The Climate Financialization Trap: Claiming for Public Action

Abstract

This opinion paper aims to offer a critical assessment on the prevalence of solutions to the climate change problem that rely on climate finance. The paper briefly recalls the key milestones in the evolution of climate finance and highlights what is referred to as a “climate finance trap,” offering some crucial insights that might help remedy potential systemic distortions and that vehemently demand public action in the domain of climate policy.

1. Introduction

The purpose of this article is to offer some lines of thought regarding the rising significance of finance when considering climate crisis solutions. The rise of green finance and the establishment of the “new discipline” of climate finance provides a new development in the environmental policies that structurally goes hand in hand with the financialization of capitalism. Climate finance should also be related to SDGs, including SDG 7 (affordable and clean energy), SDG 9 (industry, innovation, and infrastructure), SDG 11 (sustainable cities and communities), SDG 13 (climate action), and SDG 14 (life below water). For instance, climate finance can be employed to assist initiatives for renewable energy, increased access to clean water, encouraging eco-friendly transportation, and saving marine environments. Furthermore, climate finance can assist in addressing the disproportionate harm that climate change causes to weaker groups, notably those in developing nations.

The reflection offered in this paper is critically intended to highlight the risks inherent in embracing climate financialization without also implementing a public climate policy to guide private companies, investors, and the banking sector. The article challenges the notion that financialization can adequately address climate change, especially when it involves the creation of markets for capitalist accumulation.

2. The Rise of Climate Finance

In order to reconstruct the rise of green finance, a few milestones that prepared the way for the development of this financial sector should be recalled. In the late 1990s, as one of the main results of the Kyoto Protocol, the first international market for trading emissions with the Clean Development Mechanism (CDM) was established. CDMs brought the climate issue to the global dynamic as a global offset program to allow polluting corporations in the Global North that were unable to meet their reduction goals to purchase credits from emission reduction programs in the Global South. The geographical scope of climate finance is an important consideration in the context of efforts to address climate change. While climate finance can be applied in any part of the world, it is particularly important for developing countries that are the most vulnerable to the impacts of climate change. This recognition is reflected in the United Nations Framework Convention on Climate Change (UNFCCC), which calls for developed countries to provide financial resources to developing countries to support climate change mitigation and adaptation efforts. By 2005, the EU had built the world’s largest emissions trading system—a “cap and trade” system—named the European Union Emissions Trading System (EU-ETS). The CDM went into effect that same year, allowing polluting corporations to buy their way out of reducing pollution. In the past 20 years, the banking and financial sector has been one of the main players in the climate issue: the Climate Convention (UNFCCC) process in 2007 brought about the concept of a mobilization of public and private funds and investments, including the facilitation of climate-friendly investment choices [1,2]. The Climate Policy Initiative (CPI), founded at the suggestion of financier Georges Soros and supported by significant American foundations and several governments, launched a funding initiative in 2010. Since 2012, the CPI has compiled an annual study on the flows of climate funding called “Landscape of Climate Finance.” The end of the year 2015 was a turning point for the recognition of green finance: the United Nations Environment Program (UNEP) and the World Bank Group cooperated in publishing a report aimed at political decision makers to collect signatures from asset managers on climate financing [1]. In the same year, the Paris Agreement was adopted by all 195 delegations in attendance at the Paris Climate Conference (COP21). The inaugural speech by Carney in 2015, governor of the Bank of England, on the financial risks of climate change should be remembered [3]. Furthermore, on a global scale, in 2015, the United Nations Assembly officially adopted the 17 Sustainable Development Goals (SDG). In 2017, the One Planet Summit, launched by the French government, gave rise to a network of 34 central banks: the Network for Greening the Financial System (NGFS). The European Commission unveiled an “action plan” for financing sustainable growth in March 2018 [2,4,5].

Climate risk is perceived very clearly by banking and financial players, even more so than by nation states. The global financial system reacted actively in directing resources toward new green assets (mitigation), especially for clean power generation, in addition to evaluating climate risks and acting on them (adaptation). When climate change risk is expressed in financial terms, it effectively becomes a default risk [4,6,7].

