COP25, the 25th United Nations (UN) climate talks, in Madrid was a huge disappointment. As I understand it, the talks had two main goals: to seek new commitments for further drastic cuts in emissions of greenhouse gases beyond that promised in Paris‘15; and to agree on a set of regulations for new international carbon markets.
The theme of the meeting was: “Tiempo de actuar, ” i.e. time for action; its logo being a clock, showing a quarter to 12. Action? The meeting was anything but: it only managed a weak and watered-down commitment to cut greenhouse gas emissions; while the regulations for new global carbon markets had to be deferred to COP26, Glasgow in November 2020.
Since Paris’15, emissions and global temperatures have continued to rise. The consequences have been felt around the globe in devastating storms, heatwaves and forest fires, to name but a few effects.
The December’19 assessment shows that if global emissions continued at current rates, the atmosphere will hold enough greenhouse gases to warm the planet by 1.5 degrees Celsius within just 10 years.
Under the 2015 agreement, nearly 200 nations promised to stop global warming before temperatures rise by more than 1.5 to two degrees Celsius above pre-industrial levels. Privately, most climate scientists admit they hold little hope that temperature rises can be kept below the 1.5 degrees Celsius target.
Yet, the consequences of missing the target are devastating. Particularly for arid regions like the Mediterranean, and low-lying ones like Bangladesh and the eastern seaboard in America, where shorelines are being gnawed by rising seas.
So, a coalition of governments, including the European Union (EU) came to Madrid demanding, as I understand it, a strongly-worded text urging all nations to commit in 2020, to cut their emissions more and faster than promised so far.
However, the final text was scarcely an improvement, though there was mention of the gap between the reductions promised in national pledges and what the science says is necessary to avoid more than 1.5 to 2 degrees Celsius of warming. Despite EU’s commitment to reducing emissions to net zero by 2050, in practice, none of the governments appeared willing to do enough to make good their promises a reality.
A second sticking-point in Madrid was over what is known as “loss and damage” – a concept particularly important to the least-developed nations already suffering some of the worst impact of climate change (despite having barely contributed to the pile-up of greenhouse-gas emissions that is warming the planet).
They had hoped the UN would make financial provisions to help them cope with the real, immediate impact of climate change (for instance, in the aftermath of an extreme hurricane). However, that was the red line for many of those very rich emitters, who contended that other disaster funds already exist. They do not want to open a conversation about liability.
The third sticking-point was the one which, I think, COP25 will be remembered. It concerns an arcane and highly-technical Article 6 of the Paris agreement, which offers a broad framework for international carbon markets. The Environmental Defence Fund (EDF), an advocacy group, had concluded that such markets could theoretically reduce the cost of meeting climate targets by between 60% and 80%.
If those financial gains were reinvested in further efforts to mitigate emissions, cumulative reductions in global emissions between 2020 and 2035 could potentially double what is currently on the table in national pledges under Paris‘15.
The task in Madrid was to establish a set of regulations that would make such markets work for the environment, by both offering financial incentives for green projects; and generating real, measurable emissions reductions, provided that: green projects (a solar power-station, say, or a facility to flare methane from landfills) demonstrably reduced emissions above what the host country has already promised; and that “emissions credits” granted for green projects are not double-counted.
Disagreement arose over how the new carbon market could effectively link up with a similar one created under the 1992 Kyoto Protocol: the Clean Development Mechanism (CDM) – where rich countries can buy carbon credits from green projects in poorer ones in order to offset the emissions they were producing at home. Thousands of CDM projects were registered but their credits left unclaimed after their value crashed in 2012, because demand dried up. The task proved so devilishly complicated that the matter was postponed until the summit in Glasgow later this November.
The exasperation of radical climate activists is understandable. Despite decades of talk, emissions of greenhouse gases and global temperatures had continued to rise. If the trend does not alter soon, the chances of avoiding an increase in global temperatures of more than 1.5 degrees Celsius above pre-industrial levels will be zero; and those of avoiding a two degrees Celsius increase will be tiny.
The longer the delay in acting, the larger the required action becomes, until nothing can be done because it will be too late. Indeed, it is already almost too late to avoid what experts view as destructive and irreversible changes in climate.
So, dramatic policies are needed, including how to stop “greenwashing, ” in which market players label their products as green without any independent way to verify.
For investors, the green label will be the highest standard and is likely to include renewable technologies and clean energy products such as wind and solar, as well as vehicles with engines that have zero emissions.
Fund managers will have to calculate how much of their environmentally friendly assets under management will qualify as green. But, what makes a bond green? The taxonomy has to be sorted out.
Central bank role
I don’t think climate change has yet pose a critical threat to the financial system. But things can change: extreme weather can eventually leave banks with dud non-performing loans) Or, leave insurers with vast claims. Still, too much greenery risks politicising (and compromising) central banks’ core mission – which works best with politics at arm’s length.
