Importantly, the issue of coping with climate change by using financial markets is getting topical. With increasing global recognition of the need to decrease the emissions of greenhouse gases,.
Due to climate change, financial markets are beginning to find ways to change their operations to be more sustainable. Such markets include stock and bond markets, and derivative markets exercise authority over the distribution of capital and corporate management.
Thus, through the proper orientation of investment in sustainable projects and the exclusion of businesses with high carbon footprints, financial markets can become the drivers of climate change.
Cato Institute: Green Bonds and Sustainable Financing
Perhaps the most obvious is that, via green bonds and other related sustainable financial instruments, financial markets can lead climate action. That means green bonds are a type of bond that is intended for financing projects that are environmentally friendly, for example, renewable energy, energy efficiency, and climate change.
In this way, the green bonds invest in those projects that can reduce the world’s carbon footprint and contribute to the low-carbon economy.
Also, there is a rapid increase in the demand for sustainable investments. Activist investors are, therefore, looking for investments that meet their specific predefined ESG standards. As a result of this demand, the financial market calls for green mutual funds and ETFs that invest in sustainable companies and projects.
Since more capital is chased into these investments, it forms a virtuous cycle whereby more firms undertake sustainable practices to be able to attract capital.
Carbon Pricing and Emission Trading Systems
Financial markets can also encourage climate action through mechanisms like carbon pricing and emission trading systems (ETS). Carbon pricing consists of putting a price on carbon, thus putting an economic cost on emissions, and therefore encouraging companies to decrease them.
This may be effected through the imposition of carbon taxes or the use of emissions trading to facilitate the selling and buying of allowances to emit carbon.
An ETS, for instance, limits the maximum amount of greenhouse gases that firms in the capped sector might output. Those that manage to emit less than the prescribed level can sell their extra allowances to those who emit more than the cap, thus giving birth to carbon credit.
Divestment from Fossil Fuels
Another mechanism through which financial markets can effect climate change is through the divestment campaign. This includes, for instance, divesting pension funds and endowments from companies engaged in the business of fossil fuels.
The idea is to limit the funds that companies that are problematic in terms of climate change have at their disposal, together with stimulating funds to go into innovative industries such as renewable energy, among others.
The divestment campaign started some years ago, but many institutions have declared their intention to divest from fossil fuels in the recent past. It also contributes to the negative revenues of fossil fuel corporations and accompanies this path with an obvious signal in the market: The future belongs to sustainable energy investment and environmentally friendly business.
This means that when investors shy away from funding such industries, more and more companies experience pressure to shift towards the green economy.
Risk Management and Climate-Related Disclosure
Another way is that, through financial market mechanisms, the quality of managing climate-related risks can be improved, along with raising the level of disclosure of such risks.
With climate change threatening all aspects of global economic and social wellbeing, investors are becoming more aware of the financial consequences of climate-related phenomena, from catastrophes and floods to new regulations.
Therefore, governments, local and international financial institutions, and relevant bodies pressure corporations to declare their climate impacts and the measures they are taking to manage them.
For instance, the Task Force on Climate-related Financial Disclosures (TCFD) specify the exposure of organizations to climate risks and opportunities. Such transparency helps investors make better decisions; at the same time, it puts pressure on the companies to use more robust and sustainable models.
Climate change, an inherent part of the financial market, is at the core of the global crisis. Through investing in green projects, backing carbon pricing schemes, supporting divestment from fossil resources, and enhancing the approach towards managing climate change risks, the roles of financial markets in furthering the process of a sustainable shift to a low-carbon economy can be discerned.
It will be seen that the integration of sustainability into financial markets is not only the right thing to do but also the business and economic thing to do.
ASH CK