Wrestling international finance into observing the Paris Agreement

As private actors enter the climate finance fray, regulation is needed to align such investment and lending with climate-friendly goals.

Manuel Montes

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ON 3 November, at the premises of the COP 26 climate conference in Glasgow, in a triumph of illusion over hope, over 450 firms with $130 trillion in assets from over 45 countries announced a pledge of $100 trillion of private capital to transform the economy to ‘net zero’.  What was almost unexpected was the chorus of skeptical and critical commentary triggered by the announcement in those media outlets most accessible to professional players in financial markets.

The new grouping, called GFANZ (Glasgow Financial Alliance for Net Zero), was organised by Mark Carney, former governor of the Canadian central bank and then governor of the Bank of England. In 2015, in a speech at the Bank for International Settlements (BIS 2015), he made waves by presenting the concept of ‘stranded assets’, investments whose returns climate change could wipe out before their associated debt liabilities could be fully paid back.

The GFANZ proposal was seen as too big to be credible (FT 2021). Larry Fink, the chief executive officer of BlackRock Inc., in a COP 26 panel said ‘deploying that capital is going to be far harder’ than securing the announced commitments (Bloomberg 2021a).

GFANZ joins the unbroken string of, often grudging, promises on climate financing from the resource-rich North. The plodding moves towards redeeming one of these promises – annual $100 billion climate financing from developed countries to developing countries, a pledge made in 2009 that was not delivered in 2020 – were a harsh highlight of COP 26. However, COP 26 was the venue for even more new announcements (promises) from a variety of country groupings and non-state parties.

To be sure, GFANZ is not fundamental to the system of cross-topic obligations of the Parties under the 2015 Paris Agreement of the United Nations Framework Convention on Climate Change (UNFCCC). But it represents a distinct intrusion of potentially the largest source of financing that could be deployed towards climate action – private finance.

In fact, as developing countries struggle to compel developed countries in the UNFCCC to recognise the latter’s historical responsibilities and fulfil their financing obligations, the private sector, predominantly regulated (or not) by developed countries, has been making enormous profits from oil, gas and coal-related projects, and it is not clear if this sector has the ‘willpower’ to stop this practice (Metcalf and Marsh 2021). Private investments in these kinds of projects have been double those in ‘green projects’.

One well-known problem is that of ‘greenwashing’. Activists have called out banks – 12 banks that are members of Prince Charles’s Financial Services Taskforce including Bank of America, Citi, JP Morgan, Barclays and BNP Paribas – lobbying to water down GFANZ’s benchmarks (STMP 2021).

But the problem is more fundamental than the public relations dimension and is rooted in the misshapen incentives in global private finance.

The problem is less that much more private finance has to be mobilised to fund climate action –drumroll for GFANZ – it is more that the international financial sector’s deeds must be wrestled towards not acting at cross-purposes with the Paris Agreement. 

Developing countries are simultaneously energy-poor (which caps income growth rates), financing- and capital-poor (which prevents needed climate investment at scale), and fiscal-policy-resources-poor (which makes their governments more dependent on international finance compared with developed countries).

Developing countries must cope with the shifting impulses and whims arising from international private finance. At present, the enormity of the announced GFANZ resources highlights the large international pool of financial wealth that can be lent to developing countries to overcome energy poverty. However, these must be borrowed at annual interest rates of 5-8 percentage points more than the rates available to developed countries and large companies, often at floating interest rates (which can climb overnight if developed countries decide to tighten their own public spending) and for short periods, certainly for periods not as long as the life of an energy plant – whether green or not.

Lending into risky and debt-distressed countries has become a highly profitable area for international private finance. The ongoing experience with COVID-19 pandemic finance has indeed sparked interest in a possibly new, highly profitable ‘asset class’ playground called ‘distressed debt and opportunistic credit’ (Bloomberg 2021b, Oaktree 2021).

Such funding alacrity on the part of the private sector stems from the fact that international private finance has barely borne any losses from irresponsible lending in the past. Debtor countries became the only parties responsible for failed loans from private sources.

In the COVID-19 pandemic, both the poorest countries eligible for the G20 debt relief programmes and middle-income countries have run up their international public debt to pay for pandemic spending and service debt payments coming due. 

Through all of these, international private finance, through the Institute of International Finance (IIF), has stymied efforts for private lenders to provide debt relief at comparable rates to those offered by public lenders. The IIF has deeply engaged the G20 process to confine debt relief and restructuring to fully voluntary efforts (Vander Stichele 2021).

Going back to COP 26, GFANZ and financing climate action, even if certain ‘clean technologies’ might be competitive, securing finance for developing countries would still suffer the same high-cost constraints because the financing cost is still determined by the credit rating of the borrower – developing countries carrying the baggage of existing debt and previous crises.

Developing-country authorities must also understand the mechanics of money flowing out of GFANZ. The start of the process is not the planning and identification of a climate-sound port facility or the decommissioning of a coal-fired plant. Parts of the international pool are parcelled out into ‘asset classes’ and the first step is the ‘creation’ of an asset class.

Investors place their funds into asset classes. Financial investors can make money if the projects in the asset class succeed. But private investors can also succeed by betting against the success of an asset class, by taking a ‘short position’.  Thus, these investors do not have an essential interest in the long-term success of climate action.

De-risking the capitalisation and trading of nature

‘Nature’ is one such new asset class, with ‘NACs’ (nature asset companies) beginning to be traded on the New York Stock Exchange (Harty 2021). The ‘nature’ asset class falls under the umbrella asset class called ‘environmental, social and governance’ (ESG) investing. Note how expansive the category is. How can private investors make money from better governance, for example?

