A Three-Pronged Attack
Dambisa Moyo makes the case for a new policy and market environment designed to unleash climate capital
By Dr Dambisa Moyo
There is not a single room of policy makers, corporate board members, or investors that I have been in where people are not subscribed to the importance of a low carbon future, and the urgency of the transition to a global economy that is rooted in sustainable energy.
However, the global climate challenge facing the world, and policymakers in particular, is hugely daunting.
To put the climate threat into context, consider that today:
- We are consuming the equivalent of 100 million barrels a day of oil; with fossil fuels representing 80 percent of the existing energy stack supply.
- Global emissions are over 50 billion tonnes a year – and worldwide emissions increased, despite global quarantines due to the COVID pandemic between 2020 and 2021; and worryingly that, “Global net human-caused emissions of carbon dioxide (CO2) need to would need to fall by about 45 percent from 2010 levels by 2030, reaching ‘net zero’ around 2050,” according to the IPCC.
- The International Energy Agency (IEA) estimates that the energy transition alone could require US$5 trillion of investment every year if we are to achieve net zero by 2050. This is more than double the annual investment of US$1.9 trillion made today.
- There are over one billion people – or 15 percent of the world’s population – that today lack access to energy and power supply in an affordable, sustainable and reliable way.
- The World population is continuing to expand and expected to reach 9.8 billion by 2050 – increasing the risk of consigning billions to energy poverty, with real consequences for living standards, access to education, and healthcare and worsening inequality.
Against this stark backdrop, it is perhaps unsurprising that the UN Secretary General António Guterres described the current outlook as ‘code red for humanity’ as the UN’s Intergovernmental Panel on Climate Change (IPCC), released its climate change report in August 2021.
Why Public Policy Matters
The energy transition means, in practice, that the world has to transform how it consumes energy across global industry, transportation, electricity and how we heat and cool buildings.
Public policy, technology, and consumer preferences are the three levers that have the greatest influence on how we address climate action.
Of the three, public policy arguably matters the most because it has a direct impact on the energy transition- say by steering greater public investment in the direction of green initiatives; and as policy mandates can also indirectly alter and catalyse both technology and consumer preferences.
For example, policy can provide incentives – such as tax benefits, subsidies, or even outright bans – for consumers to adopt newer technologies. It can also drive shifts in behaviour and curb use of conventional carbon-based fuels.
In particular, governments are implementing policies that favour low carbon energy technologies through financial support, subsidised infrastructure, zero carbon building codes, and bans on combustion engine vehicles.
According to the IEA, 55 percent of the cumulative emissions reductions required to achieve Net Zero by 2050 could come from consumer choice alone.
Moreover, setting the right policy environment is also crucial to urgently drive climate action at scale and with speed, as well as to change the tone of the conversation.
Too often policy steps towards climate action are reactive, and focused on risk mitigation. And too rarely on proactive investment opportunities with an eye towards innovation and breakthrough technologies; such as blue and green hydrogen, extending battery life duration, and small reactor nuclear generation IV innovations.
Of course, an investment thesis for climate action must address water scarcity, extreme weather events, and the risks of increasing emissions. For example, many companies are already making strides around disclosing Scope 1, 2 and 3 emissions, which includes the complex job of measuring emissions associated with suppliers and customers.
And there are, to be sure, returns to be generated from efforts in risk mitigation – in terms of operational efficiencies, cost savings, improvements in water and energy usage, and societal benefits such as cleaner air.
However, the path to Net Zero by 2050 is steep – and if the world relies too heavily on risk mitigation, which could shrink the global economic pie, and not enough on investment, we will struggle to achieve it. Therefore, investment in climate action, which could expand the economic output, is critical, and the real upside for business and society are investments in innovation.
Good policy must be at the core for the shift from risk mitigation to investment in innovation to happen, and unleash climate capital, and thus is the foundation of the Green Industrial Revolution. The hallmarks of good policy are that it is clear, transparent, time consistent and ultimately supports private investment in research and development; fostering long-term fixes not short-term wins.
The energy transition as defined by IEA analysis, means that to reach net zero in thirty years, fossil fuel use must fall from 80 percent of energy supplies today down to just 20 percent by 2050. This pace of change is fraught with both enormous economic and political risks.
