OECD Warns of Climate-alignment “Blind Spot”
Prospects for policy progress on systemic risks limited by narrow approaches and incomplete assessments, warns report ahead of COP29.
Climate-related systemic risk will not be properly reflected by financial markets until governments ensure both real economy and financial sector policies support climate alignment, recent research suggests.
Speaking at a webinar discussing research conducted by the Organisation for Economic Co-operation and Development (OECD), Thomas Tayler, Head of Climate Finance at Aviva Investors, said the development of climate-aligned policies required a reappraisal of how systemic risks on the finance sector are assessed.
“While we look at the impact of systemic risks on individual institutions, we don’t look at the financial system as a whole – we look at systemic risk too narrowly,” he said.
The OECD report said actions to better align finance with climate goals had to be informed by robust assessments of progress, describing available evidence on best practices, finance volumes, and actions as “scattered and incomplete”.
Tayler also said more effective measurement techniques were needed to help policymakers and other stakeholders grasp the interactions between investment decisions and systemic risks such as climate change.
“Understanding how asset allocations flow, as well as the stock decisions of big investors and financial institutions, will improve understanding of how these are impacted by systemic risks [like climate change], which can be built into the frameworks that govern us,” he said.
The OECD report analysed how the climate alignment of finance globally is assessed, the current degree of alignment, and how financial sector and real economy policies and actions influence alignment with Article 2.1c of the Paris Agreement.
“We cannot yet solely rely on existing climate alignment methodologies, as they are still maturing and are incomplete across the financial system,” said Jolien Noels, Policy Analyst at the OECD and lead author of the report.
By assessing the positive and negative impacts of total volumes of financial flows and stocks on climate mitigation goals, the report found a low degree of climate-alignment across asset classes Within an outstanding corporate bonds universe of US$34 trillion in 2023, green bonds made up US$1.6 trillion, compared with US$1.7 trillion of bonds issued by the fossil fuel sector.
As comprehensive alignment assessments for climate mitigation are “not yet possible for all layers of finance” and “remain exploratory for climate resilience”, the OECD said there is heightened risk of blind spots which can hide misaligned activities and contribute to greenwashing.
“Issues surrounding climate finance are right at the heart of the political discussions due to kick off next week,” said Taylor.
COP29 – which is set to commence from 11 November – has been dubbed ‘Finance COP’, due to expectations for a deal over the New Collective Quantitative Goal, which will determine funding for low-income countries to support climate mitigation.
It is also hoped that the new round of nationally determined contributions to the Paris Agreement – due to be delivered soon after COP29 – will include detailed climate-aligned policies with encourage private investment.
Holding up the mirror
The OECD report said current efforts to align finance flows with climate change mitigation measures are falling short of net zero goals, despite the widespread introduction of policies designed to support transition to a low-carbon economy.
Since the adoption of the Paris Agreement, financial sector policies that integrate climate considerations – such as sustainable fund labelling requirements – have more than quadrupled, the report said, with more than 80 countries having introduced such policies.
By 2023, 77 countries had adopted climate-related transparency and information policies, like environmental taxonomies. Meanwhile, 41 had climate-related prudential policies, and 16 had installed climate-focused credit allocation policies.
“Real economy policies such as carbon taxes or fossil fuel subsidies are also key drivers of the climate alignment or misalignment of finance,” said Noels.
Total fossil fuel subsidies amounted to US$7 trillion in 2022, with implicit subsidies undercharging for environmental costs and forgone consumption taxes accounting for 82% of those issued.
As current policies are putting the world on a path toward 3°C of climate change, the finance sector has little choice but to invest accordingly, Tayler warned.
“The biggest blind spot the OECD review has highlighted is that the financial system is reflective of the incentives being created in the real economy that we invest in,” he said.
“Ultimately, it’s no surprise that the world is heading towards 2.4-3.1°C of warming – that’s also where analysis suggests the implied warming of major indices of equities is heading, because they reflect anticipated and currently stated policy scenarios.”
Sound the alarm
To better align finance with climate policy goals and improve underlying evidence, the OECD called on governments to develop mandatory disclosure requirements that are interoperable across jurisdictions and cover key complementary metrics that relate to impacts on emissions and resilience.
In addition, governments should aim to support assessments through improved availability of granular input data and reference points, and identify and revise policies incentivising and enabling domestic and international financial flows going to climate‑misaligned activities, the review said.
Policymakers and regulators focused on the financial system should look to collect and publicise detailed data on finance exposed to activities either contributing to or undermining climate goals, the OECD added. They should also develop disclosure requirements of core complementary metrics for financial institutions and consider the impacts of existing policies on climate goals.
Tayler said COP29 offered investors a platform to engage with policymakers on the climate-related policy guardrails they need to scale their related stewardship and investing strategies.
“Investors have to use their voices to advocate for a system that changes – currently, the financial system isn’t sounding the alarm bell to governments or regulators,” he said.
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