101 Sustainable Finance Policies for 1.5°C

A toolkit of 101 policy levers available to government, regulator, and central bank policy makers to facilitate the transition to net zero

Policymakers must grasp the opportunities inherent in the transition to net zero

The climate transition challenge is encapsulated by 1.5°C. Behind the number is a wealth of clear scientific evidence that shows it is a goal we cannot miss.

To reach 1.5°C society must undergo a transition. The transition will offer technological, industrial, and economic opportunities, but the most important opportunity will be political. The climate challenge offers a political opportunity to steer the real and financial economy towards a green future.

The green transition will bring economic development, energy sovereignty, and job creation.

Investors have been supporting the transition since 2007, and appetite is growing as illustrated by the rapid expansion of the green bond market. By greening development plans and investments, global policymakers can harness this momentum and leverage private capital flows to fund infrastructure and development.

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Without rapid climate action, countries will experience a rising cost of capital and stunted growth.

A slow transition will be more expensive than a rapid one. According to the latest research, rapid transition will be economically beneficial due to lower costs of renewable energy technologies compared to fossil fuels without even accounting for avoided costs of climate damages or other climate policy co-benefits.

Physical climate risk exposure has increased the cost of capital in vulnerable countries, costing the Vulnerable 20 (V20) nations USD62bn in higher external interest payments over 10 years. Transition risks are materialising for the 20 sovereigns with the highest ratio of net fossil fuel exports to GDP. These suffered a median net credit rating downgrade of 1.6 notches 2015-2020 and two defaulted.

Policymakers can ensure a smooth, rapid transition and safeguard development priorities

Despite the narrowing window to meet 1.5°C, maintaining ambition is crucial to limiting climate change as much as possible. Investment can be channelled to transition with many different instruments in all areas of decision making. Awareness of this variety can increase policy ambition.

There is a wealth of policies that can be implemented to direct capital to meet sustainable development needs and deliver climate mitigation and resilience, represented by three pillars:

1. Speed: ensure rapid action by all decision makers

A rapid and smooth transition enables climate mitigation and resilience activities to occur alongside and within economic development. It will also enable growth as a rapid and smooth transition will increase stability, secure voter buy-in and encourage investment.

Policy 1. Align development strategies with climate targets and capture sustainable finance flows to fund economic development. The starting point for these policies is robust national and sectoral emissions budgets, aligned with the 1.5°C global carbon budget. This provides certainty on the speed and depth of transition, encouraging decisionmakers to secure first-mover advantages in the new net-zero economy.

Policy 3. A coordinated sustainable finance roadmap ensures alignment between all government departments, the central bank, and regulators. This also provides investor certainty on policy introduction.

Policy 78. Global collaboration and coordinated action is key to enabling speed of action and facilitating cross-border investment flows.

2. Steer: tilt the whole economy to transition

Investment decisions are driven by risk-return evaluation. By proper integration of climate-related risks and opportunities, traditional investment models can be turned to deliver climate goals and stable and resilient returns. Policies which tilt investment away from high-risk carbon-intensive and towards green and sustainable investments can insulate economies from climate-related risks and open up green development opportunities.

Redistribution of capital requires a shift in perspective. Recognition of the risks of high-carbon investment will enable its rapid decline and redeployment to sustainable investments. Fossil fuel expansion must cease immediately, as highlighted by the IEA Net Zero Roadmap, and many existing plants must undergo early retirement if we are to meet 1.5°C.

Incorporate transition risk and opportunity into investment decisions

Exposing climate risk will bring clarity to the green investment opportunities. These policies can also help insulate government and central bank’s portfolios from climate-related risks.

Policy 94. Require investors and corporates to publish transition plans, as required in UK sustainability disclosures. This step can prompt immediate action. The government can then introduce risk tools for longterm assessment of transition plans and their impact on exposure. Basing these on robust standards such as the Climate Bonds transition and entity criteria will ensure credibility and speed of transition.

Policy 6. Stop subsidising fossil fuels and damaging ecosystem practices which distort perceptions of climate-related risk. This also frees up a significant level of government spending, which can be reoriented towards transition. Targeted support can prevent adverse impacts on low-income groups.

Policy 81. Central banks recognise climate risk as a risk to financial stability and address it across prudential and monetary policy. Many policies can be adapted to incorporate climate risk considerations without waiting for disclosure and stress testing evidence.

