A UN ENVIRONMENT – WORLD BANK GROUP INITIATIVE ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM N ov e m b e r 2017 UN Environment The United Nations Environment Programme is the leading global environmental authority that sets the global environmental agenda, promotes the coherent implementation of the environmental dimension of sustainable development within the United Nations system and serves as an authoritative advocate for the global environment. In January 2014, UN Environment launched the Inquiry into the Design of a Sustainable Financial System to advance policy options to deliver a step change in the financial system’s effectiveness in mobilizing capital towards a green and inclusive economy – in other words, sustainable development. This report is the third annual global report by the UN Environment Inquiry. The first two editions of ‘The Financial System We Need’ are available at: www.unep.org/inquiry and www.unepinquiry.org. For more information, please contact Mahenau Agha, Director of Outreach (mahenau.agha@un.org), Nick Robins, Co-director (nick.robins@un.org) and Simon Zadek, Co-director (simon.zadek@un.org). The World Bank Group The World Bank Group is one of the world’s largest sources of funding and knowledge for developing countries. Its five institutions share a commitment to reducing poverty, increasing shared prosperity, and promoting sustainable development. Established in 1944, the World Bank Group is headquartered in Washington, D.C. More information is available from Samuel Munzele Maimbo, Practice Manager, Finance & Markets Global Practice (smaimbo@worldbank.org) and Peer Stein, Global Head of Climate Finance, Financial Institutions Group (pstein@ifc.org). Acknowledgments This report was prepared by a team led by Samuel Munzele Maimbo (World Bank) and Simon Zadek (UN Environment). Team members are: Francisco Avendaño, Katerina Levitanskaya, Wenxin Li, Aditi Maheshwari, Quyen Thuc Nguyen, Gursimran Rooprai, Peer Stein, Wei Yuan, Rong Zhang (IFC); Juan Carlos Mendoza (World Bank); Mahenau Agha, Iain Henderson, Olivier Lavagne d’Ortigue, Jeremy McDaniels, Felicity Perry, Nick Robins, Sandra Rojas, Eric Usher, Brandon Kai Yeh (UN Environment). They are grateful for the comments received during external consultations and reviews from Howard Bamsey (Green Climate Fund), Timothy Bishop (Organisation for Economic Co-operation and Development), Martin Čihák (International Monetary Fund), Sonja Gibbs (International Institute of Finance), Leonardo Martinez (World Resources Institute), and Martijn Regelink (Dutch Central Bank). The report also benefited from comments and guidance from others in the World Bank Group including James Close, James Fergusson, Barend Jansen, Marc Schrijver, Colleen Keenan, Heike Reichelt, and overall oversight from Alfonso Garcia-Mora, Ceyla Pazarbasioglu, John Roome, and Joachim Levy. Editorial support was provided by Hope Steele. UN Environment would like to particularly thank the German Federal Ministry for the Environment, Nature Conservation, Building and Nuclear Safety (BMUB) and the Italian Ministry of the Environment and Protection of Land and Sea for their support for this piece of work, as well as the following for their financial support and strategic partnership: the governments of Switzerland and the United Kingdom of Great Britain and Northern Ireland, the European Commission, the MAVA Foundation and the Rockefeller Foundation. 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A UN ENVIRONMENT – WORLD BANK GROUP INITIATIVE ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Co nten ts EXECUTIVE SUMMARY 9 Three Drivers of Change 9 Structure of the Roadmap 10 Market-Driven Transformation 10 Nationally Driven Initiatives toward Sustainable Finance 12 International Coordination and Sustainable Finance 14 Next Steps 16 1 CONTEXT AND SCOPE OF THE ROADMAP 19 1.1 Background and Objective of the Roadmap 19 1.2 Context: Characteristics of a Sustainable Financial System 20 1.3 Transitioning toward Sustainable Finance 21 1.4 Three Drivers of Change 24 1.5 Roadmap: Definitions, Scope, and Structure 24 1.6 Structure 24 2 MARKET-DRIVEN TRANSFORMATION 27 2.1 Markets Have Led the Initial Transformation toward Sustainable Finance 27 2.2 Products, Information, and Technology 27 2.3 Business Models, Capabilities, and Incentives 41 2.4 Conclusions 45 3 NATIONALLY DRIVEN INITIATIVES TOWARD SUSTAINABLE FINANCE 47 3.1 National Public Policy Actions 47 3.2 Public Finance Measures 48 .4 3.3 Financial Policy and Regulation 53 3.4 The Global Policy and Regulatory Landscape of Sustainable Finance 54 UN ENVIRONMENT – WORLD BANK GROUP 3.5 National-Level Actions 55 3.6 National Roadmaps 60 3.7 Conclusions 63 4 INTERNATIONAL COORDINATION AND SUSTAINABLE FINANCE 65 4.1 Global Coordination and Principles 65 4.2 Results Measurement 72 4.3 Conclusions 76 5 NEXT STEPS 77 5.1 Market-Led Initiatives 79 5.2 Nation-Led Initiatives 80 5.3 International Initiatives 81 5.4 In Closing: A Broader Perspective Will Be Required to Address All Elements of Sustainable Finance 82 APPENDIX A: SUSTAINABLE FINANCE AND RELATED CONCEPTS: A SHORT REVIEW 83 Sustainable Finance Defined 83 Subset of Sustainable Finance: Climate