Transforming the Financial System

Section three

Transforming the Financial System


Section three | Transforming the Financial System


This section focuses on cross-cutting reforms and institutional changes that could improve how the financial system works to support private finance and investment in sustainable infrastructure, including by scaling up and targeting public finance through development finance institutions (DFIs) to better leverage private finance. Building on the work of the UNEP Inquiry into the Design of a Sustainable Financial System1, among others, the first part of this section highlights policy innovations in developing and developed countries that are starting to show how to better align the financial system with sustainable development, as well as international collaborations that are supporting national action to achieve that goal. The second part then examines some of the recent developments and innovations in Multilateral Development Banks (MDBs) and other DFIs that are helping to increase their direct financing for sustainable infrastructure, and to crowd in private investment.

Transforming the financial system and its intermediaries is essential to scaling up sustainable infrastructure finance. Although public finance and investment will continue to play a critical role, particularly in low-income countries, large amounts of private capital are needed as well – and this will only flow if the right market signals are present within the financial system. Private financing of infrastructure that is high-carbon, not climate-resilient, or generally unsustainable still significantly outweighs private flows to sustainable infrastructure. Actions by regulators and policy-makers in the financial system can reorient incentives and reframe how investors view risks and potential returns. Reforms in the financial regulatory system and in the practices of central banks, combined with other policy reforms (e.g. to price carbon and support innovation and to use sustainability criteria when screening projects), can level the playing field between sustainable and unsustainable options and thus give a powerful boost to private investment in sustainable infrastructure.

Mark Carney, Governor of the Bank of England, has said climate change is a “tragedy of the horizon”, because its worst impacts “will be felt beyond the traditional horizons of most actors – imposing a cost on future generations that the current generation has no direct incentive to fix”.2 Although some climate change impacts are already being felt, the most serious impacts – and the benefits of mitigation and even some adaptation today – may be several decades away. That is far longer than the timeframes for most decision-makers looking ahead: beyond the business cycle, the political cycle, and even the horizon for most regulators, including central banks. The horizon for monetary policy, for example, is two to three years – a decade if we consider the credit cycle. Addressing climate change and other sustainability issues, including the financial risks they pose, requires a shift away from the tyranny of “short-termism” to take a longer view.

Tackling climate risks now is preferable to a “wait and see” approach, as greenhouse gas concentrations in the atmosphere will continue to rise, as will the associated total costs of action in terms of emission reductions and adapting to the climate change that is locked-in.3 This is particularly true when financing infrastructure, which is relatively expensive and long-lasting. Yet investors focused on short-term gains might be discouraged by the fact that the upfront capital requirements for sustainable options can be higher relative to “brown” alternatives, with the benefits accruing over several years. Even energy efficiency investments may take five years or more to recover first costs. Infrastructure investments, by their nature, require patient capital, and sustainable infrastructure, even more so – but the benefits over time can be substantial.

Broadly, there are five policy priorities to transform the financial system to mobilise private finance for more sustainable investment – called the “5 R’s” in the UNEP Inquiry work:4

  1. Reallocation: Mobilising and reallocating private finance to green investments, including through green bonds and green banking. In the case of emerging economies and other developing countries, where local financial institutions and capital markets are weak, strategic use of resources garnered by MDBs and other DFIs will be needed, working with leadership from host country governments.
  2. Risk: Enhancing frameworks for systemic risk management to take into account macro-prudential or systemic risks in the financial system related to climate change, including from the physical risk of climate change, and from climate policies.
  3. Responsibility: Clarifying the core responsibilities of financial institutions under fiduciary duty or legal liability definitions to assess and take into consideration environmental, social, and governance factors.
  4. Reporting: Better reporting and disclosure across the three actions above.
  5. Roadmaps to a strategic reset: Harmonising and linking initiatives across countries to achieve coherence at the systems level, which will increase the capacity of increasingly global financial systems to support renewed economic competitiveness and improved sustainability performance.5

As part of the overarching architecture to mobilise private finance and investment for sustainable infrastructure, DFIs play a very important role. They are particularly important for those projects that do not otherwise offer risk-return profiles matching the appetite of private investors. DFIs can participate in a number of ways, from being an investment partner to offering to mitigate financial risk, such as through guarantees, in turn, making it possible to bring in private investors. DFIs have also played a pioneering role in launching some of the instruments discussed in this section – such as green bonds – helping to prove a concept or establish the track record necessary to mainstream widespread replication and use. There is an urgent need to scale up DFI investments in sustainable infrastructure, focussed on approaches that can help “crowd in” private finance.

Suma Chakrabarti: On Scaling Up

The actions outlined above aim to regulate and better use financial institutions for sustainable development. To be effective, the reforms must also be supported by strong environmental policies, which are key drivers of demand for green finance. The attractiveness of green investments is influenced by the risks in the real economy associated with highly polluting or resource-intensive alternative investments. It is only through setting the right broader policy frameworks that environmental costs become real in financial terms.

Greening the financial system

In the last year, there has been a great deal of progress and momentum to green the financial system through various initiatives, campaigns and task forces. National financial regulators and central banks are starting to consider sustainability factors within macro-prudential risk management.

The UNEP Inquiry is working with partners and countries across these issues, with the aim of aligning the financial system with sustainable development. Its flagship report, The Financial System We Need, published in October 2015, found that a “quiet revolution” is under way to integrate sustainable development into financial system policies and regulations, largely led by those governing the financial system and often in collaboration with market actors. The pace of action has accelerated since the report launch.

Some of the most ambitious actions have been taken by developing and emerging economies, which are recognising both short- and long-term benefits from better aligning the financial system with sustainable investment, including increased economic development, closer alignment of the real and the financial economy, and greater monetary resilience. This refers in part to the challenge that there is often an increasing volume of financial activity that is not accompanied by increased investments into economically productive and long-lived assets. It also refers to making the financial system and those productive investments resilient to climate change.

The People’s Bank of China has been leading the way. It established a Green Finance Task Force that gave 14 recommendations on information flows, legal frameworks, fiscal incentives and institutional design. It has also taken action, including the publication of a Green Financial Bond Guideline in December 2015 for bonds issued by financial institutions.6 Indonesia’s financial regulator launched a Roadmap for Sustainable Finance that lays out the developments needed to advance sustainable finance through 2019. In 2011, the Banco Central do Brasil was the world’s first banking regulator to ask banks to monitor environmental risks as part of the implementation of Basel III’s Internal Review for Capital Adequacy.

The Bangladesh Bank has an initiative to integrate socially responsible, inclusive and environmentally sustainable financing in the institutional ethos of the country’s financial sector (see Box 10). The Kenya Bankers Association and the commercial banks in Kenya have developed a set of universal principles to guide banks in balancing their immediate business goals with the economy’s future priorities and socio-environmental concerns.7 Regulators and banking associations from more than 20 developing and emerging economies have now joined the Sustainable Banking Network, organised by the International Finance Corporation (IFC) to help regulators build their knowledge and exchange best practices.8

Such reforms could equally benefit advanced economies. As noted above, a real infrastructure investment deficit exists in core infrastructure in a number of developed countries, with economic and sectoral growth starting to break-down or lose efficiency as a result.

The Swedish government, for example, commissioned the Financial Services Authority to submit a report on sustainability aspects of the bank’s lending in 2015 and published an assessment of the risks that climate change poses to financial stability in 2016910. In France, under Article 173 of the new Energy Transition Law, the government has requested a report by December 2016 on how to implement regular stress tests related to climate change.11 France has also implemented mandatory disclosure of climate risks, and the People’s Bank of China has proposed it.12

International efforts are gaining traction as well. In December 2015, the Financial Stability Board launched an industry-led Task Force on Climate-related Financial Disclosures. Chaired by Michael Bloomberg, it will develop recommendations for voluntary, consistent climate-related financial disclosures for use by companies to inform lenders, insurers, investors and other stakeholders. The Task Force’s recommendations are to be published for further consultation in late 2016; a first report has been published that reviews existing climate-related disclosures (see below and Box 14 for further discussion).13 Building on these recommendations to move towards mandatory disclosure can help to rapidly scale, standardise, and accelerate the use of climate-related financial risk information in investment decisions across countries.

Under the Chinese presidency in 2016, the G20 has established a Green Finance Study Group. Its purpose is to identify institutional and market barriers to green finance, and based on country experiences, to develop options for enhancing the ability of the financial system to mobilise private capital for green investment.14 It reported to the G20 Summit in September 2016.

