Editing IPCC:AR6/WGIII/Chapter-15 (section)

=== 15.2.1 Paris Agreement and the Engagement of the Financial Sector in the Climate Agenda ===

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This is the first IPCC Assessment Report chapter on investment and finance since the 2015 Paris Agreement, which represented a landmark event for climate finance because for the first time the key role of aligning financial flows to climate goals was spelled out. Since then, the financial sector has recognised the opportunity and has stepped up to centre-stage in the global policy conversation on climate change. While before the Paris Agreement, only few financial professionals and regulators were acquainted with climate change, today climate change is acknowledged as a strategic priority in most financial institutions. This is a major change in the policy landscape from AR5. However, this does not mean that finance necessarily plays an adequate enabling role for climate investments. On the contrary, the literature shows that without appropriate conditions, finance can represent a barrier to filling the climate investment gap ( [[#Hafner--2020|Hafner et al. 2020]] ). Indeed, despite the enormous acceleration in policy initiatives (e.g., [[#NGFS--2020|NGFS 2020]] ) and coalitions of the willing in the private sectors, the effect in terms of closing the investment gap identified already in AR5 has been limited ( [[#15.5.2|Section 15.5.2]] ).

Financial investors have started to account for climate risk in some contexts but they do so only to a limited extent ( [[#Monasterolo--2020|Monasterolo and de Angelis 2020]] ; [[#Alessi--2021|Alessi et al. 2021]] ; [[#Bolton--2021|Bolton and Kacperczyk 2021]] ) and the reasons for these remain unclear. Two aspects are relevant here. The first is the endogenous nature of climate financial risk and opportunities (with the term ‘risk’ meaning here the potential for adverse financial impact, whether or not the distribution of losses is known). Academics and practitioners in finance are aware that financial risk can in certain contexts be endogenous, that is, the materialisation of losses is affected by the action of financial players themselves. However, the standard treatment of risk both in financial valuation models and in asset pricing assumes that risk is exogenous. In contrast, endogeneity is a key feature of climate risk because today’s perception of climate risk affects climate investment, which in turn affects directly the future risk. This endogeneity leads to the fact that multiple and rather different mitigation scenarios are possible (Chapter 3). Moreover, the likelihood of occurrence of each alternative scenario is very hard to estimate. Further, the assessment of climate-related financial risk requires to combine information related to mitigation scenarios as well as climate impact scenarios, leaving open an important knowledge gap for the next years ( [[#15.6.1|Section 15.6.1]] ).

The second aspect is that the multiplicity of equilibria results in a coordination problem whereby the majority of investors wait to move and reallocate their investments until they can follow a clear signal. Despite the initial momentum of the Paris Agreement, for many investors, both public and private, the policy signal seems not strong enough to induce them to align their investment portfolios to climate goals.

Analyses of the dynamics of the low-carbon transition suggest that it does not occur by itself and that it requires a policy signal credible enough in the perception of market players and investors ( [[#Battiston--2021b|Battiston et al. 2021b]] ). Credibility could require a policy commitment device ( [[#Brunner--2012|Brunner et al. 2012]] ). The commitment would also need to be large enough (analogous to the ‘whatever it takes’ statement by the European Central Bank during the 2011–2012 European sovereign crisis ( [[#Kalinowski--2020|Kalinowski and Chenet 2020]] )). In principle, public investments in low-carbon infrastructures (or private-public partnerships) as well as regulation could provide credible signals if their magnitude and time horizon are appropriate (past experiences with feed-in-tariffs (FiTs) models across countries provide useful lessons).

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