Financing and Green Financing 84 APPENDIX B: CASE STUDIES 87 Case Study: Brazil – Steps to Sustainable Finance 87 Case Study: China – Establishing the Green Financial System 88 Case Study: European Union – Steps toward a Sustainable Financial System 90 Case Study: India – Developing Renewable Energy and Energy Efficiency Markets 93 Case Study: Morocco – A National Roadmap for Sustainable Finance 94 Case Study: Russia – Creating Market for Residential Energy Efficiency Finance 95 .5 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM F ig ures Figure E.1 Roadmap Structure 10 Figure E.2 Typology of Public Finance Interventions in Support of Sustainable Finance 13 Figure 1.1 Roadmap Structure 25 Figure 2.1 The Virtuous Cycle of Market-Driven Sustainable Finance 28 Figure 2.2 IFC Survey among Clients: Percentage Active in Climate/Green Finance 28 Figure 2.3 Use of Green Bond Proceeds: 2016 Issuance 30 Figure 2.4 Evolution of Green Bond Market, 2007–16 30 Figure 2.5 Linking Disclosure Levels 33 Figure 3.1 Typology of Public Finance Interventions in Support of Sustainable Finance 49 Figure 3.2 Selecting Public Finance Interventions 52 Figure B3.2.1 Results of DNB Exposure Analysis 58 Figure 3.3 National Roadmaps of Selected Countries 61 Figure 4.1 Recommendations of the Financial Stability Board (FSB)’s Task Force on Climate-related Financial Disclosures (TCFD) 68 Figure 4.2 Leading Sustainable Finance Global Initiatives 69 Figure B4.3.1 SBN Measurement Framework 75 Figure B4.3.2 SBN Progression Matrix 75 Figure A.1 Investment Approaches: ESG and Impact Investing 84 Figure A.2 Elements of Sustainable Finance 85 Ta b l es Table E.1 Summary of Next Steps and Timing 17 Table 1.1 Transitioning toward Sustainable Finance 21 Table B2.1.1 Steps of the World Bank Group Initiative on Green Tagging 38 Table 3.1 The Relevance of Sustainability Factors for Financial Authorities 55 Table 4.1 Key Thrusts of Global Initiatives on Sustainable Finance 70 Table 5.1 Summary of Next Steps and Timing 77 Table A.1 Selected Definitions of Sustainable Finance 84 Boxes .6 Box E.1 Key Considerations for Developing Principles of Sustainable Finance 15 Box 1.1 Sustainable Financial System: A Working Definition 24 Box 2.1 Green Tagging 37 UN ENVIRONMENT – WORLD BANK GROUP Box 2.2 The Green Digital Finance Alliance (GDFA) and Ant Financial Services Group 40 Box 3.1 Enhancing Disclosure on Climate Risk in France and California 56 Box 3.2 Examining the Impacts of the Energy Transition in the Netherlands 58 Box 3.3 An Online Sustainable Finance Diagnostic Toolkit 64 Box 4.1 Characteristics of National Roadmaps that Can Inform the Development of Sustainable Finance Principles 70 Box 4.2 Key Considerations for Developing Principles of Sustainable Finance 71 Box 4.3 Measuring Progress in Sustainable Finance: Innovation by Emerging Markets 74 Box 4.4 PRI Reporting Framework 76 Acronym s an d Ab b rev i ati o n s BACEN Banco Central do Brasil BIS Bank for International Settlements CBA China Banking Association CBI Climate Bonds Initiative CBRC China Banking Regulatory Commission CDP Carbon Disclosure Project CEBDS Brazilian Business Council for Sustainable Development CIPM Certificate in Investment Performance Measurement CRAs Credit rating agencies DNB Dutch Central Bank E&S Environmental and social ESCOs Energy service companies ESG Environmental, social, and governance ETF Exchange-traded fund FEBRABAN Brazilian Federation of Banks FI Financial institution fintech Financial technology FSAP Financial Sector Assessment Program FSB Financial Stability Board GDFA Green Digital Finance Alliance GW Gigawatt IAIS International Association of Insurance Supervisors IFC International Finance Corporation (of the World Bank Group) IFI International financial institution IMF International Monetary Fund INDCs Intended Nationally Determined Contributions ISE Corporate Sustainability Index IOSCO International Organization of Securities Commissions GHG Greenhouse gas MBA Mongolian Bankers Association MDB Multilateral development bank MFB Multifamily building NDCs Nationally Determined Contributions OECD Organisation for Economic Co-operation and Development PRI Principles for Responsible Investment RBI Reserve Bank of India SBN Sustainable Banking Network SDGs Sustainable Development Goals SEBI Securities and Exchange Board of India SERP Social and Environmental Responsibility Policies SFSI Sustainable Finance Skills Initiative SIC Standard industry classification SIF Sustainable Investment Forum SMEs Small and medium enterprises SRI Socially responsible investment TCFD Task Force on Climate-related Financial Disclosures UNEP FI United Nations Environment Programme – Finance Initiative UNFCCC United Nations Framework Convention on Climate Change WBG World Bank Group .7 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM UN ENVIRONMENT – WORLD BANK GROUP EXECUTIVE SUMMARY Historically the financial system has responded to the needs of the time. A global consensus has arisen that sustainable growth will be one of the greatest challenges of the 21st century— as demonstrated by the United Nations (UN) Sustainable Development Goals (SDGs) adopted as part of its 2030 Agenda for Sustainable