Total financial re-engineering needed to avoid climate disaster, says expert

Out-Law Analysis | 03 Nov 2021 | 11:18 am | 4 min. read

The climate crisis cannot be tackled and global disaster averted without re-engineering the world’s financial systems to align them with decarbonisation and sustainability, according to an investment expert determined to achieve fundamental changes in how capital is used.

Steve Waygood, who is in charge of responsible investment for Aviva Investors, has a vision of how radically the systems and processes that underpin global capital flow have to change.

“Think of the mindset of people like John Maynard Keynes when he helped to put in place the economic architecture that underpinned the post-World War II world,” said Waygood. “That is the scale that we are talking about if we are going to meet the Paris goals. If we don’t succeed it is likely to cause a third world war.”

If the current trajectory of temperature change continues, he said, then three quarters of the world’s population will have to migrate from places that have become too hot to live in. “We know what happens when millions or even hundreds of millions of people migrate: civil unrest, civil wars and perhaps worse. If we let the current model of fossil fuel-based growth continue then this is the consequence: money will destroy money.”

What Waygood is proposing is nothing short of a complete re-wiring of how the world’s financial activity is structured, regulated and controlled. Only by doing this can the goal of harnessing private finance to tackle the climate crisis be achieved. The current approach was designed in the aftermath of WWII to make countries economically interdependent to disincentivise going to war against each other.

Steve Waygood

Chief Responsible Investment Officer, Aviva Investors

The global financial system hasn't been designed to deal with climate change. So we need to redesign it so that it works in favour of Paris Agreement actions, not against them

Capital can flow from company to company and from country to country despite the fact that each country has different laws and regulations about how it can be used and how investing should work. This is possible because standards overseen by multilateral organisations such as The World Bank and the International Monetary Fund (IMF) underpin laws and regulations around the world.

National central banks and finance ministries legislate and regulate according to these basic principles. Changing the principles will change the way global finance works.

“But this system hasn’t been designed to deal with climate change,” said Waygood. “It was designed to ensure peace and stability. So we need to redesign it so that it works in favour of Paris Agreement actions, not against them.”

“The most important thing we can do is to price carbon properly. That doesn’t mean there will be one global carbon price, it will be set in different ways in different places,” he said. “There are many different ways to make carbon matter to companies.”

Taxes and levies on companies whose activities produce carbon can ensure that the polluter pays. This is why an acceptance by the G20 in recent days that this is a tool it may use is so important, coming after many years of opposition from the US.

The G20 group of the world’s richest countries said for the first time on 30 October that it supports the use of carbon pricing to align the economy with the climate pledges of 2015’s Paris Agreement.

The line appears in a formal commuinique from the G20 for the first time, and represents a critical step towards using the full power of the world’s financial systems to tackle the climate crisis.

“If you are going to harness financial markets to deal with the climate then you need three things. One is an international treaty to work from – we have that with the Paris Agreement. The second is a global carbon price, which should be governed by international standards. The third is to align the international financial architecture so that it supports investments that contribute to carbon reduction,” said Waygood.

This architecture shapes the regulation of the three pillars of the financial system: finance, investment and insurance, he said. It should be geared towards supporting nationally determined contributions (NDCs), the commitments that each country is making at COP26, setting out the action it will take to reach the Paris targets.

“The Paris Agreement is a political vision and leads to country plans through the NDCs,” he said. “We need to create the same kind of structure within finance, a process that enables every country to look at its NDCs systematically to work out how they will be financed.”

Aviva has been working with 38 organisations on what that framework might look like. It has proposed the creation of an International Platform for Climate Finance (IPCF), which would act as a bridge between the providers of finance and the countries which need their sustainable projects funded.

The group has proposed that the Organisation for Economic Cooperation and Development (OECD), the club of rich countries, take over the function of coordinating this action.

“The OECD was designed to restructure Europe after WWII, a job that was complete by the 1960s. It’s arguably now the world’s most expensive think tank. So we are suggesting that it could be deployed to give technical assistance, to bridge capital from rich countries to poor ones,” said Waygood.

Capacity building is essential so that countries can accurately cost their NDC plans, can access finance more cheaply than currently and can properly calculate the impact on emissions and climate.

For this to work, Waygood said, carbon must be priced properly. The IMF has proposed that carbon should be priced at $100 per tonne, and the EU’s Emissions Trading Scheme price is heading towards €70 per tonne, which he thinks is much closer to what is needed than the €1 per tonne it was priced at in the past. Having a high enough price is essential to support the ‘polluter pays’ principle, he said.

It is also essential that regulators focus less on the damage that transitioning to a net zero economy will have on businesses in the next few years, and more on the damage to the whole planet if we don’t take radical action now.

“Most regulators are focusing on the time period of their own tenure, maybe two to three years,” he said. “That’s where the transition risk is. But the physical risk – the things that will happen to the world if we don’t act, like temperatures so high human life becomes impossible – happen over 30, 60. 90 years and regulators need to focus on that and on speeding up transition. We’ve seen the mood in financial institutions and investors change massively in the last three years and regulation needs to change too.”

“Most people wouldn’t put it as bluntly as me, but the current structure of markets could precipitate world war three by the end of the century. It sounds hyperbolic but the science is clear and most citizens don’t realise how close to that we are,” he said.