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).

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.

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).

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).

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.

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.

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

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.

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.

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.

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.