Seven reasons why policymakers aren’t accelerating the green transition
Net Zero Investor kicks off its Putting a Price on Pollution Series by looking at why policymakers are reluctant to implement stronger anti-pollution policies
There is a clear and consistently made argument in favour of pricing pollution into financial markets and the global economy. If carbon emissions, and business activities that harm biodiversity and carbon sequestration, are made more expensive, then businesses will be forced to either reduce or halt their harmful practices.
In his book Saving the Planet Without the Bullshit Assad Razzouk says: “If the directors were held legally responsible for the environmental harm caused by their supply chains and as a result insurance companies stopped covering environmental destruction in their policies, everything would change overnight.”
Similarly, Professor Dieter Helm recently told Net Zero Investor that businesses and states routinely abuse and over-consume natural assets, such as the atmosphere, because they are free.
“The obvious thing to do is put a value on them by making us pay for the pollution we cause,” he said.
That sounds logical yet in practice policymakers have been reluctant to introduce more stringent measures.
In addition to the radical changes to due diligence laws outlined by Razzouk, more stringent measures could include carbon taxes, extending emissions trading schemes to make them mandatory (an indirect carbon tax), incorporating environmental risks into fiduciary duty, brown penalising factors (extra capital charges for risky brown assets), brown taxonomy
(identification of brown assets) and setting clear transition pathways for each sector with cut-off points (no more petrol cars by 2030, for example).
In its conversations with asset owners, industry associations, activists, academics, and other stakeholders, Net Zero Investor found seven reasons why policymakers are holding back.
Each of those reasons are outlined below and will be dealt with in a separate article in the coming weeks. The relatively simple question, why aren’t policymakers doing more to put a price on pollution? has a complex answer.
Reason One: Lobbying activities
The lobbying activities of major industry associations consistently discourage policymakers from implementing more stringent anti-pollution measures and being more ambitious with existing measures.
For example, a brown penalising factor, radical changes to fiduciary duty, and a brown taxonomy were initially proposed by the EU back in 2017, but met with significant resistance and never saw the light of day.
That said, the sense of an underlying conflict between fiduciary duty and managing sustainability risks is less an EU problem than a US one. UCITS Management Companies, AIFMs and MiFID firms must take sustainability risks into account thanks to recent updates to the existing legal frameworks.
The Brown Taxonomy debate resurfaced in 2021 only to be buried again. Meanwhile, after significant pushback from the industry, the EU’s new due diligence directive ended up not implicating financial firms that invest in or finance firms that commit environmental crimes.
According to Influence Map, the major finance associations, be they the representatives of insurers or fund managers or banks, tend to take the same conservative position of supporting soft regulations, such as disclosures (albeit in simplified forms with longer voluntary periods), and opposing harder measures that might have a direct economic impact on polluting firms. The boards of these associations tend to be dominated by the same global firms.
Although the financial associations tend to take a more conservative view, the policy positions of the individual firms are varied.
Among the larger financial firms, there are notable outliers with more progressive policy positions, especially in the insurance community. Then, among the smaller, more activist financial players, there is a colourful array of radical perspectives.
Reason Two: Short-termism
Short-termism is probably the single biggest factor behind the political deadlock. Politicians, which work with four/five year election cycles, and businesses, which are accountable to quarterly reports, simply aren’t programmed to deal with long term risks such as climate change and biodiversity loss.
Unfortunately, there’s no easy solution to the “short-termism” conundrum; it requires a co-ordinated policy response that covers not only misaligned financial incentives but also retraining programmes and labour laws.
Macron and the “gilets jaunes” movement is a good example of the kind of political fallout that results from uncoordinated policymaking. The protestors weren’t necessarily opposed to the carbon tax; their anger was directed at the unfairness of it.
It was strongly felt – and these views are echoed by climate justice groups – that the poorer, vulnerable sections of society shouldn’t have to pay for the transition.
Unfortunately, the most effective measures, such as carbon taxes, may have a negative impact on lower income groups by inflating prices for essential commodities/services. Introducing such measures without having a plan to support affected citizens carries a fair amount of political risk.
French politics asides, the energy crisis has clearly shown that making oil and gas more expensive really does have a knock-on effect on the global economy that is still 80% fossil fuel-based.