Globally, 80 percent of energy supply today (mostly from fossil fuels) is produced by majority state-owned enterprises such as Saudi Aramco, Petrobras of Brazil, China’s CNOOC, PDVSA in Venezuela and NNPC from Nigeria, whereas private corporations produce roughly 20 percent today. Climate policies in these countries are not just matters of market regulation, but directly affect fiscal stability. In most of these places, climate policy is a fraught political question. Diplomatic and cross-border approaches must recognise that these state interests often dwarf private enterprise.
However, good policy can resolve macroeconomic and political hurdles, which is why it is so essential to navigate the transition and ultimately enable the world to achieve future energy supply and Net Zero scenarios.
On the economic side, good policy can help reduce the green premium; the cost difference between relatively cheaper fossil fuel energy sources and more expensive renewable sources such as solar, offshore wind, hydrogen, geothermal, biofuels, battery and nuclear.
By encouraging smart investments, good policy can upgrade the regulatory environment and tackle the cost constraints that still today make renewable energy sources unaffordable and cost prohibitive and thereby unable to scale.
Tax incentives, subsidies, transparent regulation, first loss guarantees, global accounting standards on disclosures, regulatory capital requirements can, at a minimum, support financial institutions, private equity firms, asset owners and managers, to better manage how they deal with climate change risks, while encouraging investment in the energy space.
Policy efforts in the financial capital markets have already led to record increases in the ESG debt market. Global ESG bond issuance has skyrocketed from US$270 billion in 2019, to over US$3 trillion ESG debt market in 2021, and with this has come tighter spreads and costs to borrowers. No doubt, improvements in financial regulation, such as tax breaks on green bonds akin to those prevalent in the US municipal bond market, could further accelerate and support the expansion of the green bond capital markets.
Good policy can also catalyse private equity investments needed to find and fund research and development in technological innovation, which will be crucial in the energy transition (including decarbonization and carbon capture) of the world’s economic and energy systems.
Additionally, public policy is central in not only supporting efforts towards innovation, but crucially helping to ensure that these technological breakthroughs, and bringing renewable power online, can happen at scale, supported by 21stcentury public goods including modernizing manufacturing, buildings, logistics infrastructure, and a skilled workforce.
Crucially, good policy can also help manage divestment in conventional energies such as coal to ensure a smooth transition that is consistent across borders. Done in a haphazard way, disinvestment in conventional energy companies and assets lowers investment in the global energy system, leading to supply shocks, creating shortages, and driving up what is becoming referred to as Net Zero or Green Inflation, thereby worsening peoples living standards and consigning more people to energy poverty.
With respect to geopolitics, good policy can not only smooth over the political contours of managing the energy transition within a country, but also between countries.
With multilateral institutions such as IMF and World Bank having seen their influence challenged over the last two decades, it is essential that national leaders continue to come together and lead policy development beyond COP26.
Specifically, policies that take a global view can help contend with geopolitical schisms between developing and developed economies. The former are largely poor and heavily dependent on cheaper, carbon-based, energy sources to boost their economic chances. The latter, having reached higher economic levels, have greater degrees of freedom to balance the trade-offs between economic needs and environmentalism, and thus more latitude to be more aggressive in the pursuit of climate action.
Savvy policy also sets up an environment where climate investments – done right – will not only speed up the energy transition, but also counter the international knock-on effects from energy poverty – including disorderly migration and geo-political conflict. For example, it can support affordable debt packages and investment in distributed renewable energy systems that enhance energy security rather than exacerbating energy dependence.
All in all, because the world clearly needs need greater public and private investment to scale up renewable power, it is imperative that we foster a policy environment for unleashing climate capital. Good policy is the centrifugal force that will help global companies and investors make better capital allocation decisions. Moreover, public policy can help investors worldwide shepherd roughly US$50 trillion, which, according to JP Morgan, is today earmarked to Environmental, Social and Governance (ESG) priorities – much of it aimed at climate action.
For example, policy can set stronger and more consistent standards for ESG investments. It could also, as discussed later, reward investors for leaning towards investment targeting innovation rather than simply screening out fossil fuels.
In what follows, I offer three specific ways in which public policy can support the energy transition and double down on efforts to avert a climate disaster.