Financial investors must continually hunt for ways to derive a flow of returns from these asset classes, which for the most part is not available without public sector action. The Financial Times, in commenting on GFANZ, put it this way: ‘The reality is that carbon transition will require huge state intervention and investment’ (FT 2021).

The game of lending by the private sector to capital-poor developing countries began in the 1970s when the International Monetary Fund (IMF) and the World Bank proudly assisted deposit money banks based in New York to recycle petrodollar deposits from oil exporters by lending these deposits to developing countries suffering from balance-of-payments problems due to higher oil prices.

Private banks did not have the expertise and relied on IMF and World Bank staff assistance and analysis. When these loans failed, the IMF and the World Bank played the indispensable role of making sure the private bank creditors were paid back, instead of being forced to declare bankruptcy, by lending to debtor countries in the form of policy reform loans.

While there are numerous details about these ‘debtor country rescues’, these policy loans did not require investment in new activities but instead required a schedule of government reforms (the ‘G’ in ESG portfolio investment) to be met. The funds received by developing countries were immediately ‘recycled’ to pay scheduled debt service to the international private banks. No need for the slow slog to look for projects that will produce earnings from which the creditors could be paid back.

This created an international finance sector that capitalises on irresponsible lending with impunity – akin to the way that the portion of humanity with spending power consumes and produces too much under carbon prices that are set too low.  

Thus, one could say that for decades now, the ‘put’ (portfolio investment) on developing-country lending was guaranteed by public sector policies of developed countries over international debt markets (buttressed by their domestic laws on the basis of which international debt conflicts are settled). This has mutated into the present situation in which the priority is placed on ‘de-risking’ private financing for developing countries, which Gabor (2021) calls the ‘Wall Street Consensus’, to mobilise private finance to participate in global climate action.

Beware then of GFANZ whose arena of lending is ESG, with emphasis on ‘environmental’.

A former senior manager of BlackRock ESG investing characterises the ESG lending industry as downright dangerous (Armstrong 2021). BlackRock itself is a member of GFANZ and ‘co-leading GFANZ’s work on sectoral decarbonization pathways’ (BlackRock 2021).

The game of international private lending to developing countries continues to evolve under the theme of ‘de-risking’. In this framework, GFANZ generously promises enormous but hazard-laden resources to developing countries through private lending.

Instead of worrying about whether there is enough private investment and lending for climate action, public authorities of Parties to the UNFCCC should concern themselves with regulating international private finance.

This must be done, first, with international regulations that end irresponsible international lending even if the intentions are laudably ESG- or pandemic-related. As a start, developed countries whose representatives de facto dominate institutional regulators of international finance such as the IMF and the Paris Club should mandate comparable debt relief from the pandemic. As dominant shareholders of the World Bank, they must ensure that the World Bank itself participate in comparable debt relief.

After decades of experience, however, developing-country Parties to the UNFCCC cannot count on developed countries to ‘do the right thing’ and regulate international finance properly. They must institute a deliberate and transparent process to recover capabilities to regulate their capital accounts.

Through its capital controls, China has managed to keep the financing costs of domestic investments lower and independent of events overseas. This is critical for affordable climate action. Other developing countries are not China. They will need to revive tools to monitor trends in the volumes and the costs of external debts and liabilities, while engaging with international private sector creditors – not an easy task.

The alternative, however, is walking into another debt crisis.

Developing-country authorities, especially central banks, must monitor and regulate GFANZ-financed projects – particularly those involving government agencies themselves – regarding their bona fides as genuine climate action projects, their ability to generate returns in a possibly extended period of unduly low global carbon prices, and the capacity of the domestic borrower to service the loans.

If the petrodollar experience is any guide, there is room for much mischief in GFANZ.          

Manuel Montes is Senior Advisor, Society for International Development.

References

Armstrong, Robert (2021) ‘The ESG investing industry is dangerous: A BlackRock dissident speaks truth.’ Financial Times. 24 August 2021.

BIS (2015) ‘Mark Carney: Breaking the tragedy of the horizon – climate change and financial stability’. Bank for International Settlements. 28 September 2015.

BlackRock (2021) ‘From ambition to action – the path to net zero’. BlackRock.

Bloomberg (2021a) ‘Carney Unveils $130 Trillion in Climate Finance Commitments’.

— (2021b) ‘Distressed Debt Is Dead; Long Live “Opportunistic Credit”.’  Bloomberg Law. 17 November 2021.

FT (2021) ‘COP26: Carney’s $130tn climate pledge is too big to be credible’. Financial Times. 3 November 2021.

Gabor, Daniela (2021) ‘The Wall Street Consensus’. Development and Change, Volume 52, Issue 3, pp. 429-459. DOI: 10.1111/dech.12645

Harty, Declan (2021) ‘NYSE’s new investment vehicle – “natural asset companies” – will tap into ESG fever.’ Fortune. 14 September 2021.

Metcalf, Tom and Alastair Marsh (2021) ‘Green Trillions Face “Acid Test” After Bankers Toast COP Pledges’. Bloomberg Green. 6 November 2021.

Oaktree (2021) ‘Opportunistic Credit’. Oaktree Capital. November 2021.

STMP (2021) ‘Climate groups call out banks lobbying for watered down Net Zero Commitments’. Stop the Money Pipeline (STMP).

Vander Stichele, Myriam (2021) ‘The IIF and Debt Relief: How the Institute of International Finance Lobbies to Prevent Private Debt Relief for Developing Countries’. SOMO Center for Research on Multinational Corporations. 27 October 2021.

*Third World Resurgence No. 349, 2021, pp 46-48