Investors themselves, including institutional investors, are also taking action, working largely through self-regulation of the industries they invest in. Integration of environmental, social and corporate governance (ESG) is high on the agenda for many asset owners and managers across the European Union and North America. PGGM of the Netherlands, Zurich Insurance of Switzerland and PensionDanmark in Denmark are leading voices on this. ESG integration has faced resistance by some investors, who argue that it harms financial performance (see discussion on fiduciary duty below). However, recent work by Deutsche Bank and the UN Principles for Responsible Investment initiative shows that ESG integration does not have a negative correlation with corporate financial performance, and in most cases even has a positive impact.15

Beyond ESG integration in publicy listed portfolios is the use of other asset classes to steer private capital to sustainable infrastructure, such as impact investments (see Section 4 and Box 32), alternative private infrastructure funds, and alternative structured sustainable public-private partnership funds (e.g. the Africa Agriculture and Trade Investment Fund, Box 33). All are emerging private sources of capital for investment in climate mitigation and adaptation that could be scaled up and replicated.

In December 2015, more than 400 investors with US$24 trillion in assets made a commitment through the Investor Platform for Climate Actions to increase low-carbon and climate-resilient investments, including by working with policy-makers to help them develop measures that encourage capital deployment at scale for a low-carbon transition; developing their own capacity to assess climate-related risks and opportunities; identifying low-carbon investment opportunities; and improving disclosure.16

Divestment campaigns, aiming to encourage institutions to withdraw their investment from fossil fuel assets, are changing the landscape as well. Around 520 institutions with US$3.4 trillion in assets under management have committed to divest from fossil fuels, including universities, cities, religious institutions, pension funds, foundations and others.17 The Portfolio Decarbonisation Coalition (PDC) is attempting to mobilise a critical mass of institutional investors to gradually decarbonise their portfolios.18 In 2015 and 2016, Norway’s sovereign wealth fund, one of the top 10 investors in the global coal industry, has taken steps to divest from companies that are heavily engaged in coal operations (see Box 8), and has also pushed for greater climate risk disclosure by oil companies.192021 Divestment from coal makes financial sense: a 2015 Mercer report suggested that under a range of plausible climate change scenarios average annual returns from the coal sub-sector could fall anywhere from 18 to 74% over the next 35 years, with even steeper declines in the coming decade.22

In May 2016, investors with more than US$10 trillion in assets endorsed shareholder resolutions calling on ExxonMobil and Chevron to stress-test their business strategies against a scenario in which climate actions were taken to keep global warming below 2°C; though both measures failed, each was backed by about two-fifths of shareholders.23 Proxy voting and shareholder activism have a long history in certain regions, particularly the US. The ISS Voting Analytics Database shows an upward trend over 2010–2015 in resolutions related to environmental and social issues, reaching 489 in 2015.24

Development finance institutions, including MDBs and NDBs, are also moving to limit or eliminate new investments coal-fired power generation (see below).

Box 8 — Norway’s Sovereign Wealth Fund decision: An example of an institutional investor taking climate change issues into account

As noted above, Norway holds the biggest sovereign wealth fund in the world, estimated to be worth US$872 billion. In 2015, Norway’s Parliament instructed the fund to divest from companies making more than 30% of their turnover from coal operations, initially affecting investments in more than 52 companies worldwide. In May 2016, the fund indicated it might also exclude another 40 companies for using coal in their operations.25

The fund also supported shareholder motions to push ExxonMobil and Chevron to account for how they manage climate risk, and will continue to ask this of oil companies in which it invests, including ExxonMobil and Chevron, as well companies that have already done so (e.g. BP and Royal Dutch Shell).26

Norway’s decision to divest its Sovereign Wealth Fund from coal was based on both an interest to reduce its climate-related financial risks and on ethical issues. The fund has strict ethical criteria that guide its investment policy, including considerations of severe environmental damage.27

Green bonds

Bonds are familiar instruments for investors – green bonds are just bonds with proceeds that are earmarked for projects with climate or other environmental benefits. This familiarity creates great potential to rapidly scale up finance to green investments through green bond markets. The first “labelled” green bond was issued by the European Investment Bank in 2007. In 2015, labelled green bonds issuance totalled just under US$42 billion, up from US$37 billion the previous year, and more than 16 times as high as in 2012. The 2015 total included US$3.2 billion from first-time issuers in Brazil, Denmark, Estonia, Hong Kong, India, Latvia and Mexico, tapping into both domestic and international markets. In July 2016, the New Development Bank (BRICS Bank) announced its plans to issue green bonds worth approximately US$450 million.

The labelled green bonds market has historically been dominated by development banks (or DFIs including but not limited to MDBs), but the issuer base is continuously broadening. Of the US$42 billion in bonds issued in 2015, US$15 billion was issued by commercial banks, US$10 billion by corporations, US$8 billion by DFIs, US$4 billion by US municipalities and US$4 billion by regional governments. With total issuance in mid-July 2016 surpassing the 2015 total, CBI and HSBC expect issuances to soar to US$100 billion by the end of the year. While the share of development bank issuance is declining, their strong credit-worthiness helps the market to meet demand for AAA-rated green bonds.

The types of issuers have diversified; however the corporate green bond universe remains dominated by the financial, energy, and real estate sectors. There is vast potential to expand in other sectors, including marine, transport, agriculture and forestry, waste, information and communications technologies, industrial energy efficiency and investments related to adaptation

There are, however, some concerns around the credibility of green bonds that need to be addressed if these are to be successfully scaled up. For example, there is no globally accepted definition yet of what makes a bond “green”, nor are there explicit rules around green bond issuance, and the market is not standardised. This has led to concerns about potential “greenwashing”, in which bonds of questionable environmental value are marketed as “green”. Some also question whether the use of the “green” label on bonds has led to new investments or simply rebranded investments that also would have moved forward on similar terms even without the green label. As bonds are primarily refinancing instruments, they are mainly used for planned or completed projects. They allow equity investors and banks to free up capital from existing assets and recycle into new projects. In high-interest rate contexts, green bonds can provide a cheaper alternative than shorter-term bank loans to finance low-carbon and climate resilient projects. However, further market development requires transparency, monitoring and a track record of performance to establish green or climate performance in infrastructure as an asset class so as to underpin future growth in the green bond market.

There are two main voluntary practices available in the market to increase transparency and credibility of green bonds: the Green Bond Principles (GBP) and the Climate Bonds Standard. The GBP are stewarded by the International Capital Markets Association and provide process guidance for issuers, investors and underwriters about key components of a credible green bond, standardising disclosure, ensuring information to support evaluation of environmental impacts, use of external review and opinions, and facilitating transactions. The Climate Bonds Standard, developed by technical working groups under the Climate Bonds Initiative’s stewardship, builds on the GBP and also incorporates a taxonomy with technical criteria to define projects and assets that can be considered “green” and therefore qualify for green bond financing. These guidelines and standard are increasingly widely accepted, but there remains a question of whether and when common definitions and disclosure rules will become mandatory. Standards that are harmonised, simple, easy to use, and viewed as credible by businesses would help to significantly scale the market and deliver results.

To reassure investors over the use of the proceeds, around 60% of issuers to date have incorporated an independent review or second opinion on the “greenness” of the bond as part of the issuance process. Projects and assets that meet the Climate Bonds Standard can also be certified, offering investors a clear trademark of the “greenness” of the bond and guaranteeing monitoring over the whole life-cycle of the bond. Although including some form of verification adds to the issuance cost, which could prevent a more rapid scaling-up of green bonds, it has helped to boost investor confidence and demand.

Pressure for strong and harmonised standards is growing as the market expands beyond niche status, with institutional investors and ratings agencies already getting more involved in the standards discussion. For example, more than 25 of the largest institutional investors signed a Statement of Investor Expectations for the Green Bond Market in 2015, which gives guidance to issuers around eligibility, initial disclosures, intended use of proceeds, reporting on use of proceeds, project impacts/benefits, and independent assurance. China and India have already issued green bond guidelines to provide clarity and boost their green bond markets (see above and Box 9 on China).

A number of green bond indices have also been created by mainstream providers to help determine what qualifies as “green”, including offerings launched in 2014 from Barclays & MSCI, S&P Dow Jones, Bank of America Merrill Lynch, and others. The specific design of these products varies, but they are all intended and allow them to more easily identify and target green investment products in their portfolios. The Oslo Securities Exchange created the first separate green bond listing in 2015. Combined these actions are seeking to raise investor confidence and will facilitate market development.

