core assumptions’ and may lead to ‘significant’ capital reallocation ( [[#Fink--2020|Fink 2020]] ). However, metrics and indicators of assets risk exposure are inadequate ( [[#Monasterolo--2017|Monasterolo 2017]] ; [[#Campiglio--2018|Campiglio et al. 2018]] ) and transparency alone is insufficient to drive the required asset reallocation in the absence of clear regulatory frameworks ( [[#Ameli--2020|Ameli et al. 2020]] ; [[#Chenet--2021|Chenet et al. 2021]] ). A coalition of central banks have formed the Network for Greening the Financial Sector, to support and advance the transformation of the financial system ( [[#Allen--2020|Allen et al. 2020]] ; [[#NGFS--2020|NGFS 2020]] ), with some of them conducting climate-related institutional stress tests.

Governments cannot single-handedly fund the transition ( [[#15.6.7|Section 15.6.7]] ), least of all in low-income developing countries with large sovereign debt and poor access to global financial markets. Long-term sources of private capital are required to close the financing gap across sectors and geographies ( [[#15.6.7|Section 15.6.7]] ). Future investment needs are greatest in emerging and developing economies ( [[#15.5.2|Section 15.5.2]] ) which already face higher costs of capital, hindering capacity to finance a transition ( [[#Buhr--2018|Buhr et al. 2018]] ; [[#Ameli--2020|Ameli et al. 2020]] ). Requisite North–South financial flows are impeded by both geographic and technological risk premiums ( [[#Iyer--2015|Iyer et al. 2015]] ), and the COVID-19 pandemic has further compromised the ability of developing and emerging economies to finance development activities or attract additional climate finance from developed countries ( [[#15.6.3|Section 15.6.3]] , and Cross-Chapter Box 1 in this chapter). Climate-related investments in developing countries also suffer from structural barriers such as sovereign risk and exchange rate volatility ( [[#Farooquee--2016|Farooquee and Shrimali 2016]] ; [[#Guzman--2018|Guzman et al. 2018]] ) which affect not only climate-related investment but investment in general (Yamahaki et al. 2020) including in needed infrastructure development ( [[#Gray--2003|Gray and Irwin 2003]] ). A Green Climate Fund (GCF) report notes the paradox that USD14 trillion of negative-yielding debt in OECD countries might be expected to flow to much larger low-carbon, climate-resilient investment opportunities in developing countries, but ‘this is not happening’ ( [[#Hourcade--2021b|Hourcade et al. 2021b]] ).

There is often a disconnect between stated national climate ambition and finance flows, and overseas direct investment (ODI) from donor countries may be at odds with national climate pledges such as NDCs. One report found funds supported by foreign state-owned enterprises into 56 recipient countries in Asia and Africa in 2014–2017 went mostly to fossil fuel-based projects not strongly aligned with low-carbon priorities of recipient countries’ NDCs ( [[#Zhou--2018|Zhou et al. 2018]] ). Similarly, [[#Steffen--2019|Steffen and Schmidt (2019)]] found that even within multilateral development banks, ‘public- and private-sector branches differ considerably’, with public-sector lending used mainly in non-renewable and hydropower projects. Political leadership is therefore essential to steer financial flows to support low-carbon transition ( [[#15.6|Section 15.6]] ). [[#Voituriez--2019|Voituriez et al. (2019)]] identify significant mitigation potential if financing countries simply applied their own environmental standards to their overseas investments.

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