Editing IPCC:AR6/SR15/Chapter-4 (section)

==== 4.4.5.4 Scaling up climate finance and de-risking low-emission investments ====

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The redirection of savings towards low-emission investments may be constrained by enforceable carbon prices, implementation of technical standards and the short-term bias of financial systems (Miles, 1993; Bushee, 2001; Black and Fraser, 2002) <sup>[[#fn:r1407|1407]]</sup> . The many causes of this bias are extensively analysed in economic literature (Tehranian and Waegelein, 1985; Shleifer and Vishny, 1990; Bikhchandani and Sharma, 2000) <sup>[[#fn:r1408|1408]]</sup> , including their link with prevailing patterns of economic globalization (Krugman, 2009; Rajan, 2011) <sup>[[#fn:r1409|1409]]</sup> and the chronic underinvestment in long-term infrastructure (IMF, 2014) <sup>[[#fn:r1410|1410]]</sup> . Emerging literature explores how to overcome this through reforms targeted to bridge the gap between short-term cash balances and long-term low-emission assets and to reduce the risk-weighted capital costs of climate-resilient investments. This gap, which was qualified by the Governor of the Bank of England as a ‘tragedy of the horizon’ (Carney, 2016) <sup>[[#fn:r1411|1411]]</sup> that constitutes a threat to the stability of the financial system, is confirmed by the literature (Arezki et al., 2016; Christophers, 2017) <sup>[[#fn:r1412|1412]]</sup> . This potential threat would encompass the impact of climate events on the value of assets (Battiston et al., 2017) <sup>[[#fn:r1413|1413]]</sup> , liability risks (Heede, 2014) <sup>[[#fn:r1414|1414]]</sup> and the transition risk due to devaluation of certain classes of assets (Platinga and Scholtens, 2016) <sup>[[#fn:r1415|1415]]</sup> .

The financial community’s attention to climate change grew after COP 15 (ESRB ASC, 2016) <sup>[[#fn:r1416|1416]]</sup> . This led to the introduction of climate-related risk disclosure in financial portfolios (UNEP, 2015) <sup>[[#fn:r1417|1417]]</sup> , placing it on the agenda of G20 Green Finance Study Group and of the Financial Stability Board. This led to the creation of low-carbon financial indices that investors could consider as a ‘free option on carbon’ to hedge against risks of stranded carbon-intensive assets (Andersson et al., 2016) <sup>[[#fn:r1418|1418]]</sup> . This could also accelerate the emergence of climate-friendly financial products such as green or climate bonds. The estimated value of the green bonds market in 2017 is 155 billion USD ( [[IPCC:Sr15:About:Error-protocol:#errata2|BNEF 2018]] ) <sup>[[#fn:r1419|1419]]</sup> . The bulk of these investments are in renewable energy, energy efficiency and low-emission transport (Lazurko and Venema, 2017) <sup>[[#fn:r1420|1420]]</sup> , with only 4% for adaptation (OECD, 2017b) <sup>[[#fn:r1421|1421]]</sup> . One major question is whether individual strategies based on improved climate-related information alone will enable the financial system to allocate capital in an optimal way (Christophers, 2017) <sup>[[#fn:r1422|1422]]</sup> since climate change is a systemic risk (CISL, 2015; Schoenmaker and van Tilburg, 2016) <sup>[[#fn:r1423|1423]]</sup> .

The readiness of financial actors to reduce investments in fossil fuels is a real trend (Platinga and Scholtens, 2016; Ayling and Gunningham, 2017) <sup>[[#fn:r1424|1424]]</sup> , but they may not resist the attractiveness of carbon-intensive investments in many regions. Hence, decarbonizing an investment portfolio is not synonymous with investing massively in low-emission infrastructure. Scaling up climate-friendly financial products may depend upon a business context conducive to the reduction of the risk-weighted capital costs of low-emission projects. The typical leverage of public funding mechanisms for low-emission investment is low (2 to 4) compared with other sectors (10 to 15) (Maclean et al., 2008; Ward et al., 2009; MDB, 2016) <sup>[[#fn:r1425|1425]]</sup> . This is due to the interplay of the uncertainty of emerging low-emission technologies in the midst of their learning-by-doing cycle with uncertain future revenues due to volatility of fossil fuel prices (Roques et al., 2008; Gross et al., 2010) <sup>[[#fn:r1426|1426]]</sup> as well as uncertainty around regulatory policies. This inhibits low-emission investments by corporations functioning under a ‘shareholder value business regime’ (Berle and Means, 1932; Roe, 1996; Froud et al., 2000) <sup>[[#fn:r1427|1427]]</sup> and actors with restricted access to capital (e.g. cities, local authorities, SMEs and households).

