By Armida Salsiah Alisjahbana, United Nations Under-Secretary-General and Executive Secretary, United Nations Economic and Social Commission for Asia and the Pacific
The Asia-Pacific region finds itself buffeted by increasingly frequent climate-related shocks, together with the multifaceted socio-economic implications of the COVID-19 pandemic and the war in Ukraine.1 The coal-fuelled economic-growth engines of the past require urgent restructuring and transformation if we are to achieve the goals set out under the Paris Agreement. Capital markets, a key intermediator for climate finance and investment, can be an effective channel to redirect capital to climate transition.
From climate commitments to climate action
The battle against climate change will be won or lost in Asia and the Pacific. This region is currently responsible for more than half of global greenhouse gas (GHG) emissions, with more than 80 percent of future projected growth in coal demand coming from Asia alone2—a challenge since quitting coal is essential for limiting global warming to 1.5 degrees Celsius (°C). Yet, on the existing business-as-usual trajectory, it is estimated that the planet will breach the 1.5°C ceiling in less than 12 years and hit 3°C of warming by the end of the century.3
Last year’s United Nations Climate Change Conference (COP26) in Glasgow, Scotland, saw several ground-breaking agreements and positive commitments from Asian and Pacific countries to climate mitigation. This included regional powerhouses China and Indonesia committing to net-zero emissions by 2060, Japan and the Republic of Korea promising the same by 2050 and the vast majority of countries in the region pledging action through nationally determined contributions. Despite this, progress toward these commitments remains challenging for all countries, especially the Least Developed Countries (LDCs) and Small Island Developing States (SIDS). Governments and the private sectors in the region are still grappling with difficult trade-offs, balancing various economic and social priorities with the need to mitigate and adapt to climate change while ensuring a just transition for vulnerable communities.
The climate-finance gap
The availability of all forms of climate finance is crucial for turning commitments into action. (Climate finance refers to local, national or transnational financing—drawn from public, private and alternative sources of financing—that supports mitigation and adaptation actions to address climate change.)4 However, the most recent figures for global annual climate-finance flows, US$632 billion in 2020, vividly reveal the widening of the climate-finance gap. These flows represent less than 11 percent to 21 percent of the estimated $3 trillion to $6 trillion in investment needs. At the same time, investment continues to flow to high-emission sectors, such as fossil fuels, exceeding $850 billion annually. It is anticipated that climate-finance flows have slowed post-pandemic and that the climate-finance gap has grown as a result.5
The financing gap in Asia and the Pacific becomes more acute when considering that out of the climate finance that flowed to this region in 2020 ($331 billion of the previously referenced $632 billion [52 percent]),6 more than 70 percent went to China, creating a sizable cross-regional disparity with severe implications for developing countries. Another salient feature of current climate-finance flows is that adaptation finance comprises only a fraction (approximately 7 percent of the $632 billion in 2020) and is estimated to stem predominantly from public sources.7 Furthermore, the majority of climate finance was raised as debt (61 percent), usually short term in nature and frequently insufficient to finance the longer-term requirements of climate-related projects. Equity accounted for 33 percent, and grant funding constituted the remaining 6 percent. Solar photovoltaic (PV) and onshore wind attracted 91 percent of these funds.8
If we are to turn climate commitments into decisive climate actions, this is a critical moment. This region’s economies require capital for new, greener industries and transitioning their traditional growth engines. Capital markets are only one channel in the financial system but act as a bellwether of capital flows. And they need to urgently channel significant capital toward a green transition, not just conduct business as usual.
Are capital markets adequately channelling capital toward green opportunities?
