Innovative policies and strategies are needed to mobilise the finance required for a fairer transition
To make developed market financing a reality – preventing a climate emergency and supporting economic growth – will require strategy, policy and finance. It provides opportunities for private sector investors to be involved in growing flows of capital to emerging markets.
We are facing a planetary emergency. Everyone in every sector needs to take their responsibility and lead. The private sector cannot wait for the public sector, we need to work together – nobody can hide behind anybody else. It is both the size and urgency that is so stunning: we have just ten years to reduce carbon emissions by fifty per cent.
When it comes to strategy, both the global community and local markets must play their part. Global decision-makers will need to show progressive leadership, and local markets need to develop their net-zero strategies and roadmaps to encourage and support the flow of finance.
Effective strategy will need to include collaboration across sectors and value chains. For example, shipping cannot decarbonise without on-land infrastructure, aviation cannot decarbonise without a supply of biofuels, and greener steel production is reliant on the use of low-carbon hydrogen.
At a local level, a market-by-market approach is essential. Emerging markets face different challenges so governments must develop bespoke strategies, incorporating different emissions reduction pathways and paces of transition where necessary. Markets reliant on the industries and technologies that will decline in the transition will need different pathways and a robust industrial policy to reduce the chances of a disruptive transition.
A blanket approach to net-zero transition for emerging markets will not work. The level of diversity across Asia and other emerging economies is huge; these are widely varied regions and markets. We must take it down to a market-by-market level, and look at what each individual market requires to transition – and then support them in developing a net-zero strategy and pace of transition that is aligned with their needs.
Changes to developed market policies are needed: current rules create barriers to capital moving from developed to emerging markets. Very high liquidity requirements on long term assets – introduced after the financial crisis – have led to a drop-off in infrastructure financing, for example.
If capital is to flow more easily, global consensus must be achieved on climate risk management and modelling, agreed standards, frameworks and incentives (including disclosure frameworks on emissions reduction), carbon pricing and taxation, and policy tools and timelines.
Integrating carbon pricing – through carbon taxation or otherwise – is a transformative step to breaking down the current operating construct that economic growth and fighting climate change are separate issues, as it more closely aligns economic success with climate success. The net-zero transition could have many wider economic benefits, including creating new employment opportunities, far outweighing the number of jobs lost in the move away from fossil fuels. A recent study by the Inter-American Development Bank and the International Labour Organization found that the transition to a net-zero economy could create 15 million net new jobs in Latin America and the Caribbean alone by 2030.
Policy work that estimates the magnitude of the cost of inaction is also an important step in making the link between economic success and net-zero success.
Governments cannot be expected to provide all the finance, but the public sector will need to use its funds to encourage private investment. Public sector money has the potential to ‘crowd in’ private sector finance. Blended finance, for example, can encourage private sector investment by reducing the risk, as public money is used to subsidise the cost of capital or mitigate possible losses. Governments can also encourage investment by issuing more sovereign green bonds (financing products provided by governments to fund projects with environmental benefits). These initiatives indicate a country’s commitment to a low-carbon economy and can help bring down the cost of capital for green projects by attracting investment and mobilising private capital towards sustainable development.
European and American public sector bodies are currently among the most active investors in the sustainable finance space. Governments and development banks provide either direct finance or credit support mechanisms to support emerging markets with transition. For example, the World Bank helped the Republic of Seychelles to develop the world’s first sovereign blue bond – a financial instrument to support sustainable marine projects – and to raise USD15 million from international investors.
These public sector institutions can use their robust balance sheets to create products that mobilise private capital to support the net-zero transition.
Alongside this, banks, investors and other financial institutions are creating and scaling the structures needed for investment in emerging markets’ net-zero transition. Low-carbon projects in emerging markets offer great opportunities in terms of both impact and potential returns but they are not attracting the capital they need. Banks and other financial institutions can help leverage private sector investment with innovative green finance products, schemes and platforms.
Banks and other financial institutions will need to keep developing and growing offerings like sustainable deposits products, ESG derivatives, repurchase agreement transactions (repos) based on ESG principles, and sustainable trade products. Financial institutions can play a really significant role here, providing incentives for performance against sustainability targets and helping direct capital to where it is needed most.
Investors are concerned about the risk involved in investing in emerging markets, which is limiting capital flows from west to east and starving the transition of funds. Our 50 Trillion Dollar Question study – based on interviews with investors with a combined USD50 trillion in assets under management – found that more than two-thirds of investors believe emerging markets are high-risk, raising concerns over market volatility, bribery and corruption, government interference, and political risk.
These perceptions of risk persist despite evidence of strong returns: 88 per cent of investors say that investments in emerging markets have matched or outperformed developed markets over the past three years.
Lending to emerging markets can undoubtedly be risky, however, particularly for long-term projects. Practical measures provided by governments – such as technical help with projects or guarantees – will be important to give private sector investors reassurance and confidence.
While Asia, Africa and the Middle East are among the regions most impacted by climate change, investor concerns over risk, poor data and patchy reporting mean that not enough capital is reaching these markets.
Our Opportunity2030 study calculated the finance needed to achieve three of the UN’s Sustainable Development Goals (SDGs), focusing on high-growth markets in Asia and Africa.
It found that while investors, corporations and financial institutions say they are committed to achieving the SDGs, capital is not moving at the required speed to the countries where investment matters most, presenting an untapped investment opportunity of almost USD10 trillion for the private sector.