Drawing on experience to date and on industry-led voluntary initiatives, governments should agree on common standards for and scale up green bonds as an instrument to enhance liquidity in financial markets and unlock capital for low-carbon, resilient investments. Such standards could build on the GBP and Climate Bonds Standard. The standards should be internationally applied and ensure that the proceeds are used to finance projects with sufficient and demonstrable climate or other environmental benefits. The application of mandatory standards will help to build investor confidence, ensure that green bonds are actually delivering “green” outcomes and help to underpin future growth of the green bonds market.

Box 9 — Case study: China and its growing green bond market

China’s People’s Bank established a green bond market in December 2015 to complement green bank lending. It also published guidelines on the issuance of green bonds, the first country to do so.28 The market opened to strong private interest in January 2016. The Shanghai Pudong Development Bank Company raised US$3.1 billion, with the bank paying 3% annual interest on its three-year bonds, a lower rate than the central bank benchmark or similarly structured commercial bonds. More recently, the Shanghai Stock Exchange announced a pilot programme for trades of corporate green bonds that will encourage firms to seek independent assessments of green qualifications.

Chinese banks are also raising funds offshore. The Agricultural Bank of China, one of the top four commercial banks in China, issued US$1 billion in green offshore currency bonds in October 2015 that trade on the London Stock Exchange.29 It was eight times oversubscribed.30 China’s green bonds market is expected to grow to US$230 billion within the next five years,31 but green financing in general will likely need to expand even faster to support China’s ambitions. A share of this is likely to be financed through green bonds.

Growth from green investing should have great benefits for China. Ma Jun, chief economist at the People’s Bank of China, estimates that with sufficient financing, demand for green investments could grow by 10–15% per year. 2016 is likely to be pivotal in China for financing better growth, and the People’s Bank has already projected issuance of RMB 300 billion (US$46 billion) of labelled green bonds in 2016 as of August 2016.

Green investment banks and green banking strategies32

Banks play a central role in funding infrastructure of all types, particularly in the early stages. Therefore, it is important to “green” the banking system – public and private – to reduce investments into GHG-intensive infrastructure and increase the flow of capital towards sustainable infrastructure. This can be pursued through reforms of existing institutions or by creating new specialised institutions, such as dedicated green investment banks (GIB) or GIB-like entities.

Public green investment banking can facilitate private investment in low-carbon, climate-resilient infrastructure, leveraging relatively limited public resources to maximise impact. Using innovative transaction structures, risk reduction and transaction-enabling techniques, and local and market expertise, green banking can channel private investment, including from institutional investors, into low-carbon and other green projects. It facilitates investment in such areas as commercial and residential energy efficiency retrofits, rooftop solar photovoltaic systems, and municipal-level energy-efficient street lighting and waste management systems.

In some cases, “greening” existing institutions may be preferable to creating new institutions. For example, many countries have national development banks or public investment, infrastructure or industrial development banks that focus on domestic investment. These banks are typically much larger than even the largest GIB, so “greening” them, or creating separate green banking windows within them, can have a substantial impact. This is the route that China is taking. It is also possible to expand green existing investment programmes that are already housed in different government agencies and institutions.

Regulatory approaches are in place in some countries to embed sustainable development and climate change criteria into existing banking practices – spanning public and commercial bank operations – including, for example, in Bangladesh (see Box 10).

Box 10 — How Bangladesh has led the way in embedding sustainable development into banking regulations

In 2011, the Bangladesh Bank issued the Green Banking Policy and Strategic Framework3334, which explains to banks how to adopt green policies and incorporate climate risk into corporate risk management practices. Since then, the share of banks with green banking units and policies has steadily increased, now approaching 100%. The policies tend to directly replicate the Bangladesh Bank’s guidance.

Banks are asked to report on environmental due diligence carried out in relation to loan applications from environmentally sensitive areas like agribusiness, cement, chemicals, housing, engineering, metals, pulp and paper, tannery, sugar and distilleries, garment and textiles, and ship-breaking. During fiscal year 2014, banks disbursed a total of US$20 billion to 30,540 rated projects, up from US$8.9 billion in 2012 and US$3.4 billion in 2011.

Banks report on their exposure to “direct green finance”, which includes financing for key green technologies such as renewable energy and biogas, water supply, wastewater treatment, solid and hazardous waste disposal, green buildings, green products and materials, clean transportation, land remediation, and sustainable land management. They also report on “indirect green finance”, which includes overall financing to projects with end-of-pipe pollution treatment.

The Bangladesh Bank also has a public green refinancing scheme: a US$25 million low-cost refinancing window to provide liquidity support to lenders for green financing in 11 specified categories. Overall US$13 million was disbursed from this fund during fiscal years 2010–2014. The main uses were for biogas, solar assembly plants, and energy-efficient brick kilns.

Where greening existing institutions may be slow or fail to produce results, it may be faster and easier to create a GIB, to demonstrate that investment in sustainable infrastructure is viable. In advanced economies and some emerging economies, which typically do not have development banks, over a dozen GIBs and GIB-like entities have been created, typically with a focus on clean energy. They have been established at the national level (in Australia, Japan, Malaysia, Switzerland and the UK), in several US states (California, Connecticut, Hawaii, New Jersey, New York and Rhode Island), and in one city (Masdar, United Arab Emirates); now Montgomery County, MD, in the US is setting one up.

These entities can leverage large amounts of private investment. For example, for every US$1 it has invested to date, the UK Green Investment Bank has mobilised an estimated US$3 of private capital.35 The Connecticut Green Bank attracted US$10 in private investment per US$1 of public capital spent in 2013.36

Green investment banks have also achieved attractive returns. The UK Green Investment Bank turned profitable in the second half of the 2014–15 year, and is projected to generate an overall return of 9% when its projects are fully operational.37 In 2014, The Australian Clean Energy Finance Corporation achieved a 4.15% return (net of operating costs), exceeding the portfolio benchmark return of 3.14%.3839

The impact of green investment bank investments on jobs has been impressive, too. The Connecticut Green Bank’s investments as of June 2015 are estimated to have generated more than 3,000 jobs.40 The Clean Energy Finance Corporation in Australia has financed projects for businesses that employ more than 35,000 people.41 Since 2010, the 165 projects funded by the Green Technology Financing Scheme are estimated to have created about 2,500 jobs.42

Governments tailor their green banking strategies and GIBs to their national and local contexts. GIBs and GIB-like entities have diverse rationales and goals: meeting ambitious emissions targets, supporting local community development, lowering energy costs, developing green technology markets, creating jobs, lowering the cost of capital and facilitating investment in such areas as water and waste management. Given the success to date in green banking in areas such as clean energy, it is worth assessing the opportunity to engage an even broader portfolio of investments.

It is also important to motivate banks to shift their lending away from “brown” investments that are incompatible with low-carbon, climate-resilient development. Even as many leading banks have established “green” business units or product offerings, many continue to be major players in financing high-carbon projects, such as coal mines and coal-fired power plants. This is where the measures discussed in Section 2 and elsewhere in this section – from carbon pricing, to climate risk disclosure requirements – are crucial (see also discussion in Section 4, 5 and 6 on key systems – energy, cities and land use). Given the size of commercial and public banking portfolios and their key role in supporting the early stages of infrastructure investments, their choices will to a great extent determine the nature of future infrastructure.

Institutional investors43

Institutional investors, mainly based in the advanced economies, hold on the order of US$100 trillion in assets under management and represent a potential source of substantial new capital to fund sustainable infrastructure (see Table 2). They comprise banks and insurance companies, pension funds and hedge funds, mutual funds, sovereign wealth funds and endowments; they pool capital to invest in assets that may be securities, real property or other tangible assets such as infrastructure. Yet to date, institutional investors have not been major investors in infrastructure, for a variety of reasons. Surveys of large pension funds, conducted by the OECD, suggest that less than 1% of their asset allocation in 2015 went to direct equity investment in unlisted infrastructure.44 Other surveys of institutional investors show the average allocation for all forms of infrastructure investment is 6.4%.45

There are a number of main barriers to institutional investment in green infrastructure: uncertainty in the policy environment and insufficient policy support, a lack of suitable financial vehicles that provide the liquidity, risk-return profiles and aggregation investors need; and a shortage of objective information and quality data on transactions and underlying risks.46 As discussed in Section 2, similar issues hinder private investment in green infrastructure overall. In addition, some institutional investors – such as pension funds or insurance companies – often face legal constraints on the types of asset classes in which they can invest. They may also have to face the challenge that infrastructure is not recognised as a proper asset class on its own and to overcome embedded practices that do not recognise ESG issues (see Boxes 11 & 12).

