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Making Asia Pacific financial markets fit for climate change purpose

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A boy looking at the building ruins caused by abrasion on the north coast of Banten province, Indonesia, 6 May 2021 (Photo: Kevin Herbian/Pacific Press/Sipa USA via Reuters)

In Brief

Natural capital is an essential input into all economic activities but, as the enormous consequences of climate change and environmental degradation attest, it’s rarely properly valued. Natural capital is the tolerable temperatures, breathable air, drinkable water, healthy land, and the complex ecosystems that maintain them. By undervaluing the role that natural capital plays in economic activities, markets underestimate the risks from environmental damage to growth and human welfare.

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The devastating consequences of not properly pricing the cost of carbon emissions into the allocation of capital by financial markets are now a major global threat.

The United Nations Intergovernmental Panel on Climate Change (IPCC) Report last week was a huge wake-up call, especially to big polluters like China and the United States as well as climate-laggards like Australia in Asia and the Pacific. In the lead up to the Glasgow COP26 Climate Summit this November, it’s put climate change outliers like Australia on notice about their responsibilities and the urgency of avoiding climate catastrophe.

Australia’s response to climate change is more than a little puzzling. It led the world in identifying the problem with a landmark national report and plan for climate action. But the UN has just ranked Australia last of 193 countries on climate action. It is consistently one of the highest per capita emitters of carbon, up there among the top 10 in the world. And it ranks second-worst on carbon pricing after Chile.

Australians emit 3.37 times more CO2 per capita than the global average citizen, a number that jumps to 4.15 when including more potent greenhouse gasses such as methane. As the world’s largest exporter of coal and second largest exporter of liquefied natural gas, Australia’s fossil fuel exports introduce a further 565.72 megatonnes (Mt) of CO2 into the global supply chain each year. And Australia’s 2019–20 bushfires, which burned an area equivalent to the size of Iceland, released an additional 400 Mt of CO2 — an amount roughly equivalent to Australia’s yearly carbon output.

Australia is heavily invested in the production and export of fossil fuels, as one of the largest and most efficient suppliers of coal and natural gas to global markets. The resistance to energy transition has its national champions in the structure of established interests — regional communities around coal mines and companies that cling to the large residual rents from coal and gas.

Although big mining business and a climate-anxious community with longer time horizons have priced carbon emissions into investment away from coal and into renewables (with a huge uptake of household solar panels), national government, captured by climate deniers and regional political interests, has at decisive leadership-destroying moments lent against the change.

Conservative national leaders have appealed to the trope that Australia, whatever it did, as the direct source of only 1.3 per cent of greenhouse gases, would not materially affect global emissions outcomes. This is selective reasoning. More telling is that Australians are on track to suffer 12–24 times more of the damages from climate change than the global average.

Like China, Australia will be more impacted by climate change than the world on average. This exceptional vulnerability is a strong incentive to accelerate its climate effort, invest in domestic resilience and take a leadership role in de-carbonising the world at a time when the new Biden administration has joined other leading industrial powers to act on climate change.

Market solutions were always the best way to effect the transition needed to deal with climate change. Pricing carbon properly was a good place to start. Ensuring that financial markets get capital on scale to activities that mitigate climate risk is a crucial part of the market solution to the world’s climate problem.

As Adam Triggs points out in our lead article this week, ‘the substantial environmental and economic benefits from sustainable practices like lowering carbon emissions, improving land management and other environmental good practices often go unrewarded by the financial system, even though the returns to society are high’.

These missing markets are the result of deficient global financial rules, insufficient data and weak institutions. The weight of research shows that businesses and households that have good environmental credentials are also better borrowers. They are less likely to default on their loans and they are less likely to be late on their repayments.

In a well-functioning market where these broader social and economic benefits are properly priced, these borrowers would get lower interest rates and, when these loans were securitised and sold-on in the form of bonds, the bonds would be more favourably priced because the underlying asset is stronger and safer.

‘The regulations that inhibit sustainable investment globally are the Basel III global capital rules and national financial regulations that seek to implement them’, Triggs points out. ‘Among other things, these rules require banks to hold high-quality assets on their balance sheets to buffer them from shocks. But the rules around the quality of these assets don’t account for the fact that environmentally friendly loans are safer than environmentally unfriendly loans. The result is that the world’s banks aren’t holding or issuing enough green debt, resulting in less sustainable investment’. Worse still, the failure of these rules to price in environmental risks undermines the stability of the financial system itself and means there are large, uncovered risks endemic in bank balance sheets and the broader financial system.

In China, Europe and elsewhere, authorities have begun actively framing national approaches to the problem of greening finance, but the global nature of capital markets and environmental challenges requires international cooperation and a global solution. China is cooperating with the European Union to achieve convergence of green investment taxonomies by the end of this year.

In Asia and the Pacific, APEC, with its non-negotiating, market-driven tradition, is a forum that could bring China and the United States, and perhaps even Australia, into play on the way to the Glasgow Summit. The UN IPCC forecasts show there is no time to wait.

The EAF Editorial Board is located in the Crawford School of Public Policy, College of Asia and the Pacific, The Australian National University.

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