As I see it, some of what central banks have done so far should be welcome: including the global central banks network’s work on standardised ways to incorporate climate risks into banks’ stress tests; promotion of a new market in green (or greenish) bonds; special policy accommodation on loans made to fund green projects; even, green quantitative easing (QE) by not buying brown assets. But not all share this view – including the Swiss National Bank and the Bundesbank. They oppose the use of monetary policy to also tackle climate change. They regard “green” monetary policy as not “democratically legitimised.”
Indeed, there is potential for conflict of interest (climate objectives can compromise commitment to price stability); risks “overburdening” monetary policy and hence, losing its independence; and it’s wrong to use banking regulation to set climate policy incentives. However, the new president of the European Central Bank has since declared climate change as “mission-critical” priority in its current review of QE.
So far, central banks have focused on the impact of climate change risks on the financial system. But activists argue that, just as central bankers save the global economy during the financial crisis, so too must they tackle the next emergency by shifting capital away from polluters, and towards greener uses. Europe’s technocrats have shown some willingness to consider the idea. Others caution that it should be a job for politicians instead. Be that as it may, it is worth noting the channels through which climate change could threaten financial stability. They include: (i) exposure of financial firms to physical risks: floods, for instance, lead to big insurance pay-outs and sink the value of banks’ mortgage books; and then (ii) there is the “transition” risk: new government policies (such as carbon price) could see investors dump assets of polluting companies. Share prices could collapse, and defaults on bank loans rise. Polluters also risk climate-related litigation.
Furthermore, (iii) climate-related disruption could affect productivity and long-term economic growth, with consequences for interest rates. As its economic and financial effects become clearer, climate change is certain to loom larger in central banks’ thinking. What they do about it will depend on their willingness to tread on political turf.
As I see it, green QE and schemes like it can be misguided, for three reasons. First, central banks lack a clear mandate to deter emissions. True, climate policy could affect the economy – but so do all kinds of things, such as unemployment benefits, with which central banks would never dream of interfering. This is also true for other catastrophic risk: a pandemic that kills lots of workers would have huge economic implications; but nobody thinks central banks should be mixed-up with medical research. And policies to avert global warming also redistribute wealth. That is why proposals for a carbon tax are typically paired with some sort of compensation for the losers – something that is far beyond central banks’ mission today. Second, green QE would be, in my view, inferior to a carbon tax. The size of the cost-of-capital advantage it gives green firms would vary with the quantity of bonds the central bank buys. Because QE is a tool designed to stimulate the economy, that volume depends on unemployment and inflation. Why should the incentive to be green interfere with economic cycles?
Third, even if it carried democratic legitimacy, the expansion of central banks’ goals beyond their core mission can be unwise. Power is delegated to technocrats precisely because they are supposed to be neutral and can be easily held accountable against narrowly defined targets. But if it becomes normal for them to tilt capital allocation in a desirable direction, why stop at climate change? The left would leap at the chance to penalise companies that are deemed too profitable, or which have pay structures that disadvantage workers.
Populists might want central banks to favour firms that invest at home and buy local. The more politicised central banks became, the less independent they would be perceived. If governments want to penalise polluters they should do so directly with taxes, or by empowering new environmental bodies. There is no need to muddy the waters over the responsibilities of central banks.EU’s Green Deal
EU’s Green Deal (EGD) is ambitious. The overarching objectives are to reach (i) “climate neutrality” (net-zero greenhouse-gas emissions) by 2050; (ii) a circular economy that ends the destructive pollution caused by petrochemicals, pesticides and other waste and toxic substances; and (iii) a “farm-to fork” food system that neither kills people with an overly processed diet nor kills the land with unsustainable practices. The European Investment Bank will become EU’s climate bank. To succeed, three big challenges need to be addressed.
The first is to overcome status quo interests, especially of Big Oil. The second is financing. Europe will have to direct an incremental 1–2% of annual output towards the green economy, including new infrastructure, public procurement, R&D, industrial retooling, and other needs. The last big challenge is diplomatic.
Europe accounts for 9% of global carbon dioxide emissions, compared with 30% for China and 14% for US. Even if Europe fully implements EGD, it will be for naught if China, India, US, and other regions fail to match its efforts.
So, EU rightly treats diplomacy as critical to EGD’s success. Indeed, as I see it, China will determine the world’s climate future. European diplomacy can make the difference only if it refuses to go along with US’s insidious efforts to contain China; and instead offers China a clear and positive partnership: working together on sustainable Eurasian infrastructure, development, and technology, Such a partnership would hugely benefit Europe, China, and the dozens of Eurasian countries in between, and indeed the entire world.
What then are we to do
Climate change cannot be solved by one country. To succeed, policy must be effective, legitimate and global. To be effective, policy must include incentives aimed at shifting behaviour. In principle, a carbon tax, or an emissions trading system with a price floor, can be the most effective (because it’s the most comprehensive) way to influence emissions. Schemes that generate fiscal revenue can also be attractive to politicians, because the monies can be used for many valuable purposes.
Singapore, Jan 6,2020
Former banker, Harvard-educated economist and British chartered scientist Prof Tan Sri Lin See-Yan of Sunway University is the author of Trying Troubled Times Amid Trauma & Tumult, 2017–2019 (Pearson, 2019). Feedback is most welcome. The views expressed here are the writer’s own.
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