Box 11 — Unlocking new investment by establishing infrastructure as an asset class

Institutional investors represent one of the largest potential pools of new capital to fill the investment gap for infrastructure. At present, infrastructure only represents a small percentage of the investment portfolios of institutional investors, and there is not always a consistent treatment of infrastructure as a potential investment in planning portfolio investment strategies. Taken as an asset class within portfolios alongside other traditional classes such as debt and equity, infrastructure would have potential advantages in offering long-term, stable cash flows with low correlations to other asset classes to match long-term liabilities. There would thus be value in collaboration between investors and investment consultants to distinguish a subset of infrastructure that could meet the definition of a distinct asset class, and then to incorporate it systematically into portfolio planning.

When institutional investors do invest in infrastructure, they tend to choose projects that are already operational, with stable cash flows. Given the complexity of infrastructure projects, many investors prefer to focus on familiar markets, where they are best positioned to assess areas such as policy risk due to their understanding of the local context. For example, European institutional investors have become increasingly visible in renewable energy projects in Europe. As institutional assets grow in emerging markets, this represents an important potential source of investment for these markets.

Preliminary research for the G20 Green Finance Study Group by the OECD studied 33 cases of institutional investment in green finance in 17 countries, where public finance served as a risk mitigant or enabler of the financial transaction in sustainable infrastructure.474849 The cases were mostly in G20 countries, but there are also examples from Kenya and Uruguay both for wind power, from Peru for water and the Philippines for geothermal power. The study also found a pan-Asian fund, a pan-African fund, and a fund targeting countries eligible for ODA. The results suggest that governments are already working to mobilise institutional investment in green infrastructure, using a variety of approaches. For example, for the ReNew Wind project in India, a listed project bond was used to refinance project debt, underwritten by two banks in a private placement with a view to selling them to other institutional investors. The India Infrastructure Finance Company Ltd. (a wholly government-owned company) provided a partial credit guarantee, and the Asian Development Bank (ADB) provided a backstop. The study found pension funds were the most active type of institutional investor but other types of investors, such as sovereign wealth funds and insurance companies, were also active.

A key question that remains is how big a role institutional investors could play in closing the sustainable infrastructure investment gap. Even the institutional investors that are most active in the infrastructure domain only allocate around 10% of their portfolio to such assets, due to the need to maintain adequate diversification of their investments. It is unclear whether there is much scope to seek even higher allocations than this level.

Table 2

Overview of Institutional Investors’ Assets under Management, 2015

Responsibilities of investors: fiduciary duty

As noted above, many investors have expressed concern that incorporating more on ESG issues into investment decision-making would lead to lower financial performance. This, they argue, would be a breach of their fiduciary duty to deliver financial returns to their beneficiaries.

Fiduciary duties are imposed upon a person or organisation with discretion to act on behalf of another in a relationship of trust and confidence. In the financial community, this means someone who manages other people’s money must act in their interest, not in his or her own. The most important of these duties, which pertain directly to the responsibilities of institutional investors, are loyalty and prudence.50 The relevant legal texts typically contain procedural requirements that mainly serve to ensure pursuit of highest possible risk-adjusted returns on investments.

A 2005 report by the law firm Freshfields Bruckhaus Deringer commissioned by the UNEP Finance Initiative concluded that responsible investment, defined as the integration of ESG considerations into investment analysis, is “clearly permissible and is arguably required”.51 The report suggests that failing to consider drivers of long-term investment value, which include ESG issues, is actually a failure of fiduciary duty with regard to both loyalty and prudence.

Since that report, there has been progress in better reflecting ESG considerations in investment practice and in recognising the need for responsible investment. A number of countries have introduced regulations and codes requiring institutional investors to account for ESG issues in their investment decision-making. For example, South Africa introduced sustainability considerations, including ESG factors, in 2012 through the voluntary Code for Responsible Investing in South Africa (CRISA) and since 2012 the Dutch pension fund investor APG is integrating ESG factors across all its asset classes and investment processes.

Recognition of the link between fiduciary duty and ESG was one of the factors behind the launch of the UN Principles for Responsible Investment (PRI), initially a collaboration between the world’s largest institutional investors and the UN. The PRI has now grown into a membership organisation with more than 1,500 signatories from over 50 countries, representing around US$60 trillion of assets. The principles outline a range of possible actions for incorporating ESG issues into investment practice as well as a set of six basic tenets, including the statement that ESG factors can be material for investment analysis. PRI’s latest report on progress highlights strong growth in attention to responsible investment but also notes that the majority of asset owners are still focusing on high-level discussions rather than setting requirements for specific strategies or systematically integrating issues from across the ESG spectrum into company valuation.52

The UNEP Inquiry report identified a number of measures related to fiduciary duty that could support integrating ESG issues into investment research and processes. They include:53

  • Clarify that fiduciary duty requires investors to take account of ESG issues in their investment processes, in their active ownership activities, and in their public policy engagement;
  • Strengthen implementation of financial sector legislation and codes, by ensuring and clarifying that they refer to ESG issues, and require investor transparency on all aspects of ESG integration, supported by enhanced corporate reporting on ESG issues;
  • Clarify expectations for trustees – for instance, by ensuring their competence and skill and by supporting the development of guidance on investor implementation processes, including investment beliefs, long-term mandates, integrated reporting and performance;
  • Support efforts to harmonise legislation and policy instruments on responsible investment globally, with an international statement or agreement on the duties that fiduciaries owe to their beneficiaries.

Recent OECD research suggests there remain large hurdles to achieve progress in this area (see Box 12).

The understanding of fiduciary duty as it relates to ESG issues is not the only barrier to the full integration of these, including climate change, in investment decisions. There is also a lack of clarity for many investors about what ESG integration means in practice and, in particular, whether active ownership and public policy engagement form part of investors’ fiduciary duties. There is an ongoing debate over the strength of the relationship between ESG issues and investment performance, although most studies point to benefits from fuller assessment of risk. Given the evolving nature of responsible investment practices, there is a wide variation in actual practices, which is compounded by a lack of transparency around responsible investment practices, processes and outcomes.

Box 12 — Managing climate change risk as part of the fiduciary responsibility of pension funds

At the request of the French Presidency of the COP21, the OECD is analysing the governance of institutional investments in relation to ESG factors and risks, in particular those associated with climate change. The work aims to improve our understanding of the extent to which policy and business frameworks support the systematic inclusion of ESG factors in the governance of institutional investments; how institutional investors interpret their obligation towards beneficiaries in terms of ESG analysis; and how ESG analysis is implemented in practical terms.

Preliminary findings include:

  • Many institutional investors are not bound by the legal concept of fiduciary duty, in common law as well as civil law jurisdictions. Still, the debate over the interpretation of fiduciary duty is relevant to most institutional investors, as it addresses the core issue of how they understand their responsibilities and how ESG factors fit in. There are evolving views of what constitutes prudent investment and how to assess the portfolio risk of climate change, as well as regulatory developments around responsible investing.
  • For institutional investors who are subject to fiduciary duty, legal and regulatory frameworks allow them to incorporate ESG factors in investment governance to the extent that these are expected to have a material impact on portfolio performance. Integrating ESG factors into investment analysis can also be seen as a way to improve the quality of investment decisions.
  • Nonetheless, some difficulties remain for investors in reconciling the integration of ESG factors with their financial obligations towards their beneficiaries. These difficulties are largely practical, although several institutional investors also see a challenge in that ESG analysis asks different kinds of questions from traditional financial analysis.
  • There is some confusion between integrating ESG factors in the valuation of a security, and ethically motivated investing (e.g. “socially responsible” or “impact” investing). This sense that ESG integration is motivated by ethical or moral, not financial concerns, has probably delayed its acceptance by some institutional investors. New ESG investment strategies and tools are also developing rapidly, making it harder for investors to select the “right” ones.
  • There is growing consensus that ESG factors do impact corporate financial performance, but several difficulties in identifying and valuing ESG risks and opportunities have slowed down the adoption of ESG integration. In particular, there are limitations in data availability and valuation techniques, as well as modelling constraints. Most institutional investors are not well equipped to model the discontinuous and extreme risks associated with climate change.
  • As a result of these difficulties, ESG analysis usually takes the form of a qualitative input that is used alongside traditional quantitative models. Several institutional investors caution that ESG analysis could be less respected by portfolio managers than financial analysis because it is not quantitative.
  • Despite the long-term nature of their liabilities, institutional investors may take a short-term view of their investment performance, because of the prevalence of quarterly reporting cycles for both investors and the companies in which they invest, as well as mark-to-market valuations.