These are: first, to instil policies toward more transparent carbon pricing; second, to put in place a more principles-based, as opposed to rules-based, regulatory environment; and third, to strengthen the corporate governance framework so as to bed down better oversight of company efforts toward a low carbon energy system and future.
The Case for Transparent Carbon pricing
Governments, businesses, and individuals, have never been fully expected to account for their carbon emissions.
This opacity has clearly contributed to market mispricing, and the negative externalities of pollution and carbon emissions contributing to the climate crisis today.
Having a visible carbon price reduces opacity, and better reflects the true costs of energy supplies, as part of the normal course of the market. While financial market transparency has its undisputed benefits, we should not discount the shocks that more energy pricing can bring, and thus the important role policy must play in this regard; such as smoothing market disruptions.
For example, according to the IEA, the quest to reach Net Zero will require CO2 prices (such as carbon taxes) in advanced economies rise from currently approximately $10-$60 per tonne to $130 per tonne by 2030 and globally to at least $200 per tonnes by 2050.
Such a trajectory needs policy transparency, public investment and space for innovation, to help companies to quickly adopt new low-carbon technologies. Without such policy supports, the consequences of such an enormous cost jump would constrain supplies, undermine businesses and their business models and has considerable implications for what individuals and businesses will pay for energy.
Attempting to price carbon costs into our economic models is a pursuit of more accurate economics.
However, carbon emissions are so fundamental to our way of life that this must be applied to the whole economy, not just certain business models such as transportation, utilities, and construction. Unless this happens, capital allocation will not be efficient.
Applying a carbon tax or emissions trading scheme to price carbon can be fiercely complex and may need to be iterative. Yet once applied, it creates more transparent market signals, and thus a clearer picture for business to make capital allocation and human resource decisions.
As a practical matter a 2018 paper by Policy Exchange found that a carbon border adjustment mechanism (CBAM), by which imports would be taxed at the border to ensure they paid the same carbon price as UK producers, would clear out web of subsidies, levies and rules. Explicit carbon pricing and its simplifying effect might never be universal, but it will be a step in the right direction.
Crucially, an international approach to carbon pricing will lower the regulatory risks of operating across borders. Simpler, shared standards, such as common carbon prices, alleviate the trade impact of borders and would help to mobilise, rather than hinder, capital allocation.
A global treaty on carbon pricing seems nowhere on the horizon, but the blunt force of CBAMs may push more governments to adopt their own carbon pricing regimes. As the EU proposes a CBAM, Australia’s awareness that 30% of its exports go to Europe has driven the carbon pricing conversation into its political mainstream.
A proposal from the OECD suggests that the EU should recognise policies such as coal phase-out as equivalent to its own carbon pricing (in order to avoid trade barriers with countries that lack explicit carbon prices), but reliance on implicit pricing in this way will not create the simplicity that businesses need to allocate efficiently.
Fundamentally, it is the job of governments to set the market framework; and to do so as broadly as possible so as to allow private enterprise, competition and the public welfare that springs from them. If societies care about climate change, then this can be built into the market through carbon pricing.
Governments must not shirk this responsibility and pass it to companies, who must grapple with a mosaic of vague and blurry ESG standards in lieu of a clearer price signal. The resulting confusion is predictable and means efforts are suboptimal and even ineffective in combatting climate change.
Politicians must set a fair and accurate economic model by pricing carbon into market design, then letting companies get on with what they’re good at. That is, harnessing the genius of allocating capital and generating real risk-adjusted financial and societal returns.
Towards More Principles-Based Regulation
After the broad market framework is set in favour of a more accurate economics that includes priced externalities, then we must think about how regulators go about their climate action efforts, particularly in the financial sector but in many others too. Should they issue detailed legal checklists, or provide guidelines on broader expectations about good behaviour?
A regulatory regime based on the intention literally to “rule out” anything undesirable and “rule in” today’s most suitable technologies is unlikely to deliver the innovative flexibility and space needed for an unprecedented, rapid shift toward net zero technologies.
Such a stance risks constraining the investment marketplace to the technologies and logic of yesterday. No doubt a rules-based approach makes a business landscape arguably clearer and more predictable, which might appear attractive qualities under the Rule of Law. But it can also be limiting, conducive to a check-box culture and requires the presence of lawyers at every turn.
