Our generation faces a climate emergency and the risk of an environmental breakdown. The current global financial system only exacerbates these crises due to the domination of very large financial institutions focused on short-term profit and the lack of ambitious regulations. We should change finance, not climate! Here is a 9-step guide from Finance Watch to reform finance for climate action:
- 1. Redirect financial flows by defining what is clean and what is not
On financial markets, so far there hasn’t been a single and simple way to tell ‘clean’ assets from ‘dirty’ ones. We need a unified, binding classification system that determines the environmental quality of every economic activity.
The EU needs a common and mandatory sustainability taxonomy that identifies and distinguishes unsustainable (brown) from sustainable (green) economic activities. This is an essential step to guide capital flows away from harmful activities. Flagging unsustainable activities, which could face losses when the transition occurs, would also enable financial supervisors to screen for climate-related financial risks.
- 2. Make companies report on their social and environmental impacts
We cannot fix a problem that we do not see. First, private companies must be required to assess and disclose the impact of their activities in a harmonised and comparable way.
Mandating that large companies report on their risks, dependencies and impacts on the society and environment is a critical first step. This will enable corporates, policy makers, consumers, financial institutions, supervisory authorities and central banks to properly integrate the sustainability issue in their own decision-making processes. (For more on this topic: #NFRD, #DoubleMateriality, #DSR)
- 3. Let people decide where their money really goes
As clients, citizens have the right to know whether their investments contribute to harmful activities. They should be able to ask their banks, life insurance providers or pension funds to divest their own money from these sectors.
“Investors’ best interest” should not be (assumed to be) only about maximising profit, but also about generating positive environmental, social, and governance (ESG) impacts through their investments.
Financial actors (asset managers, asset-owners, banks, etc.) must be legally obliged to let clients know the ESG-related risks/benefits of their investments, and they must comply with clients’ preferred investment allocation.
- 4. Penalise polluting activities
As long as polluting activities remain profitable, someone on the market will invest in them. We must implement standards, quotas and taxes (economic regulations) to make them more costly than sustainable activities.
We need to change our environmental and economic policies to shift the profitability of activities, thus pushing all financial institutions, not only the most ethical ones, to divest. (For more on this topic: #EnvironmentalTax, #EnvironmentalRegulations, #PricingExternalities)
- 5. Divest taxpayers' money from the fossil economy
Ironically, taxpayers’ money is still heavily invested in fossil activities. As citizens demand a fossil-free economy, our representatives must stop subsidising fossil activities and redirect public money to climate action.
As public entities, public banks (such as the European EIB, the French CDC or the German KfW) must also take a decisive stance. They must lead the way by fully phasing out investments in fossil fuels and other environmentally harmful industries, while redirecting resources towards transitional projects.
- 6. Bring down fossil risk within financial institutions
The transition to a low-carbon economy is inevitable. The diminished value of fossil assets will likely trigger a financial crisis. Preparing for a fossil free future requires that our financial system reduces its exposure to these stranded assets.
Supervisory authorities and central banks must frame appropriate and timely policy to ensure that financial institutions are equipped to confront the physical and transition risks due to climate change. This will force financial actors to disclose their stranded assets and redirect capital away from the fossil economy. (For more on this topic: #NGFS #EnvironmentalStressTest #GreenCollateralFramework)
- 7. Unlock public finance for climate action
Some of the most urgent climate actions are not profitable and thus will not attract investment from private sources. Our governments must open up public finance capacity to meet these demands.
Many transition projects, especially public goods such as infrastructure and transportation, require long-term and coordinated investment planning. They also often yield low financial profits, despite their environmental and social benefits. Therefore, a consistent climate action plan must encompass the unlocking of mission-oriented public finance. (For more on this topic: #EUfiscalRules #GreenBudgeting #GreenPublicBanks #GreenEIB)
- 8. Curb short-termism on financial markets
The current ecological breakdown is driven by shareholder primacy and the short-term focus of the financial system. Regulations must guide the whole system to look beyond the profit calculations of the forthcoming months, to consider the long-term goals of society.
On financial markets, some technical modalities (such as ‘passive management’ and the wide use of ‘tracking error’) make fossil finance over-represented in trading portfolios. We must better regulate speculative and herding behaviour.
- 9. Re-diversify our financial system
In addition to constantly posing tremendous systemic risks to our society, too-big-to-fail financial institutions too often refuse to align their business interests with the interests of society, including our mission to fight climate change.
‘Financial giants’ do not finance the most-needed smaller local transition projects. Meanwhile, many of these projects have already been supported by regional, ethical banks, for whom investing in green projects aligns with their mission and criteria for lending. Governments need to establish a regulatory environment in which diverse banking models can prosper to maximise potential resources for climate projects. (For more on this topic: #GABV #COOPBanks).
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