Source: based on OECD (forthcoming) report for the Working Party on Private Pensions, and part of OECD’s contribution to the Green Finance Study Group of the G20.

Enhancing climate risk disclosure in the financial system

Policy-makers and financiers increasingly agree on the importance of climate risk disclosure for accountability and transparency in the financial system.54555657 Disclosure is also a tool for risk management that can help companies to better understand climate risks and make smarter investments. Disclosure thus serves a dual purpose: to inform decisions by external parties, and to support internal management improvements. When combined with new analytical techniques and a broader interpretation of fiduciary duty (as discussed above), disclosure can help companies to integrate climate-related factors into financial decision-making.

There are at least three different types of risks related to climate change and infrastructure investment.58 Financial disclosure in all of these areas may be warranted, and increasingly investors are interested in how companies are positioning themselves with respect to these risks:

  • Physical risks, where climate change and extreme weather events can damage property or disrupt trade;
  • Liability risks, if those suffering from climate-related losses seek compensation;
  • Transition financial risks, stemming from the structural economic adjustment to a low-carbon, climate-resilient economy – for example, the shift away from fossil fuels to cleaner fuels and energy systems, the shift to smart buildings, new disruptive business models, and shifting consumer values and preferences. This can also be driven by the adoption of government policies to reduce GHG emissions and/or to adapt to physical climate change impacts.

The Bank of England has identified two types of risks relevant to central banks: weather-related natural disaster risks (physical risks) and stranded asset risks (transition risks). It argues that climate-related disclosure across both of these risk areas could facilitate an orderly transition to a low-carbon economy by helping a wide range of investors to better assess their exposure.59

There is growing momentum on disclosure of climate related risks, in particular in G20 countries and in the EU. GHG emissions reporting is now mandatory in several EU Member States, including the UK, France and Denmark.60 Fifteen of the G20 countries have a mandatory corporate disclosure scheme, most commonly requiring reporting of direct GHG emissions.61 However, only Canada, South Korea and the US also have clear disclosure guidelines requiring companies to report exposure to climate risks and strategies to reduce emissions. Moreover, in a number of countries there is uneven progress in the enforcement of these disclosure requirements.62

Many corporations now use voluntary frameworks for more detailed disclosure. Investors have in many cases actually moved faster than governments – for example, through the creation of mechanisms such as the CDP (formerly the Carbon Disclosure Project) that seek to promote and secure corporate voluntary disclosure related to climate change (see Box 13).

Investors typically need a range of information, not just GHG emissions profiles, to understand how environmental risks affect business models and financial performance. Recognising this, regulators are moving to expand disclosure requirements. The EU Non-Financial Reporting Directive, for instance, requires companies with over 500 employees to disclose information on “policies, risks and outcomes as regards environmental matters, social and employee aspects, respect for human rights, anticorruption and bribery issues, and diversity in their board of directors” in annual reports.63

As part of the Energy Transition Act, enacted in August 2015, France now requires companies to report on climate-related financial risks. The law extends carbon disclosure requirements to cover companies’ supply chains and the use of goods and services they produce.64 The law also obliges financial institutions, asset owners and insurance companies to disclose their carbon footprints, thereby creating awareness and requiring banks and asset owners to incorporate climate aspects into their portfolio monitoring. The Chinese central bank has also proposed mandatory climate disclosure as part of a series of other reforms to help green its financial system.65

Box 13 — CDP and voluntary disclosure

CDP holds one of the world’s largest repositories of publicly available environmental data and performance information from companies, cities and other emitting entities. The data are gathered on behalf of 822 institutional investors from over 80 countries, representing US$95 trillion of assets. Of the 2,345 companies reporting to CDP in 2014, 88% considered climate change a risk to their operations.66 Many companies, including fossil fuel producers and utilities, use internal carbon prices as part of their planning and business strategy development. In 2015 CDP found 435 companies worldwide doing this.67

CDP estimates that in 2014, more than 90,000 projects were implemented by almost 1,400 companies reporting to it (59% of the sample), achieving a combined 700 Mt CO2e of emission reductions. There is some uncertainty around these reductions, however, because companies reporting to CDP are not required to use standardised GHG reporting procedures.

Increasingly, the actions taken by companies are driven by a clear business case that is outside of environmental or social concerns. Among the Fortune 100, for instance, 53 companies reported saving a combined US$1.1 billion in 2013 from energy efficiency, renewable energy and other emission reduction initiatives – an average of over US$10 million per company.

In an analysis for the We Mean Business coalition, CDP found that in 2013, the global average reported internal rate of return on low-carbon projects was 11%.68 The CDP Climate Leadership Index (made up of companies taking the strongest climate action) has outperformed the Bloomberg World Index of top companies by 9.1% over the past four years. These examples provide evidence that actions taken by businesses to reduce emissions do not undermine profitability and, instead, may even enhance it.

A promising development, first mentioned above, is the creation of the Task Force on Climate-related Financial Disclosures (TCFD), which grew out of a request by the G20 Finance Ministers to the Financial Stability Board to consider climate-related risks to the financial sector. The TCFD will develop recommendations for voluntary disclosures. A report due in late 2016 will set out the principles for adequate disclosures, a prerequisite for financial firms not only to manage and price climate risks accordingly but also, if they wish, to make lending, investment or insurance underwriting decisions that take into account transition scenarios. Following a public consultation, the report is to be submitted to the G20 (see Box 14).

While voluntary disclosure is an extremely important first step, it is unlikely to be enough on its own. Voluntary disclosures remain very limited: the UNEP Inquiry, drawing on Bloomberg data, found that 75% of 25,000 listed companies assessed did not disclose a single sustainability data point. Participation is better among the world’s larger listed companies (with a market capitalisation in excess of US$2 billion – a total of 4,609 companies): 39% of them currently disclose their GHG emissions.69

Indeed, the patterns of disclosure illustrate both the strength and limitations of voluntary reporting. The number of companies reporting is a testament to the relevance of the issue and the role of voluntary standards in addressing a regulatory gap and pioneering practices that can subsequently be mainstreamed. Voluntary standards are typically most effective at reaching leaders and companies with high public visibility, but have limited influence beyond those circles. The large number of companies that continue not to report shows that voluntary standards cannot achieve complete and consistent disclosure across entire markets.70 This suggests that governments could build on the Task Force’s work and move rapidly towards appropriate mandatory – and sufficiently detailed – disclosure standards as a matter of corporate governance.

It is also important to coordinate both voluntary and mandatory disclosure schemes across geographies. Existing mandatory schemes vary widely, including in their guidance for calculation and verification requirements. This makes it impossible to compare results across countries and corporate entities and raises transaction costs for companies operating in multiple jurisdictions. Variations across schemes also hinder investors from considering climate-related issues in their asset valuation and allocation processes, because the transaction costs of doing so are high.7172 A standard maintained by a global body and adopted by governments would reduce costs and improve the quality of disclosure. Indeed, the International Accounting Standards Board and the International Standards Organization provide two such examples of international bodies designed to promote extensive cross-border harmonization.

The more information on significant risks that can be reported, the better. Take stranded assets: changes in technology, regulation or markets can leave assets “stranded” or force their premature retirement, reducing their economic value. This is an increasingly significant financial risk following the Paris Agreement’s decisive signal to move to a low-carbon economy. Many countries and companies face substantial stranded asset risks, particularly in high-carbon sectors.

