Over the past decade, it has become clear that the financial sector can play a pivotal role in creating a more sustainable economy. In recent years, a diverse range of financial institutions and investment organisations has shown increasing awareness of the environmental, social and governance (ESG) issues facing firms, investors and the wider economy. Among these issues is climate change, which has risen quickly up the agenda for both central banks and financial regulators.<\/p>\n\n\n\n
Yet the policies of central banks continue to reinforce the fossil-fuel economy (Wdowin, 2021<\/a>; Matikainen et al, 2017<\/a>). This is despite support for greater sustainability from key figures such as Christine Lagarde, president of the European Central Bank (ECB), Kristalina Georgieva at the International Monetary Fund and Mark Carney, former governor of the Bank of England. There have also been frequent calls for firms and investors to divest from fossil-fuel assets and deny future financing of additional projects that may contribute to climate change. A key question is whether these calls have had an impact.<\/p>\n\n\n\n The current rise in global greenhouse gas emissions indicates that the world is likely to experience catastrophic consequences due to climate change (Intergovernmental Panel on Climate Change, 2018<\/a>). There is wide scientific consensus that achieving a \u2018net-zero carbon economy\u2019 by 2050 is essential for stabilising the temperature increase to under 1.5\u00b0C (Matthews and Caldeira, 2008<\/a>). Funding \u2018green\u2019 solutions and discouraging the financing of fossil-fuel-intensive activities are critical for addressing this threat.<\/p>\n\n\n\n For this goal to be plausible, researchers have suggested that any new financing of fossil-fuel infrastructure such as oil rigs and power stations needs to cease with immediate effect. Further, up to 20% of existing infrastructure should be abandoned as what are known as \u2018stranded assets\u2019 (Pfeiffer et al, 2016)<\/a>.<\/p>\n\n\n\n Stranded assets are capital investments that have been subject to unanticipated or premature changes in their value. This can take the form of a \u2018write-down\u2019 \u2013 when the listed value of an asset is reduced to reflect the fact that its fair market value has fallen \u2013 or a devaluation \u2013 adjusted down when it is assumed to be unable to deliver expected future cash flows. Stranded assets can also refer to assets that have been converted to liabilities on a balance sheet. This can occur when investors have to cover costs for clean-ups or damages, or are held liable for dangerous technologies.<\/p>\n\n\n\n Since investment choices can affect overall emissions, the economic decisions made in the Covid-19 recovery strategy must be aligned with society\u2019s environmental and climate goals. Central banks, as well as other financial institutions, can affect emissions levels through their strategic decisions, which influence the allocation of funding within the wider economy.<\/p>\n\n\n\n Progress in implementing environmental policies such as carbon taxes and emissions trading schemes has been slow. This has placed greater pressure on the financial sector to cut funding for new fossil-fuel infrastructure (Hepburn, 2010<\/a>; Le Billon and Kristoffersen, 2019<\/a>). This pressure has been magnified by the recognition that the fossil-fuel sector has a substantial influence on the policy-making process (InfluenceMap, 2020)<\/a>. As a result, several studies have called for the use of diverse financial instruments to accelerate the shift to a net-zero economy (Ascui and Mackenzie, 2009<\/a>; Flammer, 2021<\/a>; Barber et al, 2021<\/a>).<\/p>\n\n\n\n \u2018Green investing\u2019 has emerged in the past decade <\/a>and includes different investment strategies that can contribute to the advancement of environmental sustainability (Mazzucato and Semieniuk, 2018<\/a>; Global Sustainable Investment Alliance, 2018<\/a>). These include investing in low carbon energy infrastructure and innovations across financial asset classes; investing in only the top environmentally sustainable companies across sectors; designing fossil-fuel-free investment portfolios; and divesting from (and denying further finance to) fossil-fuel-based economic activities.<\/p>\n\n\n\n But what counts as green can be hard to determine (Mathiesen, 2018<\/a>; Fiedler et al, 2021<\/a>). This is why the European Commission defines which economic activities are environmentally sustainable across six objectives: climate change mitigation; climate change adaptation; biodiversity and the sustainable use and protection of water and marine resources; the transition to a circular economy; pollution prevention and control; and the protection and restoration of biodiversity and ecosystems.