The rules-led regulatory model is largely championed in the European Union, emerging naturally from the French legal model. Indeed, it is part of the bloc’s geopolitical strategy: to combine the gravitational draw of 500 million affluent consumers with the regulatory heft of the European Commission.
By doing so, companies around the world will find it simpler to understand the EU business environment. GDPR is a case in point, with the data regime slowly emerging as a global standard far beyond European shores. CBAMs are another more positive influence, with the EU developing the first major such system.
However, there is a danger that the EU’s approach to a ‘green taxonomy’, which builds a high fence around acceptably ‘green’ technologies, will also create such a draw despite its many inconsistencies, ideologies and political risks. It is an example of a strict prescriptive and precautionary model that could undermine global innovation and progress on climate and other fronts.
Rules tend to focus on what you cannot do and this encourages a risk mitigation mentality rather than promoting innovation.
The alternative is principles-based regulation (PBR), which sets its focus on expectations of behaviour and standards, rather than specific rules. This brings advantages for those looking to regulate whilst supporting the freedom of the firm to innovate.
Principles-based regulation has been championed by the UK and is an evolution of its common law approach, which learns and adapts over time. It seems no coincidence that the first industrial revolution began in the framework of such a legal system, and it is well suited to support the next – the Green Industrial Revolution.
The advantages of principles-based regulation are many, but for our purposes the two leading benefits are allocative efficiency and cross-border application. Under PBR, it is up to the firm to find the best way to fulfil expectations, finding the most efficient way to do so. This lowers the cost of compliance, but also prevents a box-ticking and risk-averse culture that limits imagination.
Equally, the costs of doing business across borders are lowered when common principles are in place in each jurisdiction, which is far more plausible than exact rules and detailed regulations. In essence, supporting cross-border exchanges of ideas and enhancing global commerce. Just as with carbon pricing, comparable regulatory regimes make it easier to invest in emerging markets without creating conflicts with ESG expectations.
A clear example is the “carry trade” in a globalised world: the ability to borrow at low rates in developed economies and invest that capital in higher-yielding emerging markets. This arbitrage has benefits for climate justice as capital is channelled to poorer economies, but is hampered by rules-led regulations. Post the 2008 financial crisis, for example, stricter capital rules for banks have made it harder for capital to flow as prescribed by the carry trade. National focus among financial institutions forces corporations to overhaul how they fund their international operations and return capital to shareholders.
If we want to decarbonise the developing world – and indeed the world in its entirety – and compete with Chinese dominance in these markets – then PBR helps emerging countries to operate on more level terms with richer countries and creates ESG visibility in the process.
Principles-based regulations certainly have their drawbacks. They can tend towards sclerosis as supplementary guidance requested by firms solidifies into de facto rules – a phenomenon that may have contributed added to the 2008 crash. To avoid this, they must be reviewed and refreshed often, and such unnecessary layering should be resisted.
A leading example in the latest generation of PBR is the UK Financial Conduct Authority’s Senior Managers Regime (SMR). The SMR expects boards to assign roles for climate action to designated senior managers, among other measures. This is not light-touch – an accusation often levelled at PBR – but the assignment of agency and personal responsibility.
Similarly, the UK’s Prudential Regulation Authority’s Supervisory Statement on climate risks makes it clear that firms are expected to lay out their exposure and plans to manage climate-related risks, or face regulatory intervention. Yes, this is risk-focused, but its approach leaves space for companies to identify upsides.
The UK is far from the only proponent of principles-based regulation. Its common law counterparts, especially in the Anglosphere and the Commonwealth, would likely welcome a diplomatic push in favour of such an approach.
As part of its ‘Brexit freedoms’, the UK should lead an informal coalition of such nations, including the US, Australia, Canada and much of the Commonwealth. These countries must consciously resist the straitjacket of rules-led ESG regulations, and unlock their capital markets to beat climate change.
With carbon pricing built into the economic design of markets, and with principles-based regulations setting behavioural expectations of firms, this leaves the firm itself to take up the gauntlet. There is a growing role for boards to lead the development of long-term strategies and cultures that reflect societal expectations and thereby protect the firm’s social ‘licence to operate’.
Company Board-level Governance and Stewardship
In economics theory, Coase’s theorem argues that there are costs to society that everyone bears, but the responsibility for the costs is unassigned, so no one does anything about it.
