THE FINANCIAL SECTOR: A LINCHPIN TO ADVANCE SUSTAINABLE DEVELOPMENT (cont.)
Levers to align the financial sector with sustainable development
There are multiple ways the financial industry can facilitate the transition to a green economy. Sustainability standards, such as the IFC Performance Standards, are the traditional way for the financial industry to self-regulate on environmental issues. However, additional levers are needed to further stimulate the financial sector to allocate capital differently. Two related solutions are emerging.
1. Pricing environmental risk
A number of initiatives, such as CarbonTracker and the Natural Capital Declaration, are developing models that quantify how the risks of climate change, ecosystem degradation, water scarcity, waste management, and other environmental challenges can affect company revenues. In extractive industries, energy, agriculture, and other sectors, environmental risks can be included in the cost of capital to borrow money or in the market value of public and private companies. Investors who fail to factor in such risks could potentially face legal action for failure to comply with their fiduciary duty.
Consider the fossil fuel sector: the December 2015 Paris Agreement presents a monumental challenge for the global community to shift, systematically and rapidly, away from fossil fuels towards renewable energy. In addition, efforts to reduce emissions from deforestation, forest degradation, and other sources of greenhouse gas must be amplified.
The European Union is committed to at least a 40 per cent domestic reduction in greenhouse gas emissions by 2030 compared to 1990, as outlined in its Intended Nationally Determined Contribution or INDC.[13] The EU must enhance the process of decarbonisation in major carbon emitting sectors, including energy and transport, by stimulating greater investments in renewable energy technologies, as well as in energy storage solutions. At the same time investments in coal and other forms of carbon-intensive energy generation become riskier and less financially viable. In other words, these fossil fuel assets could become stranded assets.
Definitions
Stranded assets refer to investments becoming less profitable due to premature write-down, devaluations, or conversion to liabilities, which could be due to environmental issues25
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