Since the crisis began, there has even been widespread public support for fossil fuel subsidies – making pollution cheaper – to take the edge off soaring prices. In 2022, governments spent more than €1 trillion on fossil fuel subsidies, the highest figure ever recorded.
Reason Three: Financial Stability Risk
The financial stability risk posed by stringent anti-pollution measures is in an extension of short-termism. If governments do nothing, the long-term risk (physical risk and the risk of a disorderly transition) increases. If it does something, the transition risk could inflict short-term pain.
According to ASN Impact Investors, only a handful of the 43,000 listed companies in the world don’t have a net negative impact on climate and biodiversity. That means anyone who owns stocks and shares is inadvertently supporting pollution. What if anti-pollution measures hit these firms so hard that they end up running into financial trouble? And what would happen to the financial firms exposed to those firms?
The aim of the on-going climate stress-testing performed by central banks is to make banks aware of both physical and transition risks and hence mitigate them.
The 2022 ECB stress tests showed that, on aggregate, almost two-thirds of banks’ income from non-financial corporate customers stems from greenhouse gas-intensive industries. In many cases, banks’ “financed emissions” come from a small number of large counterparties, which increases their exposure to transition risks.
Reason Four: Toxic Politics
Policymakers may also worry about the extreme right taking up the anti-climate cause. The anti-ESG movement in the US serves as a stark warning of the potential for certain groups to promote themselves via anti-climate policy positions.
Their main argument is that the “corporate elite” is undermining the economy and imposing themselves in an overly authoritarian manner for the sake of an illusion.
Surveys that assess how many people are actually willing to pay for the transition tend to come back with a low percentage.
A recent EU survey found that that the majority of Europeans – almost nine in ten respondents (88%) – agree that the green transition should not leave anyone behind, while 93% of respondents think that the current level of energy prices for people in their country is a serious problem. Enacting more stringent measures that push up prices could play into the extreme right’s anti-climate hands.
Reason Five: Emphasis on incentives as a driving force for the transition
Policymakers, especially in a growth-obsessed world, prefer carrots over sticks. The US’s Inflation Reduction Act (in combination with the Infrastructure Investment and Jobs Act and the CHIPS Act), for example, is often cited as a game changing stimulus package. Other examples include the EU Net Zero Industry Act (EU Green Deal Industrial Plan).
However, various stakeholders have told Net Zero Investor that incentives need to be combined with more stringent measures, such as clear transition pathways and carbon taxes, for them to achieve their goal.
Reason Six: Emphasis on soft measures, such as disclosures, anti-greenwashing rules, and stewardship activities as a driving force for the transition
In both the UK and the EU, there has been a flurry of legislative activity in the disclosures and anti-greenwashing space, with initiatives such as the taxonomy, the Sustainable Finance Disclosure Regulation (SFDR), and the Sustainability Disclosure Requirements (SDR).
However, commentators frequently argue that disclosures, although useful, will not deliver a transition to a sustainable economy within the needed timeframe.
Moreover, the emphasis on disclosures as a “first step” reflects overarching liberal ideology that markets work well when they are well informed (efficient market hypothesis).
For example, the financial crisis wasn’t caused by an inequality problem (have-nots attempting to jump on the ladder by taking on debt they couldn’t afford), but an inability to assess risks correctly (dodgy CDOs given triple A ratings), and the primary job of policymakers is to reduce information asymmetries so that markets are aware of risks and can price them in appropriately (transparency has improved but inequalities in OECD countries have worsened since the financial crisis).
Critics of this approach are quick to lament what they call the “privatisation” of what should be “public issues” (in this case, safeguarding a “liveable” world).
The experimental nature of a private-sector led transition, driven also by unregulated stewardship practices, is also a concern. It’ll take five or ten years to assess the impact and by then valuable time will have been lost.
Reason Seven: Unwillingness to make one jurisdiction “less competitive” than another in a globalised world.#
Another argument against more stringent measures is that unilateral action in a globalised world creates a competitive disadvantage, especially in high-emission sectors such as steel or chemicals.
The counter argument is that the sustainable transition is inevitable and jurisdictions that move first will foster early mover businesses which will ultimately triumph in the future legal-economic landscape.
In the absence of an internationally agreed Carbon Price Floor, as recommended by the IMF, states could enact carbon border adjustments (CBAs) mechanisms that price in an extra carbon tax on goods imported from more lax jurisdictions. This would help ease the level playing field conundrum.