Solving global environmental emergencies: are financial actors playing their part?

After a summer of record-breaking temperatures, droughts, wildfires and floods causing devastation across the globe, the need to rapidly scale-up finance and investment to support a low-emission and climate-resilient transition could not be more apparent.

Limiting global warming to around 1.5°C above pre-industrial times requires global greenhouse gas emissions (GHG) to peak before 2025 at the latest. In other words, emissions trajectories in all sectors need to radically shift in the next three years. This means a radical shift in finance. Financial institutions representing 40% of global private financial assets have committed to reach net zero by 2050. However, there are significant gaps between financial actors’ net-zero commitments and the emissions of their portfolios.

Environmental, social and governance (ESG) investing has increased rapidly in the past few years.  But there are challenges associated with ESG ratings, including data inconsistencies and lack of comparability and transparency of rating methodologies. These could compromise market integrity and raise greenwashing risks. Moreover, the reliability and acceptability of methodologies to assess the alignment of the financial sector with climate mitigation policy goals are still subject to the testing and disclosure of underlying assumptions. A forthcoming OECD study shows that regardless of the methodology used to assess climate consistency of finance, listed corporate equity tends to be misaligned with the temperature goal of the Paris Agreement.

Further, over 10,000 non-state actors – including companies, cities, regions and financial and educational institutions –  have now joined the UN Race to Zero, committing to achieve net-zero GHG emissions by 2050. In this context, non-financial corporates are increasingly called by policy makers, investors, consumers and civil society, to shift towards low-emission, climate-resilient pathways. How can corporates build credible and robust transition plans to back their pledges and ensure environmental integrity? OECD’s soon-to-be-released Guidance on Transition Finance identifies ten key elements of credible transition plans for corporates with whole-of-entity transition strategies to minimising the risk of greenwashing, and encourage the sustainable finance market to grow with transparency and integrity.

We are seeing recent and rapid growth in demand and supply of sustainable finance solutions, but there are barriers to effectively channel capital to sectors and countries that need it the most. For instance, in 2021, only about 21% of green bond issuance originated from emerging markets, with Least Developed Countries (LDCs) being largely left behind. Moreover, the strong focus to date on mitigation-related financial risks overlooks the need for climate resilient aligned finance to adapt to and manage the physical risks from climate change.

Beyond climate change, there is increasing attention towards other urgent environmental crises and their links to finance, including the global loss of biodiversity and ecosystem services. The rate of species extinction is accelerating; an IPBES report finds that around 1 million animal and plant species are now threatened with extinction, which represents a significant economic loss. The OECD estimates that ecosystem services provided by natural capital assets offer expected benefits between USD 125-140 trillion per year. These benefits are yet to be incorporated into valuations within financial markets, however, several central banks (such as those in the Netherlands, France, Mexico, Brazil, and Malaysia), are leading the way by undertaking initial assessments on biodiversity-related financial risk.

The inter-linked and global nature of climate change, biodiversity loss and other environmental issues calls for a systemic change in how the global financial system works if it is to deliver impactful green and sustainable finance. But what policy changes and incentives are needed in the financial system to foster such transformational approaches to green and sustainable finance?

This question will be at the core of discussions at the upcoming OECD Forum on Green Finance and Investment, which will take place virtually on 5-7 October 2022. Now in its 9^th year, the Forum will bring together policy makers, financial institutions, academics, and industry representatives to discuss ways to foster transformative, sustainable investments in the real economy and move from commitments to action.

Forum sessions will cover a wide range of pressing sustainable finance issues, from the emergence of transition finance and the evolution of ESG investing, to sustainability standards and impact management. Other key challenges to be discussed include financing the retirement of high-emitting assets and how to achieve ambitious renewable energy and energy efficiency targets in times of crisis. Leading experts will also explore how central banks and financial institutions can assess the financial risks from biodiversity loss and consider ways to integrate these risks into financial decision making.