Green and sustainable investment is no longer a niche investment area. By one estimate, global sustainable investments (which include environmental, social or governance [ESG] factors in portfolio selection and management) totalled $35.3 trillion of assets in 2020, up 15 percent from two years prior, equivalent to 36 percent of professionally managed capital globally.9 Another estimate indicates that environmental, social and governance assets will hit $50 trillion by 2025, representing more than a third of the projected $140.5 trillion in total global assets under management (AUM).10
However, according to ESCAP (United Nations Economic and Social Commission for Asia and the Pacific) research,11 the Asia and the Pacific region is not on track to achieve any of the Sustainable Development Goals (SDGs) and, worryingly, is regressing on two key climate-related goals (Goal 12 and Goal 13). So, despite the trillions of capital classified as “sustainable”, climate impacts continue to worsen. As concerns over “greenwashing” demonstrate, there remain gaps within capital markets and debates regarding their governance and ability to incentivize issuers and investors to support genuine green transitions.
If issuers and investors were to accurately price and structure their investments in a manner that incorporated the true costs of climate change and transition as well as the costs of the implementation of more rigorous climate-reporting standards (a significant cost that multiplies when cascaded down to investees and their business operations), profit margins and risk profiles would be downwardly altered in the short term. Eventually, as always, these costs end up being borne by the businesses behind these opportunities, which will seek to pass them on to consumers, further worsening the cost-of-living crisis at a difficult time.
Furthermore, when effective regulation is missing, poorly enforced and mismatched across economies or is distortive (in both profit and climate terms), even responsible capital that seeks green-transition opportunities faces stronger and more compelling incentives toward less risky, more profitable, less green opportunities. Without a level playing field, those that incorporate these true costs face the loss of competitive market power compared to those that do not, further worsening incentives. And, given the interconnectedness of global capital markets, aligning capital markets toward the climate can rarely be done in isolation by single markets.
Therefore, instead of leaving the generation of more responsible capital stewardship solely to private markets and voluntary norms, I believe governments in Asia and the Pacific need to provide clarity and norms to capital markets to create a level playing field that does not unduly distort such incentives. In essence, “guardrails” are needed. This requires flexibility, calibration and good governance by all.
Recommendations to better align capital markets to channel climate finance
- Collaboratively developed, balanced regulation of capital markets
While some Asian capital markets are very large and experience good connectivity, others are just emerging. Regulators across the region are grappling with how best to define and enact regulation that is internationally competitive, promotes financial stability and protects households, businesses, investors and the planet. This is not an easy task, especially given the need for a just transition in LDCs and SIDS. Too often, a new regulation is enacted without effective consultation with key stakeholders, leading to distortive burdens. At times, new regulations also overlap with existing ones, creating additional burdens, opacity and confusion. It is paramount that regulation in this complex area is collaboratively developed in dialogue with key market players. ESCAP will continue to promote dynamic and reciprocal information sharing to better identify stakeholder priorities, risks and opportunities and make the most of the comparative advantages of each stakeholder to contribute to climate finance.
- Accurate asset valuations and convergence in climate disclosures and reporting standards
There is also growing recognition that climate-related financial risks are not fully reflected in asset valuations, which still tend to use historical growth assumptions that do not adequately account for climate externalities and risks. There is also an acknowledgement that the financial system has fundamental systemic risks due to climate change. As the Network (of Central Banks and Supervisors) for Greening the Financial System (NGFS) recommends, quantitative climate-related risk analysis is needed across the financial system, using a consistent and comparable set of data-driven scenarios encompassing a range of different plausible future states of the world.12 Convergence in climate-related standards and disclosures in the region, as outlined in an ESCAP report,13 has yet to happen. Convergence is not just important for reducing transaction costs and streamlining reporting and regulatory burdens; it is needed to create a level, competitive playing field for issuers and investors across different Asian and Pacific markets. While there has been significant progress with the formation of the International Sustainability Standards Board (ISSB), regional collaboration, which ESCAP can support further, is required.
- Showcase and demonstrate successful climate-related issuances, especially to countries that have yet to see a viable deal in their capital markets.
Green-bond issuances have risen substantially globally, and science-based climate definitions are now increasingly standard practices (either linked to the use-of-proceeds clauses or sustainability-linked themes). As such, these should be presented as positive examples of capital markets benefiting both profits and the planet. While green-bond issuance is still in its embryonic stage in some markets in the region, as can be seen in the figure below, momentum is building, and regional capital markets are taking note. Thematic bond-issuance research from ESCAP14 outlines how this can be further accelerated.