Without a shift in attitudes towards emerging market investments, the world stands little chance of meeting global goals like the SDGs or the Paris Agreement – the landmark global pact on climate change.
The amount of finance required to reach net zero is substantial, but the risks – and the costs – of failing to act are much greater. Transitioning all markets to net zero in time to reach global climate change goals without hampering the economic development of emerging markets is a big task. But this monumental challenge is possible if emerging markets and developed markets take meaningful and urgent steps together, starting now. There is future work to be done on the cost of inaction in emerging markets, how climate and growth are better integrated, and how climate finance can be meaningfully scaled.
Find out more on our interim targets and methodology for the pathway to net zero by 2050
Just in Time examines what emerging markets may require to transition to net zero in time to meet global climate change goals. The study combines economic modelling, which quantifies the capital needed and the impact of different transition financing models on socio and economic development variables in emerging markets collectively and across eight focus markets, with insights from a global panel of climate change experts.
The economic modelling for this report was done using the E3ME model.
E3ME is a computer-based model of the world’s economic and energy systems and the environment. It was originally developed through the European Commission’s research framework programmes and is now widely used in Europe and beyond for policy assessment, for forecasting and for research purposes. A technical model manual of E3ME is available online at www.e3me.com.
E3ME is often used to assess the impacts of climate mitigation policy on the economy and the labour market. The basic model structure links the economy to the energy system to ensure consistency across each area.
E3ME provides comprehensive analysis of policies, including:
Overall macroeconomic impacts; on jobs and economy including income distribution at macro and sectoral level
E3ME is often compared to Computable General Equilibrium (CGE) models. In many ways the modelling approaches are similar; they are used to answer similar questions and use similar inputs and outputs. However, underlying this there are important theoretical differences between the modelling approaches.
In a typical CGE framework, optimal behaviour is assumed, output is determined by supply-side constraints and prices adjust fully so that all the available capacity is used. In E3ME the determination of output comes from a post-Keynesian framework and it is possible to have spare capacity. The model is more demand-driven and it is not assumed that prices always adjust to market clearing levels.
The differences have important practical implications, as they mean that in E3ME regulation and other policy may lead to increases in output if they are able to draw upon spare economic capacity. This is described in more detail in the model manual.
The econometric specification of E3ME gives the model a strong empirical grounding. E3ME uses a system of error correction, allowing short-term dynamic (or transition) outcomes, moving towards a long-term trend. The dynamic specification is important when considering short and medium-term analysis (e.g. up to 2020) and rebound effects, which are included as standard in the model’s results.
We used the E3ME model to integrate publicly available economic, environmental and social data to quantify the time and capital required for emerging markets to transition to meet global climate change goals (a long-term temperature target of no more than 1.5⁰C of warming above pre-industrial levels). In our transition scenarios, the point of net zero carbon emissions is reached by 206018 (rather than 2050 as in some other net zero scenarios), but cumulative total CO2 emissions (including those from AFOLU) from 2020 onwards are limited to 535 GT, very close to the 50th percentile remaining budget required to limit long term temperature rise to 1.5 degrees indicated by the IPCC’s Special Report on Global Warming of 1.5 degrees.
18 The 2060 net zero timeline selected by our economists specifically for this study, reflects the current status of commitments to net zero across many of our markets and specifically the slower pathway for emerging markets as foreseen under the Paris Agreement. This differs from the 2050 timeline we use for our own approach to net-zero highlighted in our recent whitepaper and which we encourage all stakeholders to adopt
We then developed three climate scenarios and applied different transition financing models to each and the impact of these where applicable on economic variables (GDP, household consumption, employment/unemployment, investment) across emerging markets collectively (UNFCCC’s definition of developed and developing countries referred to as ‘annex 1’ and ‘non-annex 1’ countries) and within our eight focus markets (China, India, Malaysia, Indonesia, UAE, Kenya, Nigeria, South Africa).
Modelled on current trends including existing climate policy. Includes a recovery from COVID-19 and a return to previous rates of growth, with interest rates rising gradually back to historical norms. Assumes no further climate policies are added but renewable electricity and electric vehicles continue to increase market share following current trends. No additional financing provided. Total warming expected to be over 3⁰C above pre-industrial levels by 2100.
Contains a wide range of regulatory and market-based policies required to meet the long-term target to limit warming to a maximum of 1.5⁰C above pre-industrial levels. Additional financing provided domestically. Total financing gap is the sum of the finance gap in all emerging markets cumulated over the period 2021-2060; this is additional to investment already accounted for in the No Additional Financing scenario. Financing required and provided by emerging markets (75 per cent from domestic households and 25 per cent from domestic borrowing; this split reflects the relative share of consumption and investment spending in the economy). Supports decarbonisation in emerging markets only.
Contains a wide range of regulatory and market-based policies required to meet the long-term target to limit warming to a maximum of 1.5⁰C above pre-industrial levels. Additional financing provided internationally. Total financing gap is the sum of the finance gap in all emerging markets cumulated over the period 2021-2060; this is additional to investment already accounted for in the No Additional Financing scenario. Financing required by emerging markets and provided by the developed world through a combination of public and private sector finance. Supports decarbonisation and socio-economic development in emerging markets.
The cost of climate risks is not incorporated into the model, so in reality the baseline scenario – which would result in a failed transition – would result in much greater negative economic impacts.
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Just in Time is based on in-depth research commissioned by Standard Chartered, designed by Standard Chartered and Man Bites Dog.
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