The development of CDM and the EU-ETS, which have risen during the neoliberal transition, has been decisive in decreeing the supremacy of climate finance, but it must be emphasized that they were not successful initiatives in reducing carbon emissions. Already by the end of 2012, after the two implementation phases of 2005–2007 and 2008–2012, permits and credits were oversupplied and then depreciated and devalued. The national states developed the financialization infrastructure to trade pollution units for incommensurable offset certificates rather than stepping in to create regulations to keep fossil fuels underground [8]. After the Cop 2019 in Madrid, the CDM was transferred into a new system called Sustainable Development Mechanism (SDM).

Carbon markets remain the best option going forward despite the dilemma of permit overproduction from the already planned phases 3 and 4 of the CDM. Voluntary, uncontrolled carbon markets were established with the end of the Kyoto Protocol and the Paris Agreement. Thirty-one emission trading systems (cap and trade with offsets) and thirty carbon tax systems were operational as of the end of 2019, and it is expected that they transacted over USD 45 billion in 2019. Voluntary marketplaces supplement this. For actual operators and real businesses, each of these financialized trades represents real money. Many sizable fossil fuel firms, such as Shell, have internal trading platforms. This illustrates how crucial climate finance is [9].

There are, nowadays, many other instruments that can be included in climate finance, such as green bonds issued by businesses, governments, or other institutions to support climate-friendly initiatives such as the use of renewable energy sources or the construction of energy-efficient structures: sustainable loans, to fund initiatives or endeavors that benefit the environment or society (e.g., for sustainable agriculture, energy-efficient building renovations, and renewable energy projects); environmental, social, and governance (ESG) investing, which is the practice of funding businesses that exhibit high ESG performance; and impact investing, aimed at providing financial gains and favorable social or environmental results in investment projects.

Through financial instruments, there are many ways to address climate risk while making financial decisions: negative and positive screening of funded companies (e.g., ESG performance assessment employed by the financial industry to evaluate the sustainability performance of businesses seeking finance. Depending on the objectives of the financial institution and its clients, positive and negative screening help in fostering sustainable development and responsible investing), active ownership, focused investments in green assets (such as green bonds and clean energy public equity), specialized funds in renewable energy infrastructure (such as project finance), cleantech venture capital, and alternative finance are some examples of green investment strategies [10,11]. The fact that policymakers have acknowledged finance as a component of the response to the climate change problem lends even more legitimacy to the financial approach to climate. Along with the expansion of global finance, which is rapidly emancipating itself from political control, particularly because of neoliberal financial deregulation, comes an increase in the political influence of multinational corporations [12]. Although climate financialization is, however, a crucial step in combating climate change, it is an insufficient solution for several reasons: Firstly, it may place a higher priority on profits than actual emission reductions. Although climate financialization may offer financial incentives for funding environmentally favorable initiatives, these initiatives may not necessarily result in actual emission reductions. Investments in energy conservation, which may be less profitable but more effective in reducing emissions, may be prioritized above investments in renewable energy projects, for instance. Secondly, it may not address the root causes of climate change: climate financialization can provide a way to finance and scale up climate-friendly projects, but it may not address the root causes of climate change. For example, it may not address the overconsumption and overproduction of goods that contribute to greenhouse gas emissions. Lastly, it may not be accessible to all: climate financialization can create new financial instruments and markets that may not be accessible to all investors and stakeholders, particularly those in developing countries. This can create inequalities in access to financing for climate-friendly projects [13].

3. The Risk of Trapping Climate into Financialization

When identifying which are the main junctures to define the financialization trap, at least three should be mentioned. A first important juncture on which the financialization of climate is based is an established background element, namely the financialization of the entire economy and of the public finance [14,15]. The urgency of the climate crisis, the necessity to invest in changing an economic system that generates too many greenhouse gases, and the need to safeguard society from the effects of global warming are compelling nations that want to take action to spend a sizable amount of money.

This is precisely where climate finance fits in as a solution, between the political actor that seeks to mobilize resources to finance investments that the public budget would not be able to support and private companies that can offer financial expertise applied exactly in the logic of investment, that is, with an expectation of economic return [16].

