The EU cannot go it alone in the green transition
Tackling the climate emergency with every chance of success requires sustainable funding. It is difficult to overstate what the financial sector can do to catalyze change by reorienting risk management and investments in line with the criteria of sustainability and support stakeholders in their energy transition. With assets four times the gross domestic product of the European Union of 15 billion euros, the European financial sector has great firepower. This consists of € 30bn from banks, € 18bn from investment funds, € 9bn from the insurance industry and € 3bn from pension funds. It is clear that the role of the private sector in the green transition will be substantial.
The need for private investment and finance to green Europe opens up vast opportunities. the European Green Agreement and New generation EU The program will finance around € 140 billion of the € 300 billion per year needed to meet the United Nations 2030 agenda for sustainable development. A little more than half of these 140 billion euros will come directly from the European budget.
Thus, three quarters of the additional investment needs until 2030 must come from the private sector. Applying the same ratio to the total needed to decarbonise the European economy by 2050, which McKinsey estimates at 28 billion euros, the challenge for the private sector is to finance and invest some 700 billion euros each year. for three decades.
Along with the commitments of responsible investment principles, European financial institutions must follow the European Commission’s action plan (which involves a new taxonomy, bond standards and other green finance and transparency obligations) and work under increasingly demanding supervision. To this is added a growing societal demand for green investments. Control of global investment funds, grouped under Climate Action 100+, has also increased. These funds, whose assets under management represent nearly two-thirds of global GDP, have made climate change the central focus of their strategy and have engaged in activism against companies that do not take sustainability seriously.
So there are reasons for hope. There are a large number of investment funds that provide investors, large and small, with assurances about the green destination of their investment.
This is the good news. But there are three points which cast doubt on the chances of success. The first concerns speed. Progress is palpable, but slow. Many European companies are not taking action. According to the European Investment Bank, only 45% have made investments to adapt or mitigate climate change.
On the other hand, despite all its dynamism, green bond issue still represents just over 4% of the total. Markets still haven’t done enough to internalize the cost of brown activities. While some green portfolio indices are performing better than average, this is not yet the case for green bonds, which often have to pay a premium over traditional bonds. What is behind this disappointing fact is the decline in liquidity, as well as poor and non-standardized environmental assessments.
The second complication concerns fungibility. There is still no consistent evidence that green bonds have resulted in lower corporate level emissions. In energy production and distribution, the largest green emitters perform below average, according to studies by the Bank for International Settlements. A probable cause is that the funding is fungible. A green bond can fund a project that would have been done anyway and might not even lead to environmental improvements if the same company makes other brown investments.
Currently, Europe is concluding its discussions on the principles of green bonds and loans, and what it takes to get a green label. This will be based on taxonomy, use of funds and scrutiny by third parties. A criticism of the design of green financial products is that in addition to not being conditioned on the elimination of brown activities, recipient companies are not required to reduce their emissions. A general and transparent framework is necessary. Company level, rather than simply product and project, ratings would provide essential information.
Third, there is an overwhelming need for substantial public intervention. Without it, even the best case scenario for sustainable finance would fail to meet the goal of net zero by 2050. The problem is simple. Half of the investment projects required for net zero are not financially viable. This is the case for most investments aimed at increasing the energy efficiency of buildings, transport and energy production and distribution.
There is an obvious way to fix this problem. If the European carbon price remains just below € 40 per tonne, a large number of investments in clean energy will not have a business case. Only with a carbon price of at least double the current price will most green investments be viable.
But raising the price of carbon would not solve everything. Many projects are too uncertain to justify the initial investment, such as carbon dioxide capture and storage systems. Direct public investment may be the only solution. In other cases, public-private partnerships, first-loss guarantees or subsidies will be needed.
The private funds available to deal with the climate emergency are plentiful. But without a combination of transparency, an adequate carbon price, green public investments and incentives for the private sector, achieving the goals of Agenda 2030 and a net zero for the EU by 2050 is a matter of course. pure fantasy.
José González-Páramo is a former member of the management board of the European Central Bank.