<\/p>\n\n\n\n This emerging \u2018EU taxonomy\u2019 is an important science-based classification system, and can be used to guide investors towards funding environmentally sustainable solutions (EUR-Lex, 2021<\/a>).<\/p>\n\n\n\n Countries around the world have deployed a broad range of Covid-19 spending packages in response to the pandemic. Fiscal policies \u2013 including increased public spending as well as tax cuts \u2013 have become prominent features in green recovery strategies (Hepburn et al, 2020<\/a>). But what is less well understood is whether monetary policy has a part to play. A crucial question is whether central banks\u2019 decisions protect fossil-fuel industries or whether they can instead promote sustainable growth (Battiston and Monasterolo, 2019<\/a>).<\/p>\n\n\n\n Many argue that central bank interventions should be \u2018market-neutral\u2019 and not discriminate between sectors (Matikainen et al, 2017)<\/a>. This does not mean, however, that such neutrality is achievable in practice. For example, during the post-2008 \u2018quantitative easing\u2019 (QE) programme, assets purchased by the ECB in order to stimulate economic recovery benefitted more than assets not purchased by the bank (Haldane et al, 2016<\/a>; Matikainen et al, 2017<\/a>).<\/p>\n\n\n\n Clearly, the choices made within central bank purchasing programmes have an effect on the wider economy and are not always neutral. Indeed, some argue that there can be no such thing as neutrality: either central banks are driving green recovery or they\u2019re holding it back (Agarwala and Zenghelis, 2020<\/a>).<\/p>\n\n\n\n There is evidence that the ECB\u2019s asset purchasing programme favours the fossil-fuel industry (Battiston and Monasterolo, 2019<\/a>; Matikainen et al, 2017<\/a>). Within the ECB\u2019s corporate bond purchases, over \u20ac50 billion (out of a possible \u20ac82 billion) are currently in emissions-intensive sectors, despite the fact that firms in these sectors make up only 18% of the euro area economy.<\/p>\n\n\n\n In addition, there is evidence suggesting that the ECB\u2019s Pandemic Emergency Purchase Programme (PEPP) portfolio is likely to favour companies with anti-climate lobbying activities and less transparent emissions reporting processes.<\/p>\n\n\n\n One study suggests that a potential solution to the strict market-neutrality principle \u2013 which results in central banks buying bonds from emissions-intensive firms \u2013 would be to allow for portfolio rebalancing using the \u2018emissions compliance verification\u2019 approach (Bressan et al, 2021)<\/a>. The authors suggest rebalancing the central bank\u2019s portfolio to lower its exposure to climate risk, while respecting all other criteria for the portfolio. In the fossil sector, for example, this can be achieved by increasing exposure to companies with a higher share of renewable energy sources relative to coal in their production.<\/p>\n\n\n\n It is also important that the use of fossil fuels within firms\u2019 business models is discouraged (Green and Denniss, 2018<\/a>; Le Billon and Kristoffersen, 2019<\/a>). In recent years, the fossil-fuel divestment campaign has gathered momentum. This can be traced back to the advocacy work of 350.org in 2008. By 2013, it was the fastest growing divestment campaign in history; and by early 2020, divestment pledges reached over $14 trillion (Ansar et al, 2013)<\/a>. But given that this movement has grown against a backdrop of increasing investment in fossil fuels, it is uncertain whether the divestment movement has had any effect.<\/p>\n\n\n\n Figure 1 illustrates how the primary sources of financing for the oil and gas sector have evolved in recent years (Cojoianu et al, 2020)<\/a>. The chart shows that financing came primarily from syndicated bank loans (68%), followed by bonds (25%) and equities (7%) as of 2015. While loan financing has dried up in the aftermath of the global financial crisis of 2007-09, it has rebounded as the dominant asset class through which the oil and gas sector finances new operations and refinances existing debt.<\/p>\n\n\n\nWhat is the link between climate change and finance?<\/h3>\n\n\n\n
What is green investing?<\/h3>\n\n\n\n
How can central banks promote a green recovery?<\/h3>\n\n\n\n
Fossil-fuel divestment<\/h3>\n\n\n\n
Figure 1: Global oil and gas bank loan financing, equity and bond issuance\/underwriting amount<\/h4>\n\n\n