Editing IPCC:AR6/WGII/Chapter-18 (section)

==== 18.4.2.2 Economics and Sustainable Finance ====

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===== 18.4.2.2.1 Economics =====

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System transitions towards CRD is contingent on reducing the costs of current climate variability on society while making investments that prepare for the future effects of climate change. Climate change and responses to climate change will affect many different economic sectors both directly and indirectly ( [[#Stern--2007|Stern, 2007]] ; [[#IPCC--2014a|IPCC, 2014a]] ; [[#Hilmi--2017|Hilmi et al., 2017]] ). As a consequence, the characteristics of economic systems will play an important role in determining their resilience ( ''very high confidence'' ). These effects will occur within the context of other developments, such as a growing world population, which increases environmental pressures and pollution. This impact is higher for developing countries than for high-income countries ( [[#Liobikienė--2018|Liobikienė and Butkus, 2018]] ). While looking for sustainable climate-resilient policies, many complex and interconnected systems, including economic development, must be considered in the face of global-scale changes ( [[#Hilmi--2010|Hilmi and Safa, 2010]] ).

[[#Miller--2017|Miller (2017)]] discusses some of the planning for, and application of, adaptation measures that improve sustainability, noting the importance of considering a range of factors including complexities of interconnected systems, the inherent uncertainties associated with projections of climate change impacts and the effects of global-scale changes such as technological and economic development for decision makers. For example, addressing climate impacts in isolation is unlikely to achieve equitable, efficient or effective adaptation outcomes ( ''very high confidence'' ). Instead, integrating climate resilience into growth and development planning allows decision makers to identify what sustainable development policies can support climate-resilient growth and poverty reduction and understand better how patterns and trends of economic development affect vulnerability and exposure to climate impacts across sectors and populations, including distributional effects ( [[#Doczi--2015|Doczi, 2015]] ). [[#Markkanen--2019|Markkanen and Anger-Kraavi (2019)]] highlighted that climate change mitigation policy can influence inequality both positively and negatively. Although higher levels of poverty, corruption, and economic and social inequalities can increase the risk of negative outcomes, these potential negative effects would be mitigated if inequality impacts were taken into consideration in all stages of policy making ( ''very high confidence'' ).

The primary objective of economic and financial incentives around carbon emissions is to redirect investment from high to low carbon technologies ( [[#Komendantova--2016|Komendantova et al., 2016]] ). Recent years have seen policy interventions to incentivise transitions in energy, land and industrial systems to address climate change and sustainability focus on price-based, as opposed to quantity based, interventions. Price-based interventions aim at leveraging market mechanisms to achieve greater efficiency in the allocation of resources and costs of mitigating climate change. For example, carbon pricing initiatives around the world today cover approximately 8 gigatons of carbon dioxide emissions, equivalent to about 20% of global fossil energy fuel emissions and 15% of total carbon dioxide GHG emissions ( [[#Boyce--2018|Boyce, 2018]] ). Meanwhile, environmental taxes and green public procurement push producers to eliminate the negative environmental effects of production (Danilina and Trionfetti, 2019). There are several advantages for environmental taxation including environmental effectiveness, economic efficiency, the ability to raise public revenue, and transparency ( ''very high confidence'' ). These gains can provide more resource-efficient production technologies and positively affect economic competitiveness ( [[#Costantini--2018|Costantini et al., 2018]] ).

Policies encouraging eco-innovation, defined as ‘ ''new ideas, behaviour, products, and processes that contribute to a decreased environmental burden'' ’ ( [[#Yurdakul--2020|Yurdakul and Kazan, 2020]] ), can positively affect economic competitiveness. By implementing policies to encourage eco-innovation, countries enhance their energy efficiency. These gains can provide more resource-efficient production technologies and positively affect economic competitiveness ( ''very high confidence'' ) ( [[#Costantini--2018|Costantini et al., 2018]] ; [[#Liobikienė--2018|Liobikienė and Butkus, 2018]] ). Other than eco-innovation, it is important to also consider exnovation, meaning the phasing out of old technologies, as otherwise the expansion of supply could lead to a rebound owing to cheaper prices for carbon-based products (Arne [[#Heyen--2017|Heyen et al., 2017]] ; [[#David--2017|David, 2017]] ). Hence, decarbonisation strategies that set limits to carbon-based trajectories can be beneficial. Quantity-based interventions—or so-called ‘command-and-control’ policies—involve constraints on the quantity of energy consumption or GHG emissions through laws, regulations, standards and enforcement, with a focus on effectiveness rather than efficiency.

For a transition from dirty (more advanced) technologies to clean (less advanced) ones, market-based instruments such as carbon taxes should be considered alongside subsidies and other incentives that stimulate innovation ( [[#Acemoglu--2016|Acemoglu et al., 2016]] ). Research and development in energy technologies, for example, can help reduce costs of deployment and therefore the costs of operating in a carbon-constrained world. [[#Hémous--2016|Hémous (2016)]] indicates that a unilateral environmental policy which includes both clean research subsidies and trade tax can ensure sustainable growth, but unilateral carbon taxes alone might increase innovation in polluting sectors and would not generally lead to sustainable growth.

