Uneven Channels

This year’s Conference of the Parties (COP), opening October 31, is hosted by the United Kingdom, whose agenda-setting privilege as host has made private finance a central focus of the 2021 meeting. The UK ambition to center the City of London as a hub for a growing green finance industry dates back to at least 2010, when the “Capital Markets Climate Initiative” launched at the London Stock Exchange. Brexit has likely intensified this ambition: fear of a post-Brexit abandonment by the financial sector has spurred the government to position the City as a premier center for sustainable finance. The City of London Corporation’s 2021 pamphlet contains an extensive discussion of climate-related and sustainability metrics as part of its “competitive offering” to financial and professional services firms.

Private finance and climate governance

Several of the UK’s COP-hosting period goals focus on mobilizing climate finance, around the “billions to trillions” catchphrase—reflecting the gap between the amount of finance currently dedicated to decarbonization, and the far larger volumes the International Energy Agency and the Intergovernmental Panel on Climate Change estimate are necessary for the green transition. Deliverables identified by the COP26 office include aligning development finance with Paris climate goals; “supporting development of [a] pipeline of investment grade projects;” and “encouraging the development of new market structures and products.”

These aims echo numerous initiatives that seek to link the multilateral Paris Agreement to pledges to cut emissions by “Non State Actors” (NSAs)—from municipal authorities to multinational corporations. Compared to other areas of international policy effort, such as security, trade, and finance (which tend to limit access and inclusion for entities that are not national governments), the UN’s climate diplomacy framework places significant emphasis on the role of these private actors. While this approach accelerated after the near-failure of the Copenhagen COP in 2009 as a way to harness support for climate action, the broader version of multilateralism predates both the Paris Agreement and the Copenhagen COP. Political scientist Steven Bernstein traces this “liberal environmentalism” to the 1992 Earth Summit in Rio. Bernstein writes:

By 1992, a shift in norms of environmental governance had occurred, characterized by a general acceptance of liberalization in trade and finance as consistent with, and even necessary for, international environmental protection. These norms also promoted market and other economic mechanisms (tradeable pollution permits, privatization of the commons, and so on) over command and control methods (standards, bans, and quotas) as the preferred method of environmental management. The concept of sustainable development legitimated and masked this compromise at the heart of international environmental governance.¹

The market pricing framework was developed and advanced in the 1970s and 1980s by economic experts in the OECD’s environment committee. These officials, Bernstein writes, used cost-benefit analysis as their primary method of evaluating policies. An alumnus of the committee, Jim O’Neill, believed that an economically rational approach could correct the limited impact of earlier global environmental efforts such as the 1972 UN Conference on the Environment, held in Stockholm, which fit the now-familiar pattern of resolution without implementation. The approach also gained traction in the environmental movement as a way to overcome the zero sum “environment versus economy” binary. O’Neill advanced these ideas throughout the 1980s via platforms such as the Brundtland Commission, bringing environmental action in line with the emerging “liberal market consensus.” By the time multilateral climate action debuted at the UN Conference on Environment and Development in Rio in 1992, market-based ideas such as pricing pollution were well established in both environmental policy and multilateral initiatives.

Building on these ideas, the Paris Agreement cemented a “hybrid” approach in which nonstate actors play a near-formal role in implementing commitments through initiatives like Non-State Actor Zone for Climate Action (NAZCA), the Global Climate Action Agenda, and the High-Level Climate Champions. Such programs are meant to reinforce top-down agreements from the bottom, relying on diplomatic influence to compensate for weak enforcement capacity. Among these is the “Race to Zero” campaign in which cities, business, and universities can commit to cutting their emissions in line with net zero by the middle of the century. Its affiliate schemes include alliances of asset managers and other investment institutes that are among the biggest managers of developing country debt. Across these initiatives, there is a common refrain of “moving,” “shifting,” or otherwise “unleashing” trillions in private financing to address climate change.

Climate finance in the global financial architecture

The emphasis on capital flows, particularly from the private sector, leaves the structural features of the global financial system largely unaddressed. The vast difference in financial terms available to peripheral versus core countries, and the rising proportion of debt owed to global capital markets in many developing countries, has been neglected by a framework which is primarily concerned with attracting private investment.

Sustainable finance is a booming business in the global north, where allocations to “environmental, social and governance” themed funds are on track to become the default, and instruments like green bonds routinely break new issuance records. But in the global south, the availability, cost, and terms of finance to develop sustainably remain extraordinarily restrictive. While there are variations between individual countries, the weighted average costs of capital for low carbon technologies can be more than twice as high for African countries as for Australia or Canada, and almost three times that of the western EU countries.² The divergence between core and periphery countries in the monetary and financial system curtails the ability of developing countries to decarbonize.

