The G20, under the Italian Presidency, hosted in Venice on 11 July the International Conference on Climate Change. This was a high-level event to discuss economic policies to support the transition to a low-carbon economy, as well as the international regulatory and supervisory framework to address climate-related financial risks and encourage the alignment of financial flows to net zero carbon objectives.
Professor Stefano Battiston explores this topic in the third and final article of the Venice G20 series.
The Italian Presidency of the G20 occurs in the year 2021, which has become a symbolic time for the start of the recovery from the pandemic crisis.
At the same time, Italy has the co-presidency of the global policy event on climate change, COP26. This is only a coincidence but it is symbolic of the complex relations between sustainable development, climate change, and finance.
The COVID-19 pandemic has reminded all of us that social and economic well-being is not not insulated in the abstract space described by many economics textbooks, but rests upon the biological well-being of humans and ecosystems. In turn, the latter rests upon the stability of planetary climate (at time scales of centuries, at least). In short, there is no economic development without sustainability, in particular in terms of human impact on climate.
In contrast, before the pandemic, the world was on a path of increasing global warming and increased likelihood of reaching tipping points that could trigger catastrophic changes, as documented by the special report by the Intergovernmental Panel on Climate Change (IPCC) in 2018. Therefore, the pandemic recovery can be the opportunity to take issues of sustainability and climate seriously. Indeed, 2021 could mark the turning point from the business-as-usual trajectory to kickstart a technological and social transition to a low-carbon economy. Or, it could mark the moment in which the world misses the opportunity to contain global warming within the limit of 2 degrees Celsius, as stipulated in the Paris Agreement.
A failure to mitigate climate change implies high risks deriving from climate-related impacts on people and economic activities (e.g. extreme weather, or sea level rise), and we have been seeing the first effects already. Further, a failure to drive a timely transition to a low-carbon economy implies high risks deriving from the loss of value of economic activities relying on the use of fossil fuels.
Despite the fact that scientific evidence about the risks related to climate change have been known for two decades, until a few years ago, in finance, climate was regarded as a niche ethical issue.
Today, climate change is fully recognised by financial supervisors and the private financial sector as a new source of financial risk. Finance is the strongest driver of modern economies, as economic activities follow the directions of financial flows. Therefore, this new awareness of climate risks is a potential game changer.
As a platform of the ministries of finance of the largest economies in the world, the G20 is very influential in the debate of where the world will be heading in the next 20 years, which is a decisive time window for limiting global warming. Since 2017, the G20, through its Task Force on Climate-related Financial Disclosures, has played a key role in drawing the attention of the financial system to the risks arising from climate change. The Italian proposal to relaunch G20 Sustainable Finance Study Group and to promote it to Sustainable Finance Working Group has been approved. This initiative gives a more central stage to sustainability, and climate mitigation in particular, in the recovery phase.
Once climate risks are recognised, “building back better” in alignment with climate objectives makes perfect economic sense, because high-carbon infrastructures would make the transition more costly.
Therefore, aligning the economic recovery from the pandemic with climate targets has been a central aspect in the debate on the design of the EU Recovery Plan for Europe. For the EU Recovery and Resilience Facility (RRF), a political agreement was reached in December 2020 for it to include a minimum of 37% of expenditure on investments and reforms to support climate objectives, while respecting the main other sustainability objectives (such as biodiversity and water, i.e. the “do no significant harm” principle). The agreement specifies in detail the list of eligible activities and excludes for instance from the funding transport infrastructures that rely on fossil fuel such as airports or shipping of fossil fuels. This has also direct implications for the Italian national recovery plan (PNRR). While member states have discretion in the implementation of the RRF, the EU Commission can reject funding items that do not meet the criteria. The first tranche of the Italian PNRR has been approved last June.
There are two main challenges between the release of these funds and their best use to support Italy’s alignment to climate objectives. The first is the risk of greenwashing i.e. that somewhere down the chain of outsourcing, some economic activities are less climate-friendly than it looks on paper and how their compliance should be certified. The second is the underestimation of risk because of models and scenarios that are too optimistic and may lead market players to underinvest in climate-aligned activities with respect to what they would have invested, had they known the risk they were actually facing (assuming no moral hazard).
With both challenges, there is enormous societal value in the scientific research, independent and policy relevant, that only academia can carry out. In this context, Ca’ Foscari has been expanding its team and efforts on sustainable finance. The topic of energy efficiency in ESG rating is currently the focus of a H2020 financed project, TranspArEEns. Moreover, how different climate scenarios imply different levels of financial risk and how pandemic, financial and climate risk compound are areas in which Ca’ Foscari is at the forefront of scientific research.
Written by Stefano Battiston, Professor at the Department of Economics of Ca’ Foscari University of Venice.