Development—along with the measures to combat climate change and adapt to its effects that are part of the Paris Agreement. As in previous structural transformations, the financial system will play a major role in this process: the full potential of the financial system needs to be harnessed to serve as an engine in the global economy’s transition toward sustainable development. The objective of this Roadmap is to propose an integrated approach that can be used by all financial sector stakeholders—both public and private—to accelerate the transformation toward a sustainable financial system. This approach can bring policy cohesiveness across ministries, central banks, financial regulators, and private financial sector participants to focus efforts. The ultimate vision that the Roadmap seeks to reach is one of a financial system that integrates sustainability considerations into its operations, including the full costing of positive and negative externalities that sustainability implies, leading to a reorientation of the flow of resources toward more inclusive and sustainable activities. THREE DRIVERS OF CHANGE The ongoing transition toward a sustainable financial system is taking place through the interaction of three types of initiatives: 1. Market-based initiatives. Through the development of collective initiatives such as the Sustainable Banking Network (SBN) and the United Nations Environment Programme – Finance Initiative (UNEP FI), private and public finance institutions have worked to integrate environmental and social risks and opportunities into their business lines and approaches. 2. National initiatives. The initial momentum for sustainable finance has been driven by country-level initiatives that, in many cases, arose from national planning processes to implement climate change policies or other long-term strategic development initiatives. 3. International initiatives. Cooperative efforts carried out by the G20, the G7, the UN, and the Financial Stability Board (FSB) have all addressed different aspects of sustainable and green finance while at the same time increasingly involving the private sector. This effort has been complemented by the multilateral development banks (MDBs) and other international financial institutions (IFIs) that are continuing to actively promote sustainable finance with initiatives ranging from the adoption of sustainable practices in their core financial activities to the launching of new products aimed at driving capital to sustainable and green applications. .9 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM STRUCTURE OF THE ROADMAP The Roadmap document is structured in five chapters that use the three drivers of transformation toward sustainable finance as its organizing principle (Figure ES.1). Figure E.1 Roadmap Structure Context Next Market National International and scope Steps Products, Global National public information, and coordination and policy actions technology principles Business models, National Results capabilities, roadmaps measurements and incentives Source: UN Environment/WBG Roadmap Team. MARKET-DRIVEN TRANSFORMATION Markets have led the development of sustainable finance products, information, and technological innovations. More recently financial institutions (FIs) have started turning to adapt their business models, skills, and incentives to embed sustainability into their core strategies. The process of market transformation needs to be accelerated to meet global sustainability demands. This will require enhanced coordination with national and international initiatives to facilitate the process of FIs transitioning toward sustainable finance as well as additional regulatory prodding to increase the pace of change. . 10 Products, Information, and Technology Sustainability considerations are transforming the real economy, and the financial sector is UN ENVIRONMENT – WORLD BANK GROUP evolving to respond to that reality. FIs are realigning existing products as well as creating new ones to match the risk-reward and maturity needs of sustainable investments. The expected financing needs are large: a review of the Nationally Determined Contributions (NDCs) and other policies in 21 developing countries that represent 48 percent of global greenhouse gas (GHG) emissions finds an initial investment opportunity of US$22.6 trillion from 2016 to 2030 in key sectors. Although these estimates refer to levels of investments, most of these resources are intended to flow through the financial sector as bank lending, project finance, institutional investing, or equity investing. Further growth in the supply of sustainable finance requires addressing important information gaps. Information relevant to sustainable finance will be critical to ensure the alignment of incentives, results measurement, proper valuation of assets, and effective risk management. Current efforts to move to a more advanced disclosure paradigm are uneven across asset classes and jurisdictions, but consensus is building around methodologies for the disclosure of certain types of information (such as the carbon footprint of investment portfolios). Measuring flows and stocks of green financial assets requires converging