“Work Should Start Now”

Thomas Tayler, Senior Manager, Sustainable Finance Centre for Excellence at Aviva Investors, says structural reform can prevent the finance sector being overwhelmed by the climate crisis.

IMF Managing Director Kristalina Georgieva described a dark economic outlook at the opening ceremony of this year’s COP27 Summit in Egypt.

“We must recognise the tremendous suffering of people that is a result of this darkness. We have widespread hunger. We see poverty going up. Energy prices are soaring. And most significantly, we are living through geopolitical fragmentation. At a time when we need each other the most—particularly to address the climate crisis—it is harder to work together.”

But working together is exactly what Georgieva says is needed if developing countries are to adapt to climate change and participate in a just transition to a carbon neutral economy.

In response, a coalition of multilateral development banks (MDBs) used COP27 to release a statement promising to make it easier for developing countries to access climate finance.

The statement said: “MDBs are working with an increasing number of countries, regions and cities to develop mitigation, adaptation and nature-positive programs. Applied at scale, this programming approach can mobilise significant financing to implement the actions, plans and policies needed to drive the global transition.”

In October, the IMF unveiled the Resilience and Sustainability Trust which it says will provide “long-term affordable financing” to help low income and vulnerable countries manage the shocks of climate change and pandemics.

Georgieva says US$40 billion will “soon be available” through the trust, and three countries are already in receipt of funding while others are poised to join them.

Calls for reform

Despite Georgieva’s claims that the IMF has kept its COP26 promises to “create a long-term instrument that provides financing on concessional terms to low-income and vulnerable middle-income countries”, there are growing calls for more reform of MDBs.

In July the Bridgetown Initiative, which was drawn up by global financial leaders in Barbados, called for reform of the global financial architecture to help countries respond to the climate change and the cost-of-living crisis.

This was followed in November by Aviva Investors, the investment management arm of the UK-headquartered insurance group, which published what it calls “a climate emergency roadmap” and includes reform of the world’s financial architecture, including the Bretton Woods institutions.

Thomas Tayler, Senior Manager, Sustainable Finance Centre for Excellence at Aviva Investors and co-author of the report, says: “The international financial architecture has evolved, rather than been designed in a coherent way, and reacted to past crises instead of pre-empting future ones. To address the climate crisis before it overwhelms the system, coordinated planning and reform is needed.”

The Aviva paper coincided with a report from the London School of Economics’ Grantham Research Institute on Climate Change, which was commissioned by the UK and Egyptian governments and co-authored by the institute’s Chair Lord Nicholas Stern.

The report argues that the failure to deliver US$100 billion in funding promised by developed countries to help developing counterparts adapt to climate change, was down to the “inadequate growth in official concessional finance”.

“There is a growing recognition of the need for a change in the mandate, operating models and scale and mix of financial support required from MDBs to enable them to respond to today’s pressing global and development challenges, including, very centrally, climate change,” the Institute stated.

Perhaps most significantly, COP27’s final text said net zero goals required “a transformation of the financial system and its structures and processes, engaging governments, central banks, commercial banks, institutional investors and other financial actors.”

Tayler says the demands for reform received a notable shot in the arm from French President Emmanual Macron at COP27 who demanded that by spring 2023 the IMF, World Bank and OECD propose “practical solutions for activating innovative financial mechanisms to enable us to develop access to new liquid assets and new lending capabilities for countries – including middle-income countries – which are being affected by these shocks”.

Tayler says: “MDB reform was very high on the agenda [at COP27] and we found a lot of fertile ground for discussions. Alok Sharma [President of COP26], was speaking on similar terms both at the Egypt summit and at World Bank annual meetings this year.”

He adds: “There seems to be a willingness to think about the financial regulatory and supervisory piece in the context of prioritising climate change.”

Regulatory disincentive

The Aviva report argues that unless global supervisory regimes incentivise financial institutions to mobilise finance to support the mitigation and adaptation efforts of countries around the world, particularly in emerging markets and developing economies, “there is risk is that those actions are only ever a second-tier priority”.

Tayler says: “The world is pivoting towards net zero, and finance needs proactive net zero leadership from its regulators, which means they need to evolve to embrace the new paradigm.”

Tayler argues that the prudential regimes governed by the Basel Committee on Banking Supervision and the International Association of Insurance Supervisors – which demand banks and insurers match assets to liabilities and encourage holding assets perceived as low risk – disincentivise institutions and investors from allocating to those countries that desperately need private finance for climate adaptation.

“There are good reasons for telling insurers to match investments to liabilities, but if you invest according to market neutrality, you hold lots of developed market sovereign debt and investment grade credit. The latter tends to be issued by automotive manufacturers or petrochemical companies which are the biggest contributors to climate change. So, what we end up with is a house of cards,” Tayler says.

In a climate-induced financial crisis or collapse, Tayler says no asset class or geography will be unaffected, including the assets perceived as ‘low risk’ that are required by prudential regimes to be held in huge quantity.

“A more holistic and systemic approach is needed this could be provided through the preparation and implementation of climate roadmaps throughout the architecture,” he says.

The current climate risk disclosure regime also acts as a disincentive to investors to allocate capital to companies and countries that most need it, since they have relatively higher risk profiles that asset owners do not want to include in their own reporting.

Instead, Tayler wants to see all companies and financial institutions produce a roadmap indicating how they, and those that regulate them, “will manage the physical risks of climate change and will seize the opportunities of the transition”.

He proposes that an international body – possibly the Financial Stability Board, established by the Group of 20 (G20) in the aftermath of the global financial crisis – annually assess the overall state of the transition and make recommendations for change.

Echoing Georgieva’s calls at COP27, Tayler acknowledges that without collaboration there is no hope of reform.

“It makes no sense for any single country or actor to win a race towards its own net zero ambition while others lag far behind – or even head in the opposite direction. The G20 member states and interested G77 members should begin work towards convening a summit to collectively harness the international financial architecture to promote a global net zero target, inviting institutions within the architecture to develop roadmaps and proposals for reform.”

He adds: “This work should start now, with a view to proposals being adopted at such a summit: the ultimate aim is to make the global economic system operate in the interests of the global public good by supporting action to address the biggest challenge faced by humanity.”