IINVESTOR ENTHUSIASM for the financing of the green transition is growing – just look at the rise in interest in the electric car industry. Tesla shares rose 50% in 2021; those from CATL, the Chinese battery giant, rose 68%. Yet if you take a closer look you will find huge problems. If the world is to reach net zero emissions by 2050, investments will need to more than double, to $ 5 billion per year. And fund management is full of “green-washing”. Sustainability rating systems have proliferated but are extremely inconsistent, while many funds mislead investors about their green credentials.
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To the rescue came the European Union, which has developed a new labeling system, or taxonomy, which sorts the economy into activities it deems environmentally sustainable, from the installation of heat pumps to anaerobic digestion. sewage sludge. The idea is that funds and companies will use this to disclose how much of their business is considered green, and this clarity will help free up a flood of capital from the markets. The proposals have been in the works for years and on December 31 the European Commission released its final thoughts.
Countries have different sources of energy, so the exercise was necessarily political. Still, the classification seems reasonable. Calling nuclear power green – subject to conditions, including the safe disposal of toxic waste – has been greeted by howls from the Green Party in Germany. But nuclear can play an important role in achieving net zero; indeed, by judging it green only during the transition, the taxonomy is, if at all, too timid. The plan to label natural gas as green has also been controversial. But the rules reflect a stubborn assessment that it will be a vital transitional fuel over the next decade. They treat gas projects as green for a limited period, if they replace more polluting fossil fuels, receive approval by the end of the decade, and contain plans to switch to cleaner energy sources. here 2035.
The flaws in the plan lie in its bureaucratic design. The simplistic nature of the labeling can lead to a purity test in which funds exclude dirty assets. In fact, a key job of capital markets is to own polluting businesses and manage their emissions. Classification is static, while technological changes will reduce the carbon intensity of some activities and lead to inventions that classifiers have not considered. This fits a model of well-intentioned but marginal European climate finance ideas, including using the European Central Bank to buy green bonds (which could overstep its mandate) and imposing green ‘stress tests’ on banks, even if the lifespan of their assets is shorter than the horizon of the most devastating climate change.
What else to do? The aim should be to make it easier for investors to track the carbon emissions of their portfolios (today, this is difficult to do with precision). Zero-emission funds would be virtuous, but those that quickly shrink their footprint could be even better. This will require re-disclosure, so investors can track emissions and avoid double counting in supply chains. Such a system would be easier to administer and would require less of countries struggling to agree on what counts as green. A new global green disclosure body has been set up, but it needs to act faster.
the EUThe broader goal of should be to use carbon pricing to change the way capital is allocated. Relying on investors to save the planet with the help of a taxonomy has obvious limitations. Less than a third of global issues come from companies listed on the stock exchange and controlled by institutional investors. And investors don’t have a clear incentive to be green. If you don’t mind the stigma, owning polluting assets can pay off, which is why they are increasingly being held privately.
In contrast, putting a price on carbon sends a signal that reaches the entire economy, not just listed companies, and fully aligns the profit motive with the goal of reducing emissions. the EUThe main carbon pricing system in is the richest world ‘s largest, but although work is underway to expand it, it only covers 41% of emissions. If the EU wants to lead the world by unleashing the power of finance to fight climate change, it is on the carbon market that he should focus his efforts. ■
This article appeared in the Leaders section of the print edition under the title “The Meaning of Green”
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