Following the neoliberal pattern, the public actor must remain neutral and let the market make its own choices. What is expected from the public actor is to act as regulator, providing “incentives” or defining the disclosure regulation. Companies make their choices, and they are just required to explain their operations under the “comply or explain” principle, which stipulates that if a company does not fulfill its disclosure obligations they have to provide an explanation. There is a substantial lack of any legally binding contractual responsibilities for the green obligations. To date, it is the financial industry that sets the rules for the financial industry (no pun intended) [5,10].

A second juncture regards the commodification of “climate” and the supremacy of a financial logic: through systems that turn pollution and natural processes into comparably traded “units,” approaches to conservation and climate change policy have been financialized [17]. What is novel is how proponents of “nature” markets mistakenly assert that by valuing and financializing pollution, which is considered as a waste or an externality from an economic perspective, they can both neutralize pollution and delay climate change. However, it should be made clear that financial and market logic uses the decision binomial of risk or return on investment. Now that climate change is a problem, it necessitates large investments that are difficult to finance, either because the expected return is too low or even negative for the investor (even though it is good for society), or because the risk is too great, particularly given the length of time it takes to see the expected benefits.

Here, a potential path to a solution, or at the very least a crucial hint, appears: public finance intervention is required to make up for the deficit by increasing returns (for example, through tax exemptions) or lowering risk (through co-financing or the provision of guarantees) in order to allow for the completion of more projects [15]. As of now, it appears that public finance serves as the foundation for green financing [18].

However, the recognition of green finance as a possible way forward reveals a structural contradiction: on the one hand, finance is allowed to follow the rules of the market and competition, limiting the intervention of the state, which could only intervene in the event of market failure; on the other hand, green finance projects, once they have passed under the risk/return lens, would require public financing. This suggests that governments can only intervene to a limited extent within this framework and must rely on the markets to control private financial flows. However, even on this aspect, there are limits given by potential greenwashing behavior on the side of the financial asset managers in the absence of clear and binding regulations on disclosure [10].

However, the role of the state is crucial in supporting and developing green finance. First, it can set laws and rules that encourage the creation of green finance, e.g., through tax incentives, grants, and other forms of assistance for green investments and projects. The state can also develop standards and certification programs that support credibility and openness in green finance, making it simpler for investors to recognize projects that are truly sustainable. Second, the state can assist green finance by using its own financial resources. This can involve making green bond purchases or other environmentally friendly investments, as well as providing green loans or other funding choices for environmentally friendly enterprises. In general, the state and green finance relationship is crucial because the state has the authority to provide the legal and policy framework required to support the growth of sustainable investments and encourage the shift to a more sustainable economy.

A last pivotal element is the price rule. Like markets for pollution permits (EU-ETS), green finance is predicated on the idea that polluting participants will change their behavior by acting on pricing (or on the information provided prior to their formation). When it comes to carbon pricing, the rise in the price of carbon should motivate businesses to invest in environmentally friendly technologies. Green finance aims to make funding green initiatives less expensive than financing brown companies so that investors will be enticed to invest in green.

4. Conclusions and Future Perspectives

Around an apparently technical and aseptic goal such as decarbonization, there are numerous underlying choices of an intrinsically political nature, which affect the economy, society, and nature as a whole and shape the way these components interact and relate to each other. The pre-eminence accorded to the public interest in the ecological transition sheds important light on the role of the state, which is required to functionally and ultimately reorient the economic system towards ecological goals and the market, i.e., in the relationship between the latter and the environment (ecosystem) [19].

A wide range of financial innovations and instruments are necessary to make the transition to a low-carbon economy and to an eco-social society, and these developments will have a significant impact on all the actors, states, markets, businesses, intermediaries, and investors [20]. Tracing back to Robert C. Merton’s functionalist theory of finance (1995) [21], we must unleash financial innovation to effectively mobilize capital toward investments that can reduce climatic risks and their effects. Some lines of conclusion, which are not intended to throw away the finance completely, emerge from this reflection.