Coase says that to deal with these negative externalities we need to identify and give the problem to someone to solve: it doesn’t say who to give it to; but that we should make them own the consequences. Ideally, the entity to give the risk to is the one who is best equipped to manage it.
A confluence of factors mean that the private sector and businesses, have largely been assigned the cost of climate change, and therefore assumed the responsibility of catalysing climate action and driving climate change, de facto if not de jure.
Geopolitical fissures and the absence of agreement by the international community on how best to address climate change. This is particularly worrisome given the lack of consensus among the leading advanced economies underlined as competing interests and differing approaches ahead of COP26.
Additionally, there is the absence of agreement between the world’s worst CO2 emitters – China and the US, who together represent nearly 40 percent of global emissions – on how to convincingly address the climate challenge.
The fact that only a few countries have explicitly and publicly announced net zero targets alongside appropriate plans for achieving them, and that the US commitment to the Paris climate accord has been inconsistent under different administrations, means there is a policy vacuum that corporations step into to try and tackle climate concerns.
Global corporations have also picked up the climate baton as they face relentless expectations from institutional investors, pension funds and endowments, increased scrutiny by regulators, and they remain under pressure from society writ large, to curb their emissions and overhaul their business models to become greener.
Climate action campaigns press for greater disclosure, and push for action and demonstrations to show that companies are drastically cutting their emissions and making concerted efforts to upend their use of the existing, traditional energy sources.
Anti-fossil fuel campaigns push for more aggressive stress tests and even threatening defunding and divestment from companies – and in particular banks and traditional energy companies – in a dogged quest to speed up the energy transition at any cost.
As a consequence, companies themselves have grasped the nettle moving from economist Milton Friedman’s 1970 doctrine, which in short espouses “the business of business is business” stance to one which embraces the utility of a broader stakeholder regime as enshrined in the Business Roundtable statement in 2019.
With these tectonic changes, and new ESG priorities emerging for businesses, has come a flurry of new reporting metrics, resets in evaluating executive compensation to better measure climate targets, the greening of company operations, and business models to embed water and energy intensity targets, as well as more aggressive investments in renewables.
Still there is more that policy can do to help the private sector optimize its allocation of capital and resources towards profitable returns, while finding sustainable and equitable solutions to the enormous climate challenge.
A key part of this is policymakers making sure that a lack of policy clarity does not (inadvertently) lead companies to make investments today that are undermined by new policy direction tomorrow – and fail to generate real financial returns above the cost of capital.
After all, it is a profoundly dangerous idea that corporations alone will solve the complex dynamic optimization problem of climate change.
There are, to be sure, compelling arguments for corporations and private investors being ideal problem solvers. They generally have and manage resources with foresight – and can look over 10-30 years horizons. They do focus future investments and upside, and are generally comfortable with navigating through uncertainty.
But even so, public policy can help define parameters for better governance for 21st century corporations and the broader business landscape.
Specifically, policy can help improve corporate boards and governance so that: companies move from broad, shorter term commitments and proclamations to target deeper climate change with more specific and measurable (say 5-year) strategic plans; companies enhance disclosures and metrics – so that a company’s performance can be compared against peers, as well as companies in other sectors, and the companies progress over time; boards ensure that companies are driving for innovation and upgrade finances, operations and business models to address climate change; and finally, futureproofing organizations by planning for the transition of assets (bad banks).
Climate action initiatives should be strategic and long-term focussed and not drawn to tactics and short-termism. Boards should act boldly to oppose short-termism by continually setting their sights on long-term strategy.
The average Chief Executive’s tenure in the Russell 3000 index is seven years. That shortens to 5.5 years in the FTSE 100. Research by the Financial Times finds that, in high-emissions sectors such as oil, aviation and cement, there will be an average of four holders of the CEO position before the Net Zero target date of 2050. As the newspaper quotes one business leader, this makes climate-related targets “next, next, next, next management’s problem.” This doesn’t necessarily lead to a lack of targets and commitments, which abound in the corporate world. But it can keep meaningful ESG action low down on the corporate action plan, creating a mismatch between public declarations and actual capital allocation.
Even 2030, the focus of the Paris Agreement’s Nationally Determined Contributions (the voluntary emissions targets that will be the focus of COP26), is further away than most CEOs’ leaving parties.