Policy 88. Central banks adjust risk weightings for capital and reserve requirements and collateral frameworks to incorporate climate risks. This will help insulate the balance sheet from climate-related risk and encourage financial institutions to green their capital allocation.

Policy 8. Carbon pricing reform, removing free allowances and limiting purchase of carbon credits, will ensure that pricing can force change. High and stable carbon prices will ensure investor confidence in the price signal. Overreliance on carbon pricing could hinder transition if it delays implementation of other mitigation policies.8 Particularly in emerging markets (EM), non-price instruments may better overcome political economy restraints and avoid regressive impacts on consumers.

Policy 21. Adopt carbon border adjustment mechanisms (CBAM), whereby imports are subject to local carbon pricing. These are important to avoid relocation of high-carbon activities to countries without pricing schemes.

Policy 37. Establish energy transition mechanisms to fund early retirement of fossil fuel assets and their replacement with renewables installations. Energy transition mechanisms can address the financial risks of continued fossil fuel assets operation and create just transition opportunities.

Derisk green opportunities to ensure speed of growth

While investment will eventually flow to green, risk sharing and diversification will speed this up, maximising investment opportunities and ensuring climate targets are met. Derisking also ensures investment flows meet sustainable development needs.

Global capital flows are large, but risk appetite is low. Policymakers can mobilise private finance to support higher-risk projects, whether nascent technologies or in EM.

Policy 10. Encourage the use of green and sustainable financial instruments through subsidies and incentives which reduce the cost of green capital and ensure attractive returns.

Policy 18. Project guarantees and credit enhancement provide investors with greater certainty of returns, thereby enabling private investment into projects that would otherwise be viewed as too risky. As much of the capital available for transition is highly risk averse, guarantees are crucial to channel investment to higher-risk projects.

Policy 11. Green bond guarantees can encourage green bond issuance over vanilla and attract international investment.

Policy 13. DM to EM sovereign-to-sovereign guarantees can derisk local currency sovereign issuance and decrease the cost of capital for EM sovereigns.

Policy 19. Increase blended finance provision. Public investment can facilitate the flow of capital to riskier projects by absorbing the higher-risk (junior capital) portion and offering the lower-risk (senior capital) portion to private investors in blended finance deals. This leverages concessional financing to reduce a project’s credit risk, allowing for greater mobilisation of private capital. Including other de-risking facilities such as policy risk hedging can protect from negative market fluctuations and can further increase financing flows, especially important in EM where access to long-term capital is limited.

Policy 45. Targeted subsidies are crucial to enable cost competitivity of specific green technologies and to enable industrial transition. Accelerated depreciation can reduce upfront cost of green infrastructure investments.

Policy 22. Establish preferential green trade windows, with low tariffs for low-carbon trade. This can compensate for CBAM limitations and facilitate the flow of capital to EM, crucial to the success of the global transition.

3. Simplify: clarify and streamline sustainable investment

To ensure capital moves to green at scale, policymakers can simplify decision-making and streamline investment processes.

Policy 97. Establish science-based green standards or taxonomies to provide clarity on what a sustainable investment is and identify green investment opportunities. Including transition standards provides guidance on how to decarbonise high-carbon activities and enables financing of these activities’ transition. Aligning with international taxonomies and standards will also enable international private finance flows.

Policy 33. Minimise potential bottlenecks to investment by fast-tracking permits for green projects, such as renewable energy deployment, and developing regular and replicable auctions.

Policy 101. Green bond segments and fast tracking makes investing in and issuing sustainable instruments easier. This can help overcome inertia.

Policy 59. Carbon credit trade threatens the transition if used to offset avoidable emissions. Market reform can identify qualified offset purchasers and ensure credits are only reserved for residual emissions. Reform can also focus on preserving high-carbon stocks. This will facilitate growth of legitimate carbon credits to fund crucial conservation.

Policy 14. Kickstart change with a sovereign green bond programme. Sovereign green, social, sustainability, and sustainability-linked bond (GSS+) issuance provides a clear demonstration to market of the pricing and visibility benefits of green bonds, acting as a guide for potential issuers. It draws international investors into the local market. It also enables funding of key government expenditures and encourages government departments to grow their pipeline of eligible expenditures.

Contact the team at policy@climatebonds.net to find out more.

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