Collective Action and Climate Finance

This is the third edition of The Polycrisis newsletter, written by Kate Mackenzie and Tim Sahay. Subscribe here to get it in your inbox.

At UN climate summits, the items that appear on the agenda are usually those that advocates have fought hard to include. This year’s COP27 meeting in Egypt is no exception. Years of effort have culminated in getting loss and damage—finance for unavoidable climate harms—on the agenda and in the central discussions.

One agenda fight that has animated meetings this year came in the form of a push by the EU and France to add an item from the Paris Agreement that was not on the agenda, Article 2.1c: “Making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.”

A letter from the French and EU delegations to the UNFCCC argues that including 2.1c is “an essential means to achieve the mitigation and adaptation goals in article” and could defuse issues, including the relationship between 2.1c itself and Article 9 of the Paris Agreement, which sets out a framework for mobilizing the still-undelivered $100 billion per year promised from developed to developing countries.

To the Europeans, 2.1c represents a potential way to address finance writ large. Harmonized, climate-aware financial rules around the world could, the logic goes, shift the colossus of global capital markets to make a cleaner, more resilient world.

The indeterminate language of “aligning financial flows” has been tested as an avenue for driving change in the Global North, and been found wanting. Financial climate standards and regulations have been deployed, or at least attempted, in numerous countries. Progress tends to be incremental at best, and where industry or state interests are directly challenged, financial regulation tends to be weakened or unwound (cf, for example, the EU allowing natural gas investments to be included in a sustainable finance taxonomy).

There are genuine fights over finance taking place, and the “flows” language of 2.1c—together with much of the literature on global climate investment needs—elides the most important element. In the Global North, the blocking role of finance is more a function of limited political willingness to intervene in energy systems, export industries, and industrial policy. This is what holds back the energy transition—not a lack of financial rules.

In the Global South, finance is indeed an issue—of access, and of terms and cost. What most developing countries need to decarbonize or develop cleanly is, simply, access to good finance and fiscal space in the face of a worsening climate, which tends to evade the investing decisions of private interests. 

No prisoners?

The language of “alignment” exemplifies an approach to climate politics that has probably already peaked, based on the premise that no country really wants to decarbonize, and that diplomacy can change that. The global climate policy architecture is structured around a belief that the biggest impediment to climate action is the collective action problem. 

But it’s domestic economic and political interests that determine when and how countries cut emissions—not free riders and prisoners’ dilemmas. During periods of US intransigence, Akins and Milenderberg argue, the EU, Germany, Mexico, and New Zealand all pursued climate policy. Similarly, Colgan, Green, and Hale posit that, at both domestic and international level, owners of climate-vulnerable assets and owners of high-emitting assets are in an existential contest, from US utilities fighting homeowners’ selling rooftop solar back into the grid, to Saudi Arabia’s undermining of UN science panel work on the 1.5C warming limit. Material commercial and state interests and political veto players play the determinative role. 

The outlook for multilateralism is bleak. But interest blocs shift, and they are doing so as the energy complex evolves. Renewables, storage, and electrification are becoming cheaper, meaning cutting emissions is as well—and incumbent interests are less immune to change. “Given the economic implications of the ongoing energy transformation, the framing of climate policy as economically detrimental to those pursuing it is a poor description of strategic incentives.” Mercure et al write.

The analysis suggests a different way to view 2.1c and the entire range of discussions at COP27, and perhaps an explanation of what it is that international fora do. (Disparaging climate summits is easy after almost three decades of them have failed to arrest greenhouse gas emissions.)

Changes are made possible by another, often underestimated feature of the COP forum: a two-week long opportunity to flex soft power, and for charismatic and persuasive leaders to build coalitions beyond the scope of what is formally required in the Paris Agreement.

Deals

An announcement last year at COP26 of a $8.5bn “deal” for South Africa to close and replace its domestic coal power supply was followed this year by a $20 billion “deal” for Indonesia to something similar. (Indonesia had insisted on a lower cost of capital than the market was offering.) The fact that this second arrangement was also developed outside of UNFCCC processes and announced at the G20 meeting could be considered a win for climate diplomacy reaching outside of its UNFCCC wheelhouse. The connection became stronger still in the G20 leaders’ communique referencing the narrowing window for limiting warming to 1.5C.

One of the smaller but more significant events at COP27 was the launch of a model term sheet for incorporating resilience clauses into sovereign bonds. This feature has already been included in bonds issued by Grenada and Barbados, but a working group including IMF, MDB, and private sector officials produced a template published by the international markets body, ICMA. This would be a gradual way to make sovereign debt more accommodating to climate-vulnerable countries, by allowing those struck by disasters to suspend debt repayments. Avinash Persaud, Barbados climate envoy, said the clause would immediately release 18% of GDP if a crisis hit his country. Like collective action clauses that were introduced into sovereign bonds to protect from “holdout” behavior, the proposed climate resilience clause will take some time to become widespread; they can’t be retrospectively added to issued bonds. An HSBC official, Alexi Chan, confirmed during a COP panel: the effectiveness of the model clause in helping vulnerable countries will depend on whether his bank and its peers actually implement it.

Another test case for both public and private finance is Sri Lanka’s new “climate prosperity plan,” a combination of national industrial strategy and prospectus created under the V20 alliance of climate vulnerable countries. The draft plan envisages flagship projects such as an offshore wind “megaproject,” and an overhaul of transportation to include electric vehicles, light rail and bike paths, and a $100 million subsea power cable to India’s electricity grid as a source of export earnings. Sri Lanka’s government developed the proposal while racing to secure debt restructuring and an IMF package after it defaulted earlier this year. It has been hit hard by a combination of rising commodity import prices, an exchange rate hurt by Fed rate rises, and plummeting tourism revenues thanks to COVID. One of the biggest single items in its plan speaks volumes of the real problems in climate finance: $2 billion for forex hedging.

Systemic financial reforms, which would help all countries, can be spurred on by COP, even if it’s only through amplification. The repeated references throughout COP27 to bold proposals like the Bridgetown agenda—which includes IMF and MDB reforms and a new, $500bn facility for the Global South—bode well, as do the G20 communique’s exhortations on climate change in the midst of a war. The UNFCCC meetings do appear able to provide signaling and impetus for outside processes. Within the negotiations, however, the creation of a Loss and Damage fund was the focus of fraught negotiations in the final days and hours of COP27. Material financial transfers to the poorest and most climate vulnerable countries, whose voices get little support elsewhere, is something it should be able to deliver. 

The Polycrisis is a publication focusing on macro-economics, energy security & geopolitics.