The divergence is worsened by climate change itself. Climate-vulnerable countries pay an average of 117 basis points more to borrow, according to a 2018 analysis.³ Investors’ growing curiosity about how “climate risk” affects sovereign creditworthiness—it is the subject of numerous commercial offerings and a new UN initiative—may widen the spread even further. Countries suffering at the intersection of both climate change and global finance, such as the Climate Vulnerable Forum group, are increasingly seeking to highlight the interdependency of the two problems: susceptibility to the effects of climate change make it harder to obtain the financing that is needed to deal with those effects.

Accounting for the global structure of power

Just as the structure of the global financial system shapes the realities of financial flows, so the global structure of power mediates the realities of climate diplomacy. There is little space for diplomatic manoeuvring in the interactions of developing countries with international capital markets, where negotiations are mostly concealed from the public view that enables and incentivizes orchestration. Debtors must persuade creditors to participate in restructuring discussions and hope that they will not take advantage of contracts that allow for a minority to hold out. Sub-Saharan African countries rely on US dollar-denominated sovereign debt markets for about a third of their external finance. The low-for-long official interest rates in wealthy countries has helped to drive money towards the high coupons of emerging market debt. Financing that is readily available and has no policy conditions attached is attractive to low-income nations, even with steep costs, unfavourable conditions, and denomination in foreign currencies—usually US dollars—that enhance pro-cyclicality. External debt servicing, as a proportion of export revenue, rose from 5 percent to 14 percent in Sub-Saharan African countries in the decade before 2019, World Bank data show. In Latin American countries, it grew from 19 to 27 percent. Even before the pandemic, Ghana and Kenya were spending more on debt servicing than on healthcare. This leaves little for building out clean energy generation and other low carbon infrastructure in accordance with the Paris Agreement.

In contrast to the abundant public-facing fora, diplomatic channels, and committees for all types of entities pursuing climate-related diplomacy, there is virtually no forum or mechanism that governs developing countries’ access to credit markets or even to creditors themselves. When events such as pandemics arise, or when climate-warmed hurricanes smash into small island states, no rules-based avenues are available for collective negotiations with creditors—and means to compel participation are limited. The “Paris Club” of creditor countries has performed this role in some situations, with recent treatments mostly for sub-Saharan African countries and small island states, but the Club’s membership does not include China, which is now a large lender to a number of developing countries, or commercial creditors such as bondholders. This means that there’s little prospect for organizing among debtor countries that may have suffered a common fate.

More broadly, access to global capital markets for poorer countries is intermediated by a handful of US, British, Swiss and German investment banks. Three of these—Citigroup, Deutsche Bank, and JP Morgan—coordinated more than half of Sub-Saharan African bond issues in the past decade. Ownership is also not as diffuse as assumed, with a smaller number of larger asset managers now dominating the field. The holdings of peripheral country debt, while small relative to overall portfolios, are immensely profitable. For BlackRock, sovereign bonds of DSSI-eligible countries at \$2 billion is an almost negligible portion of its over $9 trillion assets under management; but interest payments from those bonds equates to almost a percentage point of BlackRock’s revenue, Munevar found. For Amundi, a big French asset manager active in sustainable investment circles, DSSI bond coupons are equivalent to more than 10 percent of its revenue.

Many of the private and official finance actors that play key roles in the global financial architecture also happen to be prominent supporters of the nonstate actor climate diplomacy initiatives. BlackRock joined the Net Zero Asset Owners’ Alliance in March, and JP Morgan joined the Net Zero Banking Alliance just a few weeks ahead of COP26.

Like all their peers, these institutions declined to grant any suspension of servicing of their debts from the world’s poorest countries in the midst of a pandemic that crushed lives, health systems, and livelihoods. Repeated exhortations in G20 communiques, and from the World Bank and IMF chiefs, have been ignored. Many of these financial institutions are members of the climate initiatives facilitated by the COP26 office and the UNFCCC, with their logos displayed on pages headed by United Nations crests. But these institutions are loath to address their own role in a system that compounds disadvantage for climate vulnerable countries and the possibility of a global decarbonization effort. While the hierarchies of the international financial and monetary systems remain beyond the scope of climate commitments, and nonstate actors can easily acquire quasi-diplomatic climate kudos, countries in the global south have limited means to advance the twin goals of climate protection and economic development.

Possibilities and reforms

Prospects for reform within the UNFCCC/COP architecture are limited. Among the tracks that seek to pursue redress for the systemic inequities, “loss and damage” and the notion of the “$100 billion” both take a capital flow approach. The former, established in 2013 through the Warsaw International Mechanism, is distinct from “mitigation” (cutting emissions), and “adaptation” (building resilience), and offers emergency response to and recovery from the actual harms caused by climate-related events such as droughts, floods and hurricanes. The latter emerged during the final stages of the 2009 annual climate conference in Denmark, which almost ended with no agreement to build on the Kyoto Protocol. Ultimately, countries agreed to the “Copenhagen Accord,” indicating the need to limit warming to 2 degrees celsius. The target was to be secured with the promise of transfers of $100 billion from wealthy to low income countries per year by 2020.