De-risking policy instruments to enable low-emission investment encompasses interest rate subsidies, fee-bates, tax breaks, concessional loans from development banks, and public investment funds, including revolving funds. Given the constraints on public budgets, public guarantees can be used to increase the leverage effect of public financing on private financing. Such de-risking instruments imply indeed a full direct burden on public budgets only in case of default of the project. They could back for example various forms of green infrastructure funds (de Gouvello and Zelenko, 2010; Emin et al., 2014; Studart and Gallagher, 2015) <sup>[[#fn:r1428|1428]]</sup> . <sup>[[#fn:10|10]]</sup>

The risk of defaulting can be mitigated by strong measurement, reporting and verifying (MRV) systems (Bellassen et al., 2015) <sup>[[#fn:r1429|1429]]</sup> and by the use of notional prices recommended in public economics (and currently in use in France and the UK) to calibrate public support to the provision of public goods in case of persisting distortions in pricing (Stiglitz et al., 2017) <sup>[[#fn:r1430|1430]]</sup> . Some suggest linking these notional prices to ‘social, economic and environmental value of voluntary mitigation actions’ recognized by the COP 21 Decision accompanying the Paris Agreement (paragraph 108) (Hourcade et al., 2015; La Rovere et al., 2017b; Shukla et al., 2017) <sup>[[#fn:r1431|1431]]</sup> , in order to incorporate the co-benefits of mitigation.

Such public guarantees ultimately amount to money issuance backed by low-emission projects as collateral. This explains the potentially strong link between global climate finance and the evolution of the financial and monetary system. Amongst suggested mechanisms for this evolution are the use of International Monetary Fund’s (IMF’s) Special Drawing Rights to fund the paid-in capital of the Green Climate Fund (Bredenkamp and Pattillo, 2010) <sup>[[#fn:r1432|1432]]</sup> and the creation of carbon remediation assets at a predetermined face value per avoided tonne of emissions (Aglietta et al., 2015a, b) <sup>[[#fn:r1433|1433]]</sup> . Such a predetermined value could hedge against the fragmentation of climate finance initiatives and support the emergence of financial products backed by a new class of long-term assets.

Combining public guarantees at a predetermined value of avoided emissions, in addition to improving the consistency of non-price measures, could support the emergence of financial products backed by a new class of certified assets to attract savers in search of safe and ethical investments (Aglietta et al., 2015b) <sup>[[#fn:r1434|1434]]</sup> . It could hedge against the fragmentation of climate finance initiatives and provide a mechanism to compensate for the ‘stranded’ assets caused by divestment in carbon-based activities and in lowering the systemic risk of stranded assets (Safarzyńska and van den Bergh, 2017) <sup>[[#fn:r1435|1435]]</sup> . These new assets could also facilitate a low-carbon transition for fossil fuel producers and help them to overcome the ‘resource curse’ (Ross, 2015; Venables, 2016) <sup>[[#fn:r1436|1436]]</sup> .

Blended injection of liquidity has monetary implications. Some argue that this questions the premise that money should remain neutral (Annicchiarico and Di Dio, 2015, 2016; Nikiforos and Zezza, 2017) <sup>[[#fn:r1437|1437]]</sup> . Central banks or financial regulators could act as a facilitator of last resort for low-emission financing instruments, which could in turn lower the systemic risk of stranded assets (Safarzyńska and van den Bergh, 2017) <sup>[[#fn:r1438|1438]]</sup> . This may, in time, lead to the use of carbon-based monetary instruments to diversify reserve currencies (Jaeger et al., 2013) <sup>[[#fn:r1439|1439]]</sup> and differentiate reserve requirements (Rozenberg et al., 2013) <sup>[[#fn:r1440|1440]]</sup> in the context of a climate-friendly Bretton Woods (Sirkis et al., 2015; Stua, 2017) <sup>[[#fn:r1441|1441]]</sup> .

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