An analysis by the European Bank for Reconstruction and Development (EBRD) and the Climate Policy Initiative calculated budgetary risk arising from policies for a low-carbon transition and found, for example, that under a low-carbon scenario, the economic value of Russian oil to producers would decline from US$1.25 trillion now to US$630 billion in 2035.73 Of this, the Russian government is at risk for US$515 billion, with investors at risk for the remaining US$107 billion. The range of benefits for consumers, such as lower energy prices, is US$190 billion to US$360 billion, resulting in a total cost to Russia of US$260–430 billion, to be shared between the government, consumers and taxpayers. In addition, the value of Russian coal production would fall by US$64 billion in a low-carbon scenario, from US$215 billion to US$151 billion through to 2035. But it is investors that are most exposed, as the industry has been completely privatised. In addition, the second-order effects of curtailed operations, such as unemployment, may have negative implications for the economy and the national budget if social payments have to increase. Consumers are expected to receive a benefit of US$32 billion, and the estimated total cost to the Russian economy is US$23 billion by 2035.

Similarly, in Egypt, the analysis shows the value of oil production falls from US$112 billion in the business-as-usual scenario to US$88 billion in the low-carbon scenario, with the government bearing US$18 billion of the value at risk by 2035. However, Egypt has some of the highest energy subsidies in the world, distorting current markets and creating inefficiencies. As a result, Egyptians would benefit more than most countries from falling oil demand and prices in a low-carbon scenario. The range of benefits for consumers is US$57–109 billion, resulting in a total potential benefit to Egypt of US$28 billion to US$85 billion by 2035.74

Beyond stranded assets, companies also face the risk of stranded technologies, products, and business models – all part of transition risk. For example, the automotive industry is vulnerable, given uncertainty around future requirements for mobility, fleet fuel economy standards, the speed of improvement of new technologies (electric vehicles, batteries, hydrogen fuel cells), and new business models such as ride-sharing. As companies consider future scenarios for their business strategies, the transition risks to various business models of these potential new developments should be incorporated into disclosures.

Physical risks due to climate change will also alter financial performance of companies in many instances, and these need to be accounted for. For example, how will the higher probability of drought or flood events affect corporate operations, across the value chain?

Few companies today report on physical risks, yet they have clear implications for financial performance and are increasingly recognised as important by leading companies and regulators.

Box 14 — The Task Force on Climate-related Financial Disclosures

There has been an increase in demand for useful information for decision-makers on the risks and opportunities from a changing climate. However, the information available today on climate risks at the corporate level is inconsistent and inadequate.

The industry-led Task Force on Climate-related Financial Disclosures (TCFD) is conducting a high-level review of the existing landscape of climate-related disclosures, including current voluntary and mandatory climate-related disclosure regimes, to identify commonalities, gaps, and areas for improvement.

The TCFD’s initial report proposes seven principles for effective climate-related financial disclosures: 1) present relevant information; 2) be specific and complete; 3) be clear, balanced and understandable; 4) be consistent over time; 5) be comparable among companies within a sector, industry or portfolio; 6) be reliable, verifiable and objectives; 7) be provided on a timely basis.

As part of the next stage of its work, the TCFD will develop recommendations for common standards for voluntary disclosures. Target audiences include preparers of the disclosure information (listed companies and issuers of public securities for financial and non-financial companies) and users of the information (investors, lenders and underwriters). Target locations for this information are mainstream financial filings and investor annual reports. The information and metrics to be disclosed will aim to be financially relevant, efficient, qualitative and quantitative (“through the eyes of management”), historical and forward-looking (scenario analyses), and short-, medium- and long-term.75

More complete, consistent disclosure of climate-related risks and opportunities can promote more informed decision-making by the users of disclosures and better risk management by boards and management – which, in turn, will enable a more appropriate pricing of risk, thereby helping promote a more stable financial system.

Strengthening the role of Multilateral Development Banks and other Development Finance Institutions

Multilateral Development Banks (MDBs) and other Development Finance Institutions (DFIs) have a key role to play both in directly financing sustainable infrastructure, and in leveraging or “crowding in” private investment. DFIs – notably MDBs, bilateral development banks and national development banks – can boost the effectiveness of limited public resources by mobilising private finance to fill large gaps in sustainable infrastructure financing. They can help build capacity, prepare projects and structure deals upfront. They can also offer direct financing to mitigate risk for other co-financiers, such as through loan guarantees or other first-loss instruments. Not covering the full cost of investment frees up limited public resources for more projects while encouraging private investment. Through targeted private-sector operations that use blended finance approaches, MDBs and other DFIs can help scale up investments in infrastructure and make them more sustainable (see Box 15).

DFIs have essential expertise and capacity to draw the relevant players to the table to bring a project to closure. Their interventions are even more effective where they build on public-private investment dialogue owned and led by national governments. Such efforts can be usefully complemented by dialogue at the international level, working across providers, also country-led.

MDB financing of infrastructure more than doubled from 2004 to 2013, rising from US$20 billion in 2004 to about US$54 billion in 2013. Looking across the bilateral and multilateral portfolios of official development finance (international public concessional and non-concessional finance), the share going to infrastructure is about a third of the total in 2013, and growing. Of the total infrastructure portfolio of official development finance, roughly half is multilateral, and half bilateral.76 However, by far the largest source of finance for infrastructure in developing countries is domestic – it originates within each country. That is where there is a large opportunity to crowd in private investment from local capital markets.

Box 15 — Financial innovation to boost private investment in sustainable infrastructure in Southeast Asia

In a ground-breaking initiative, the ADB recently combined the lending operations of its Asian Development Fund (ADF) with its ordinary capital resources balance sheet to boost its total annual lending and grant approvals to as much as US$20 billion – a 50% increase from prior levels.77 Through this action alone, which takes effect in January 2017, ADB assistance to low-income countries will rise by up to 70%. Combined with a commitment to grow the share of spending on climate change to 30% of its portfolio by 2020, these financial innovations could contribute significantly to delivering sustainable infrastructure.

Another example is the issuance of the first climate bond for a geothermal project in an emerging economy, the Philippines, in an example of credit enhancement.78 The US$225 million-equivalent local currency bond comes in addition to a direct ADB local currency loan of US$37.7 million equivalent. The ADB’s credit enhancement is in the form of a guarantee of 75% of principal and interest on the bond. This is the first climate bond in the Asia-Pacific region certified by the Climate Bonds Initiative, and the first climate bond for a single project in an emerging market. Credit-enhanced project bonds such as this one, offer an attractive alternative to bank financing, and by mobilising cost-effective, long-term capital can help close the region’s infrastructure gap.

There are at least five specific ways in which DFIs can make a significant difference. Some of these actions are already being undertaken, but could be done at a larger scale:79

  • Significantly scale up their own direct financing for sustainable infrastructure, thereby augmenting the availability of long-term debt finance and reducing the cost. This can be achieved by borrowing in international and domestic (provider) or local (host country) markets at competitive rates, which will be much lower than what even fairly advanced developing countries can access due to the creditworthiness of the DFIs.
  • Crowd-in other sources of long-term debt finance from all sources, including through loan syndication, which allows development banks or other primary lenders to recycle their capital for more sustainable infrastructure investment, thus increasing the number of projects they finance for a given budget allocation.
  • Enhance use of well-designed and standardised risk mitigation instruments and credit enhancements – for example, through greater use of loan guarantees, risk insurance or credit line operations. In this context, there is continued scope for MDBs, NDBs, and other DFIs to deepen communication on successful models for financing sustainable infrastructure and the means to replicate these across regions and different institutions.
  • Help close the viability gap in financing of sustainable infrastructure – for example, due to high social benefits that are often not reflected in the returns from the projects. This can be done by mainstreaming climate change performance criteria and other thinking related to sustainable development goals into investment criteria and strategies.
  • Help developing-country partners plan and direct external development finance to sustainable infrastructure priorities that are tailored to national contexts.

There is a real potential to use DFIs, working in tandem with local financial institutions, to help significantly scale up private financing. Their role can be both to help meet the large upfront financing costs and for long-term take-out financing once the project reaches the operating phase. Banks or local financial institutions are well suited to provide long-term debt finance in the construction phase. But there is also much greater scope to attract institutional investors through use of equity offerings. Local capital markets for financing can provide the large sums that will be needed for take-out finance. This effectively means that local banks lend to infrastructure projects, eventually selling a part of that loan to a third party after the project has become operational, thereby freeing up financing for more projects over time. But this will require concerted action to reduce actual and perceived risks and to develop replicable and scalable financing models that can crowd in private finance and bring down the cost of capital. Demonstrated models include use of mitigation instruments such as loan guarantees or first-loss insurance as well as the use of blended finance more generally, where local financial institutions are critical actors to financing projects in the construction phase.

Recent work led by the African Development Bank, the Inter-American Development Bank and the OECD highlights the role of DFIs more generally to work with local financial institutions, including national development banks and commercial banks, to build capacity and the level of interest for investment in sustainable infrastructure (see also discussion in Section 4: Energy).