Proposed by the rich countries, the famed $100 billion framework has become a far more central part of climate diplomacy than “loss and damage” (which is favored by developing countries and accordingly has an unclear status at the COP). But even the designation of \$100 billion in the Paris Agreement hasn’t guaranteed effective delivery. With global official development aid flows at about $150 billion per annum, $100 billion of dedicated “climate finance” would be significant, even if it is inadequate in the scale of the costs of both decarbonizing and building resilience to the effects of climate change. But the “$100 billion” suffers from a deep and persistent ambiguity, with its characteristics—concessional finance, mitigation versus adaptation—never specified. Consequently, measuring how much of the $100 billion has been reached is difficult in part due to the challenges of conclusively identifying flows dedicated to climate, but also because of the absence of a definition of climate spending in either the Paris or the Copenhagen accords. Wealthy countries tend to want to define their own contributions generously, but to date the amount hasn’t been reached by even expansive definitions.

Another set of solutions focuses on more structural features of global finance. Campaigners with blunt topline demands of debt cancellation are echoed by some of the most establishment voices. The lack of a sovereign debt resolution mechanism, the jurisdiction of sovereign bond contracts in New York and London, and the lack of sovereign transparency on both official and commercial external debts are all lamented by legal experts, activists, and officials at international financial institutions. But solutions all seem to be undermined by the very structures of power they seek to overturn. When a sovereign debt resolution mechanism was advanced by then-IMF deputy director Anne Krueger in 2002, it was blocked at the UN by the US, UK, and Japan. In 2015, an attempt at a resolution for a non-court sovereign debt workout mechanism in the UNGA was opposed by Canada, Germany, Israel, Japan, US and UK.

In the G20, the intersection of climate change and finance has been explicitly addressed through the lens of “sustainable finance.” A newly revived and elevated G20 sustainable finance working group is preoccupied with matters like reporting standards and regulatory measures such as climate risk disclosure rules, which have little bearing on the financial constraints on global south countries to mitigate and adapt to climate change. Such topics are addressed inadequately on a crowded agenda, and most states tend to be excluded, with limited agency in the international financial system without the support of the more powerful few.

With the termination of its limited debt payment suspension programme, the DSSI, the G20 has proposed a new “Common Framework” which implicates private creditors in repayment delays if not actual writedowns. In practice, however, countries that have ventured to seek relief are liable to have their credit ratings downgraded, as Ethiopia found earlier this year, when it was downgraded by the three main credit ratings agencies. (Two of those three, Moody’s and Standard & Poor’s, joined a new initiative launched in September for financial service providers to commit to net zero emissions; it is aligned with the UN-backed Race to Zero.)

Nevertheless, there is some hope for reform. In the wake of the COVID outbreak, powerful G7 members voted in favour of an allocation of Special Drawing Rights, the reserve asset issued by the IMF. Although the SDR distribution quotas means the poorest countries receive the least, it’s a progress of sorts, and the proposed new IMF facility that would provide finance to countries hit by pandemics or climate change could represent a further small advancement. And some wealthy countries have indicated they will donate a portion of their SDRs to developing countries.

Finally, debt-for-nature swaps, which can be structured in a variety of ways, have delivered variable results in terms of both debt relief and environmental impact. The heyday for such swaps was the 1990s when large, official creditors sponsored debt restructurings with environmental measures thrown in. Belize has recently discussed such a swap with some of the owners of its only US-dollar denominated bond; a charity would help buy back the bond at a reduced rate provided some investments are made in the country’s reefs. Investors declared the “ESG” part of the proposal helped them to accept 55 cents on the dollar. It’s not clear if climate-vulnerable peripheral countries with less beautiful fauna and flora could similarly benefit from the vagaries of sustainable finance.

But these and all other unconventional reforms inevitably come up against one of the oldest tensions between development and climate action: conditionality. What are the policy strings attached to money that’s provided? Who decides what is good development, or good climate policy? As they design paths forward, policymakers must negotiate these considerations; or at least win support of enough of the more powerful voting member countries to put them on the table. Days before COP26, the finance ministers of forty-eight climate-vulnerable countries signed a statement calling for large scale green debt swaps that would support a self-determined climate policy agenda.

Leaders of many of the biggest banks, asset managers, and policy institutions will be in attendance at COP26. The conference will yield dozens of announcements about financial initiatives relating to climate change, ranging from official finance to aspirational “net zero” alliances. Some will be pragmatic attempts to compensate, if only in small ways, for a global financial system that is structurally blocking efforts to stabilize the climate and keep people safe. Most will barely acknowledge that this situation exists.