Firstly, financial innovation related to climate change (for instance, green bonds) can be used more properly if public guidance and greater control of instruments such as financial and extrafinancial reporting, as well as capacity to measure carbon emissions, are guaranteed. The term “greenness” is frequently overused to describe financing options provided by issuers who misrepresent the true environmental impact of their activities (also known as “greenwashing”). The measurement and reporting of environmental footprints are typically only partially done, not always audited, and largely up to the issuers and asset managers’ discretion. The measurement of the actual environmental footprint of corporate and sovereign issuers is uneven and unreliable because of different metrics and rating systems, as well as the inherent conflict of interest between issuers, investors, and score/rating providers [22]. The actual accountability of issuers, coupled with transparency and comparability, are necessary to direct private money toward issuers and projects that can facilitate the transition to a low-carbon economy [5,23].

It is still obvious that financial innovation is needed to move beyond simple disclosure to effective management of climate risk, even though institutional investors who are long-term oriented are actively pursuing greater standardization of legitimate mandates and seeking trustworthy climate performance metrics. On the other hand, more financial regulators are intensifying their efforts to enhance the information that financial actors have access to regarding the climate (Task Force on Climate-Related Financial Disclosures). It is crucial to understand that central banks are considering the prospect of controlling or favoring emitters with reduced volatility in the distribution of their assets [24,25]. For the cleanest sectors, this would result in a marginal reduction in capital costs, notably, significantly accelerating the ecological transition of the real economy.

A second point of primary importance for its impact on the real economy is the definition of a public climate policy at the national and regional levels [26,27], the so-called climate plans. The development of a climate agenda at the regional and even local level, which acts with the instruments of the tax system to promote adaptation policies, restores legitimacy to the public actor and can act more closely to civil society. Polanyi (1944) [28] emphasized that in order for markets to be established and for certain sectors to be protected during times of crisis, the state must use its legal and judicial authority. The expansion of capital accumulation through financialization depends heavily on the role of strong nations and their capitalist partners. This is exactly the case for financialized market-based climate change policy. The development of regional as well as national and international plans creates schemes for action of a public nature directed at the main actors of pollution and global warming impact, thus translating climate responsibility into a collective and not an individual one [29,30]. According to the perspective of the foundational economy [29,31], the climate issue acts on an indirect level, i.e., it becomes a form of social and global inequality when it is dealt with through financialization. The public policy instrument closest to civil society in the area of climate change is therefore local climate plans, in which the public actor can draw the lines of action to promote emission reductions, acting on various levels, such as from mobility, housing, agriculture, and support for the adoption of energy efficiency measures to the development of renewable energies at the local level (energy communities are an example of this type of development), and also acting above all at the administrative level [32]. A decisive intervention in authorization procedures is undoubtedly a priority. Rather, the obstacles to the granting of authorizations relate to the effective implementation of these provisions, which are systematically disregarded in administrative practice, especially regarding the timeframe for the conclusion of procedures.

In summary, this paper sheds light on the following aspects within the complex discourse of ecological transition towards a decarbonized economy, with a particular focus on climate change:

• Decarbonization is a political issue that affects the economy, society, and nature.
• Financial innovations are necessary to promote a low-carbon economy, but they need to be guided by public control.
• Reporting on climate performance is essential for promoting transparency, accountability, and comparability, as well as for managing climate-related risks and meeting regulatory requirements.
• Public climate policies at the national and regional levels are crucial for the real economy in order to promote emission reductions, renewable energy development, and other measures that affect society as a whole.

5. Limitations

The conclusion of the paper puts forward a viewpoint on the cooperation between the public and private domains concerning the climate. Starting from the standpoint that green finance is crucial and based on public finance, the paper discusses three crucial junctions that illustrate the financialization mechanism and identify, among the many potential interventions, how two primary existing instruments can be more effectively employed. Many other arguments could further extend the topic of this paper, which, nevertheless, offering the critical opinion of the author, is consciously limited to certain aspects.

The sphere of climate change, with its diverse areas of focus, is continuously evolving and will demand constant scientific attention to balance the disparate courses of action that political parties and markets are undertaking.