Over the last decade, developing country governments have seen an increase in the set of the financing options they can access to support their national strategies and plans.80 Governments are using this to their advantage, and approaching donors from a strengthened and more assertive negotiating position and strategy for their borrowing. They are expressing clear preferences for development finance to be aligned to their national priorities, for development needs to be directly identified by them, and for programmes to be delivered as quickly as possible (which can be done by further streamlining safeguards, procurement and bureaucratic procedures).8182 Development partners – including MDBs and other DFIs – should deliver programmes that meet these three priorities to increase the effectiveness of their action and remain relevant to partner country governments.

A review of development cooperation portfolios shows that a small but growing share – about 20% – of overall bilateral and multilateral development finance portfolios targeting climate change objectives also aim to engage the private sector. There is growing knowledge of good practices in this area (see Box 16).83

The relatively small share of activity targeting the private sector in climate-related development finance suggests significant untapped potential. Providers of development finance can work with and through the private sector, particularly in local contexts and with the support of partner countries, to achieve climate change and sustainable development objectives.84 For example, in bilateral development cooperation, a large part of the portfolio is dedicated to technical assistance for partner country governments or other stakeholders, to develop strategies and policy reforms to implement these goals. This assistance can include identifying policies that create an enabling environment to attract private investment to sustainable infrastructure over the medium to long term.

In contrast to bilateral development cooperation more broadly, MDBs and bilateral development banks (often these are separate branches of bilateral development cooperation agencies or ministries) have a much larger share of their portfolio in infrastructure operations. Thus the relative competences of these types of DFIs are complementary to those of others. Better collaboration and recognition of the specialised competence of various types of DFIs can help tackle the full range of financing challenges faced by developing-country governments to finance sustainable infrastructure.

Box 16 — Emerging lessons from development cooperation to engage the private sector for green growth and climate action

Recent OECD and Donor Committee on Enterprise Development work offers a number of recommendations for development cooperation aiming to engage the private sector for climate action and green growth:85

Understand the demand for donor support from the private sector in partner countries: How can donors partner with local stakeholders in developing countries to address the barriers that companies face in pursuing green growth and climate action?

Do not distort the market, and have clear exit strategies in place. To drive lasting positive environmental change, these approaches need to promote sound business models and be financially feasible to help create commercially viable opportunities and good quality employment over the near- to medium term.

Build enabling conditions for greener businesses to thrive – for example, by promoting green value chain development. GIZ (the German Federal Enterprise for International Cooperation) and the International Labour Organization, for instance, recently produced a toolkit that supports stakeholders in selecting green value chains.

Combine different approaches into a package of activities. For example, technical assistance to support enabling conditions can be paired with tools and specific instruments aiming to leverage private investment in the near-term. An example of the importance of signalling from the public sector to mobilise private investment is the 20×20 Initiative that helped bring impact investors into land restoration projects in Latin America and is now being extended to Africa through the African Forest Restoration Initiative (AFR100) initiative (see Section 6).

In an example of good practice, DFIs are increasingly committed to mainstreaming climate change considerations within their strategies and operations. Through the Mainstreaming Climate Initiative, for instance, DFIs are working together to explore emerging practices, strategies and share experience. They have identified five key principles:

  • Commit to climate strategies,
  • Manage climate risks,
  • Promote climate smart objectives,
  • Improve climate performance, and
  • Account for climate action.

Multilateral, bilateral and other development finance institutions should double their investments in financing sustainable infrastructure as quickly as is feasible, scaling up further as warranted. A number are starting to step up their investments already, including through measures to expand their capital base and increase their use of risk mitigation instruments and blended finance to leverage investment. Their efforts should focus on countries to strengthen policies, institutions and capacities to reliably deliver domestic resources and ensure a solid pipeline of bankable projects, as well as approaches that can crowd in private finance. They could have a significant impact by boosting the amount of capital available for sustainable infrastructure and ensuring that they have measures to crowd in private investment (e.g. by taking first losses) rather than crowd it out. The role of DFIs should be to help build capacity to turn the many good projects being put forward into a pipeline of bankable projects. An essential first step is to establish key performance indicators for heads of DFIs and, in the case of MDBs, for country office leads on mainstreaming sustainability thinking into their infrastructure investments and technical assistance. Coupled with in-country leadership to advance domestic policy reforms, this would begin to align incentives to drive action at scale.

  1. UNEP Inquiry, 2015. The Financial System We Need: Aligning the Financial System with Sustainable Development. The UNEP Inquiry Report. UNEP Inquiry into the Design of a Sustainable Financial System. United Nations Environment Programme, Geneva. LINK

  2. Carney, M., 2015. Breaking the Tragedy of the Horizon: Climate Change and Financial Stability. Speech at Lloyd’s of London, 29 September. LINK

  3. IPCC, 2014. Climate Change 2014: Synthesis Report. Contribution of Working Groups I, II and III to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change. Core Writing Team, R. K. Pachauri, and L. A. Meyer (eds.). Intergovernmental Panel on Climate Change, Geneva. LINK

  4. UNEP Inquiry and 2° Investing Initiative, 2016. Building a Sustainable Financial System in the European Union. The Five ‘R’s of Market and Policy Innovation for the Green Transition. UNEP Inquiry into the Design of a Sustainable Financial System. United Nations Environment Programme, Geneva. LINK

  5. Ibid.

  6. LINK (in Chinese).

  7. UNEP Inquiry. 2016. Green Finance for Developing Countries. Needs, Concerns and Innovations. UNEP Inquiry into the Design of a Sustainable Financial System. United Nations Environment Programme, Geneva. LINK

  8. LINK

  9. Finansinspektionen, 2015. Environmental and Sustainability Perspectives in Credit Granting to Companies. Ref. 15-14755. Stockholm. LINK

  10. Finansinspektionen, 2016. Climate Changes and Financial Stability. Ref. 15-13096. Stockholm. LINK

  11. UNEP Inquiry and 2° Investing Initiative, 2016. Building a Sustainable Financial System in the European Union.

  12. UNEP Inquiry and 2° Investing Initiative, 2016. Building a Sustainable Financial System in the European Union.

  13. See: The first report is: TCFD, 2016. Phase I Report of the Task Force on Climate-Related Financial Disclosures. Presented to the Financial Stability Board. LINK

  14. LINK

  15. Deutsche Asset and Wealth Management, 2015. ESG & Corporate Financial Performance: Mapping the Global Landscape. S11 Special Issue. Confidential report for institutional clients. December.

  16. LINK

  17. For a complete list: LINK

  18. LINK

  19. Agence France-Presse, 2016. World’s biggest wealth fund excludes 52 coal-related groups. The Guardian, 15 April. Environment. LINK

  20. Byrne, B., 2016. Norway Sovereign Wealth Fund pressures Exxon, Chevron on climate. ValueWalk, 4 May. LINK

  21. Doyle, A. and Fouche, G., 2016. Norway wealth fund turns up climate heat on Exxon and Chevron. Reuters, 3 May. LINK

  22. Mercer, 2015.  Investing in a Time of Climate Change. LINK

  23. Olson, B. and Friedman, N., 2016. Exxon, Chevron shareholders narrowly reject climate-change stress tests. The Wall Street Journal, 25 May. Business. LINK

  24. LINK

  25. Byrne, B., 2016. Norway Sovereign Wealth Fund pressures Exxon, Chevron on climate.

  26. Doyle and Fouche, 2016. Norway wealth fund turns up climate heat on Exxon and Chevron.

  27. Agence France-Presse, 2016. World’s biggest wealth fund excludes 52 coal-related groups.

  28. Climate Bonds Initiative, 2015. PBoC Takes Post COP21 Step on Green Bonds. New Definitions, Market Guidance and Disclosure Rules. 22 December. LINK

  29. London Stock Exchange, n.d. Agricultural Bank of China Green Bond Case Study. LINK

  30. Bloomberg News, 2015. China to boost $100 billion green bond market for renewables.

  31. Bloomberg News, 2016. China’s $230 billion green bond thirst to supercharge market.

  32. This section is based partly on a NCE background paper from the OECD; OECD, 2016. Eklin, K., and Youngman, R., Green Investment Banks: Innovative Public Financial Institutions Scaling up Private, Low-carbon Investment. (forthcoming) LINK