- Encourage capital to seek adaptation opportunities, not just mitigation.
As noted above, only about 7 percent of the 2020 climate finance was allocated to adaptation, almost entirely by the public sector. Therefore, it is critical to incentivize climate finance to flow to not only clearly profitable climate-mitigation projects in solar and wind through easy lender-preferred instruments, such as short-term, dollar-denominated debt, but also to adaptation projects and nature-based solutions as well. The latter may offer longer-term profits, albeit with more uncertain timelines, and need financing instruments that are appropriate to the projects’ success. These include longer-term maturities, mezzanine solutions and/or equity, and instruments denominated in local currency so that as hard-currency interest rates rise, developing countries do not see the financing gap widen even more.
- Encourage the building of green pipelines of opportunities for capital markets.
As a joint report from ESCAP and the Global Green Growth Institute (GGGI) outlines,15 the growth of green-transition opportunities to which capital can flow depends upon such opportunities being appropriately developed and funnelled into a pipeline of investable deals (investability being newly defined to include climate factors). If capital markets are to meet their own climate commitments, they need green pipelines and cannot leave the issue to project developers (especially small-scale developers) to shoulder the risky and expensive burden of project preparation. Governments also have essential roles in incentivizing the growth of green pipelines by providing appropriate guidance. More innovative methods of upstream project identification, risk sharing and development are needed.
Capital markets in Asia and the Pacific are entering a new world. This requires new approaches to collaborative thinking—between governments and markets as well as public and private stakeholders—through new ways of incorporating uncertainty and fresh methods of sharing risks and returns. ESCAP stands ready to work with the region’s countries and support them in their journeys.
1 UNESCAP (United Nations Economic and Social Commission for Asia and the Pacific): “The War in Ukraine: Impacts, exposure and policy issues in Asia and the Pacific,” Policy Brief, May 2022.
2 Asian Development Bank (ADB): Asia and the Pacific’s Climate Bank: “Key Figures in the Fight Against Climate Change.”
3 IPCC (Intergovernmental Panel on Climate Change): “Climate Change 2021: The Physical Science Basis,” Sixth Assessment Report, Working Group 1, August 9, 2021.
4 United Nations Framework Convention on Climate Change.
5 Climate Policy Initiative (CPI): “Global Landscape of Climate Finance 2021,” Barbara Buchner, Baysa Naran, Pedro de Aragão Fernandes, Rajashree Padmanabhi, Paul Rosane, Matthew Solomon, Sean Stout, Githungo Wakaba, Yaxin Zhu, Chavi Meattle, Sandra Guzman Luna and Costanza Strinati, December 14, 2021.
9 Global Sustainable Investment Alliance: “Global Sustainable Investment Review 2020,” July 2021.
10 Bloomberg: “ESG Assets Rising to $50 Trillion Will Reshape $140.5 Trillion of Global AUM by 2025, Finds Bloomberg Intelligence,” ESG 2021 Midyear Outlook Report, July 21, 2021.
11 UNESCAP (United Nations Economic and Social Commission for Asia and the Pacific): “Asia and the Pacific SDG Progress Report 2022: Widening disparities amid COVID-19,” March 17, 2022.
12 Network for Greening the Financial System (NGFS): “First comprehensive report: A call for action: Climate change as a source of financial risk,” April 17, 2019.
13 UNESCAP (United Nations Economic and Social Commission for Asia and the Pacific): “Financing the SDGs to build back better from the Covid-19 pandemic in Asia and the Pacific,” October 12, 2021. Sales No. E.21.II.F.13 Bangkok.
14 UNESCAP (United Nations Economic and Social Commission for Asia and the Pacific): “An Introduction to Issuing Thematic Bonds,” December 22, 2021. Sales No. Bangkok.
15 UNESCAP (United Nations Economic and Social Commission for Asia and the Pacific): “Green and Climate Finance Options to Support the Post-COVID-19 Pandemic Recovery and Climate Action,” UNESCAP and GGGI (Global Green Growth Institute), 2021.