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===== 18.4.2.2.2 Climate Finance =====

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Achieving progress on system transitions will be contingent on the ability of actors and institutions to access the financing they need to invest in innovation, adaptation and mitigation, and broader system change ( ''very high confidence'' ). By greening their investment portfolios, investors can support reduction in vulnerability to the consequences of climate change and the reduction of GHG emissions. Finance can contribute to the reduction of GHG emissions, for example, by efficiently pricing the social cost of carbon, by reflecting the transition risks in the valuation of financial assets, and by channelling investments in low-carbon technologies ( [[#OECD--2017|OECD, 2017]] ). At the same time, there is a growing need to spur greater public and private capital into climate adaptation and resilience including climate-resilient infrastructure and nature-based solutions to climate change. For instance, the Green Climate Fund, established within the framework of the UNFCCC, is assisting developing countries in adaptation and mitigation initiatives to counter climate change.

Recent evidence sheds light on the magnitude and pervasiveness of climate risk exposure for global banks and financial institutions. According to [[#Dietz--2016|Dietz et al. (2016)]] , up to about 17% of global financial assets are directly exposed to climate risks, particularly the impacts of extreme weather events on assets and their outputs. However, when indirect exposures via financial counterparts are considered, the share of assets subject to climate risks is much larger (40–54%) ( [[#Battiston--2017|Battiston et al., 2017]] ). Hence, the magnitude of climate change-related risks is substantial, and similar to those that started the 2008 financial crisis ( ''high agreement'' , ''limited evidence'' ).

Financial actors increasingly recognise that the generation of long-term, sustainable financial returns is dependent on stable, well-functioning and well-governed social, environmental and economic systems ''(very high confidence'' ) ( [[#Shiller--2012|Shiller, 2012]] ; Schoenmaker and Schramade, 2020). Institutional approaches to a variety of environmental domains (Krueger et al., 2019) which seek to integrate the pursuit of green strategies with financial returns include targeted investments in green assets (e.g., green bonds, clean energy public equity) and specialised funds/vehicles for renewable energy infrastructure ( [[#Tolliver--2019|Tolliver et al., 2019]] ; [[#Gibon--2020|Gibon et al., 2020]] ); cleantech venture capital and alternative finance ( [[#Gianfrate--2019|Gianfrate and Peri, 2019]] ); investment screening to steer capital to green industries ( [[#Nielsen--2019|Nielsen and Skov, 2019]] ; [[#Ambrosio--2020|Ambrosio et al., 2020]] ); and active ownership to influence organisational behaviour ( [[#Silvola--2021|Silvola and Landau, 2021]] ).

Despite the expansion of green mandates across the investment chain, definitions of some of the asset classes associated with green investing are ambiguous and poorly defined. The EU taxonomy for sustainable activities is a promising step in the right direction. For example, a ‘green’ label for bonds is often stretched to encompass financing facilities of issuers that misrepresent the actual environmental footprint of their operations (the so-called risk of ‘greenwashing’). Even in cases where the bonds’ proceeds are actually used to finance green projects, investors often remain exposed to both the green and ‘brown’ assets of the issuers ( [[#Gianfrate--2019|Gianfrate and Peri, 2019]] ; [[#Flammer--2020|Flammer, 2020]] ). The heterogeneity of metrics and rating methodologies (along with inherent conflict of interests between issuers, investors and score/rating providers) results in inconsistent and unreliable quantification of the actual environmental footprint of corporate and sovereign issuers ( [[#Battiston--2017|Battiston et al., 2017]] ; [[#Busch--|Busch et al.]] ).

In order to promote financial climate-related disclosures for companies and financial intermediaries, the financial system could play a key role in pricing carbon and in allocating capital towards low-carbon emission companies ( [[#Aldy--2019|Aldy and Gianfrate, 2019]] ; [[#Bento--2020|Bento and Gianfrate, 2020]] ; [[#Aldy--2021|Aldy et al., 2021]] ). Stable and predictable carbon-pricing regimes would significantly contribute to fostering financial innovation that can help further accelerate the decarbonisation of the global economy, even in jurisdictions which are more lenient in implementing climate mitigation actions ( ''very high confidence'' ) ( [[#Baranzini--2017|Baranzini et al., 2017]] ). A growing number of financial regulators are intensifying efforts to enhance climate-related disclosure of financial actors. In particular, the Financial Stability Board created the Task Force on Climate-related Financial Disclosures (TCFD) to improve and increase reporting of climate-related financial information. Several countries are considering implementing mandatory climate risk disclosure in line with TCFD’s recommendations. Central Banks are also considering mandatory disclosure and climate stress testing for banks. For instance, in November 2020 the European Central Bank (ECB) published a guide on climate-related and environmental risks explaining how the ECB expects banks to prudently manage and transparently disclose such risks under current prudential rules. The ECB also announced that banks in the Euro-zone will be stress tested on their ability to withstand climate change-related risks. In addition to disclosure requirements and stress testing, some Central Banks are considering the possibility of steering or tilting the allocation of their assets to favour the less polluting issuers ( [[#Schoenmaker--2019|Schoenmaker, 2019]] ). This, in turn, would translate into lower cost of capital for cleaner sectors, significantly accelerating the greening of the real economy.

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