  33. BRPD 2011. Policy Guidelines for Green Banking. LINK

  34. UNEP Inquiry, 2015. The Financial System We Need: Aligning the Financial System with Sustainable Development. The UNEP Inquiry Report. LINK

  35. UK Green Investment Bank, 2015. Annual Report and Accounts 2014–15. LINK

  36. Connecticut Green Bank, 2013. Connecticut’s Green Bank, Energizing Clean Energy Finance. 2013 Annual Report, Connecticut Clean Energy Finance & Investment Authority. LINK

  37. UK Green Investment Bank, 2015. Annual Report and Accounts 2014–15.

  38. Clean Energy Finance Corporation, 2015. Factsheet: CEFC and the City of Melbourne accelerate sustainability initiatives. October 2015. LINK

  39. Clean Energy Finance Corporation, 2015. Annual Report 2014-2015. LINK

  40. Connecticut Green Bank, 2015. Connecticut Green Bank – Investment and Public Benefit Performance from Clean Energy Projects from FY 2012 through FY 2015. LINK

  41. Clean Energy Finance Corporation, 2015. CEFC has Helped Accelerate $3.5b in Total Investment Towards a Competitive Clean Energy Economy. Press Release, Clean Energy Finance Corporation, July 15, 2015. LINK

  42. GreenTech Malaysia, 2015. Malaysian Green Technology Corporation Annual Report 2014. LINK

  43. Based on Bhattacharya et al., 2016. Delivering on Sustainable Infrastructure for Better Development and Better Climate.  and OECD, 2016.

  44. Kaminker, C., Kawanishi, O., Stewart, F., Caldecott, B. and Howarth, N., 2013. Institutional Investors and Green Infrastructure Investments. OECD Working Papers on Finance, Insurance and Private Pensions. Organisation for Economic Co-operation and Development, Paris. LINK

  45. Prequin, 2015. Infrastructure Spotlight. June. LINK

  46. Kaminker, C., Kawanishi, O., Stewart, F., Caldecott, B. and Howarth, N., 2013. Institutional Investors and Green Infrastructure Investments. OECD Working Papers on Finance, Insurance and Private Pensions. Organisation for Economic Co-operation and Development, Paris. LINK

  47. OECD, 2016. Progress report on approaches to mobilising institutional investment for green infrastructure. LINK

  48. OECD, 2016. Progress report on investment governance and the integration of ESG factors. LINK

  49. OECD, 2016 (forthcoming). Institutional Investors and Green Infrastructure Investment. A Policy Brief prepared as  Contributing Paper to this Report of the Global Commission on the Economy and Climate. It was prepared by Chris Kaminker, Environment Directorate, OECD, and draws on the Reports references above. LINK

  50. Loyalty: fiduciaries should act in good faith in the interests of their beneficiaries, should impartially balance the conflicting interests of different beneficiaries, should avoid conflicts of interest and should not act for the benefit of themselves or a third party. Prudence: Fiduciaries should act with due care, skill and diligence, investing as an ‘ordinary prudent person’ would do.

  51. UNEP Inquiry, 2016. Fiduciary Duty in the 21st Century.

  52. PRI, 2015. Report on Progress 2015. LINK

  53. UNEP Inquiry, 2016. Fiduciary Duty in the 21st Century.

  54. Baron, R. and Fischer, D., 2015. Divestment and Stranded Assets in the Low-carbon Transition. LINK

  55. UNEP Inquiry, 2015. The Financial System We Need: Aligning the Financial System with Sustainable Development. The UNEP Inquiry Report. LINK

  56. OECD and CDSB, 2015. Climate Change Disclosure in G20 Countries: Stocktaking of Corporate Reporting Schemes. Organisation for Economic Co-operation and Development and Climate Disclosure Standards Board, Paris. LINK

  57. FSB TCFD, 2016. Phase I Report of the Task Force on Climate-Related Financial Disclosures. Presented to the Financial Stability Board. March 2016. LINK

  58. FSB TCFD, 2016. Phase I Report of the Task Force on Climate-Related Financial Disclosures. See also: Bank of England, 2015. The impact of climate change on the UK insurance sector. A Climate Change Adaptation. Report by the Prudential Regulation Authority. LINK

  59. Sandra Batten, S., Sowerbutts, R., Tanaka, M., 2016. Let’s talk about the weather: the impact of climate change on central banks. Bank of England Staff Working Paper No. 63. May.

  60. UNEP Inquiry and 2° Investing Initiative, 2016. Building a Sustainable Financial System in the European Union.

  61. OECD and CDSB, 2015. Climate Change Disclosure in G20 Countries: Stocktaking of Corporate Reporting Schemes. Organisation for Economic Co-operation and Development and Climate Disclosure Standards Board, Paris. LINK

  62. See, for example, Gelles, D., 2016. S.E.C. Is Criticized for Lax Enforcement of Climate Risk Disclosure. The New York Times, 23 January. LINK

  63. UNEP Inquiry and 2° Investing Initiative, 2016. Building a Sustainable Financial System in the European Union.

  64. Ibid.

  65. Carbon Pulse, 5 Nomber 2015. China central bank chief economist proposes mandatory CO2 reporting for listed companies. LINK

  66. CDP, 2015. Corporate Ambition & Action on Climate Change. CDP policy briefing, based on analysis conducted for the New Climate Economy. New York. LINK

  67. CDP, 2015. Putting a Price on Risk: Carbon Pricing in the Corporate World. LINK

  68. We Mean Business, 2014. The Climate Has Changed: Why Bold, Low Carbon Action Makes Good Business Sense. Report prepared by CDP. LINK

  69. UNEP Inquiry, 2015. The Financial System We Need: Aligning the Financial System with Sustainable Development. The UNEP Inquiry Report. LINK

  70. Note that these disclosure statistics hide two important subtleties. First, climate change is not material for all companies and all sectors, so some of the “non-disclosures” may indeed be complying with expectations. Second, actual disclosure varies across countries and disclosure rates are much higher in countries with national requirements. Third, the OECD and Climate Disclosure Standards Board review found that largely due to the complexities and uncertainties involved, existing requirements of the mandatory systems in place do not broadly cover other material aspects of climate-related financial risks such as potential losses due to climate-related extreme weather events.

  71. OECD and CDSB, 2015. Climate Change Disclosure in G20 Countries: Stocktaking of Corporate Reporting Schemes. Organisation for Economic Co-operation and Development and Climate Disclosure Standards Board, Paris. LINK

  72. Mercer LLC, 2015. Investing in a Time of Climate ChangeLINK

  73. EBRD, 2016. Government Assets: Risks and Opportunities in a Changing Climate Policy Landscape. Prepared by the Climate Policy Initiative. European Bank for Reconstruction and Development, London. LINK

  74. EBRD, 2016. Government Assets: Risks and Opportunities in a Changing Climate Policy Landscape.

  75. FSB TCFD, 2016. Phase I Report of the Task Force on Climate-Related Financial Disclosures.

  76. Miyamoto, K. and Biousse, K., 2014. Official Support for Private Sector Participation in Developing Country Infrastructure. OECD Development Co-operation Working Papers, No. 19. Organisation for Economic Co-operation and Development, Paris. LINK

  77. ADB, 2015. ADF-OCR Merger to Boost Support for Region’s Poor. Asian Development Bank news release, 2 May. LINK

  78. ADB, 2016. ADB Backs First Climate Bond in Asia in Landmark $225 million Philippines Deal. Asian Development Bank news release, 29 February. LINK

  79. Bhattacharya et al., 2016. Delivering on Sustainable Infrastructure for Better Development and Better Climate.

  80. Prizzon, A., Greenhill., R. and Mustapha, S., 2016. An Age of Choice for Development Finance: Evidence from Country Case Studies. ODI report, April. LINK

  81. Prizzon, A., Greenhill., R. and Mustapha, S., 2016. An Age of Choice for Development Finance: Evidence from Country Case Studies.

  82. Davies, R. and Pickering, J., 2015. Making Development Co-operation Fit for the Future A Survey of Partner Countries. OECD, Paris. LINK

  83. Crishan Morgado, N., 2016 (forthcoming). Private sector engagement to address climate change and promote green growth. OECD Policy Brief.

  84. Ibid.

  85. Crishna Morgado, N., 2015. Development Co-operation and the Environment: Engaging the private sector for green growth and

    climate change. OECD – DCED Workshop Report (Summary record). Paris: OECD. LINK

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