As individual C-Suite leaders struggle to see past their own tenures, then corporate boards must do so for them. Otherwise, the ball is effectively being thrown back to governments and regulators. So that, working in concert, regulators and corporate boards could require more detailed climate plans – such as 5-year plans – that could be Paris-aligned.
The G7’s commitment to TCFD shows how regulators can help boards encourage identification of underlying systemic risks to financial stability. Companies should be producing strategic plans that clearly factor in the physical, transitional and liability risks posed by climate change and the societal response.
Better still, firms should be laying out the efficiency gains of climate-related measures combined with other trends. Such opportunities should be built into long-view strategic plans and required by boards as standard.
Short-term approaches and thinking can quickly lend themselves to charges of green washing and worse still misallocation of capital as boards and companies they serve are pushed to invest in renewable assets to demonstrate “green credentials” and burnish their reputations, which in turn can lead to inflation of renewable assets prices and ultimately create bubbles.
Boards must tackle the climate problem with a clear-eyed view of their own role as stewards – responsible for leaving a stronger, healthier firm over the long-term, than they found. To assist in this effort their governance role must be steeped in metrics and disclosures.
Board audit function and committees have detailed metrics for financial performance, operations, and even worker audits.
In the context of climate efforts, the Climate Action 100+ Net Zero Benchmark enables boards to assess the climate transition plans of management – and to anticipate the views of shareholder and activist investors. Such independent data sources are increasingly important for boards that must take a wider view of society’s expectations and a longer view of global trends. The energy trajectory will not be a switch from today’s equilibrium to a future equilibrium, but a transition which will not be linear – and will ebb and flow, and thus must be managed sensibly.
Meanwhile, a leading example of corporate governance setting a responsible climate agenda for firms is South Africa’s King Committee. Commissioning an update to the previous four King reports (a ‘King V’), this time incorporating climate considerations, could be endorsed by governments and industry bodies. The reports help to set a standard of behaviour that large and smaller entities can adopt at the board and senior management levels.
Rebalancing incentives to reflect climate expectations can be done in the short and medium terms, such as altering executive compensation to include 10-year deferred payments that vest only if carbon emissions reach a Paris-aligned metric in 2030.
With the support of policy, company boards have an important role of reminding and emphasising to management that the more options that we have to address and accelerate climate action, the better.
A criticism of the overarching climate agenda is that it lacks an openness to innovation. That current climate action efforts are often prone to a priori picking winners versus losers, rather than allowing/enabling innovation to sieve out the best, scalable, sustainable, cost-effective solutions.
Current efforts and framing necessarily leads to a narrative that “everything renewable is great, and everything fossil fuels-related is awful”- a doctrine that engenders a rush to judgement; even though the reality of what works and what does not, is to large extent not yet known. For example, existing fossil fuel infrastructure can support the production of blue hydrogen, carbon capture and storage, and – through natural gas – can provide a transition fuel in emerging markets where growth outpaces renewable deployment. Moreover, electric vehicle and existing battery technology still relies considerably on fossil fuels – thus we should not be in a rush to jettison fossil fuels which are supporting the energy transition.
In essence, efforts that are too hasty and too doctrinaire could delay the energy transition; and make it harder for society to maximize the chance of finding a sustainable, equitable, and greener solution to climate risk.
Additionally, company boards will be expected to better oversee the transition and how best to manage stranded assets – such as coal through the energy transition. Part of this effort will be around possibly ring-fencing so-called “bad” assets, and managing them down accordingly.
Each level of the three-tier market has a role to play: in setting the market framework and the clarity of price signals through carbon pricing; in creating the high-level expectations of firms at the regulatory tier; and in setting the governance framework and company culture and other norms that factor climate into the firm’s short and long-term strategies.
Taken together, in a more joined up, holistic way, these actions help to set a business environment that leaves companies ample space to allocate capital efficiently and create the solutions needed, but with clear expectations of a move to a Net Zero economy.
There are myriad other measures needed, from clear sector-specific policies for Net Zero transition, to new technologies that will make all of the above easier and more effective. However, first we must set the right market environment. The prevailing status quo, often characterised by vague and disparate, non-binding ESG frameworks, is not helping anyone – not least the climate.