on criteria and methodologies to identify these assets in FIs and investors’ portfolios. Identifying these assets is not only critical to assessing the evolution of the financial sector towards sustainability, but also permits measuring the risk performance of, for example, green assets, and contrasts them with non-green ones. Digital finance, or innovative financial technology—fintech—has emerged as a powerful disruptor that is rapidly reshaping the real economy and the financial sector on a global scale. Digital finance has the potential to deliver environmental outcomes and support a transformation in financing for sustainable development by, for instance, mobilizing capital for critical priorities and mainstreaming social and environmental factors throughout the financial system. Ultimately, the impact of digital finance will depend on a number of policy and regulatory innovations that enable scaling and minimize its potential negative unintended consequences, such as cyber security risks. Business Models, Capabilities, and Incentives Sustainability considerations should be established as a key strategic pillar by shareholders and the senior management of FIs. Sustainable finance requires a strong commitment from owners and managers to make sustainability considerations a primary component of business strategy, not a niche area associated with other initiatives that—while also important, such as corporate social responsibility and environmental risk management— are not at the core of most FIs’ business strategies. Putting sustainability considerations front and center requires incorporating sustainability strategies into the process to allocate resources—both the firms’ own capital and intermediated resources—in support of creating new sustainable businesses lines, fostering the growth of existing ones, and moving away from activities not aligned with sustainability. The capacity of financial sector stakeholders to use sustainability information needs to be enhanced. Differences in the familiarity, understanding, and capabilities of practitioners related to sustainability factors affect the capacities of institutions to appropriately consider and act on risks and opportunities stemming from sustainability factors. Gaps in skills, inadequate institutional frameworks, and a lack of clear leadership signals can hinder efforts to respond to dynamic market conditions, changing client demand, or new regulatory requirements, potentially posing competitive disadvantages. Because skills upgrading can pose significant costs to institutions, a lack of understanding of a clear business case for engagement on sustainability issues can further compound capacity issues. Capacity issues related to sustainable finance are also a pressing challenge for public authorities, including financial supervisors, regulators, and governments. Finally, a lack of understanding of the financial dimensions of sustainability challenges—such as investments in energy efficiency— can constrain consumer demand for sustainable finance products. .11 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Ultimately, the success of efforts to effectively integrate sustainability information into financial decision making is significantly influenced by the incentives that shape practice within FIs. If information is available, and readily understood by practitioners, transformation is contingent upon the core values, culture, and policies of firms—which at their core are motivated by incentive structures. Increased sustainability disclosure in financial markets contributes to help align incentives across participants in the financial system. The cultural change needed in the transition to sustainable finance also requires an appropriate alignment incentive within FIs. This requires incorporating sustainability targets into the usual business key performance indicators to which officers in the institution are held accountable, as well as ensuring that initiatives such as internal carbon pricing are used to direct business units’ behavior. NATIONALLY DRIVEN INITIATIVES TOWARD SUSTAINABLE FINANCE The multiplicity of market failures that constitute barriers to sustainable finance require governments to kick-start, sustain, and accelerate its development through the use of fiscal resources and public policy measures. A systematic approach is necessary to select government interventions; this can be accomplished through the development of national sustainable finance roadmaps with broad support across all parts of government and the private sector. Public Finance Measures Government responses with fiscal implications can be categorized into four categories depending on the area of involvement and instruments. Figure E.2 categorizes government interventions in support of sustainable finance that imply financial outlays or revenues forsaken. This is not meant to be a full catalog of potential interventions, but a categorization that can guide the development of specific national approaches.1 The first (horizontal) dimension refers to whether or not actions are taken directly in support of the financial system or whether they seek to support the real sector of the economy or other parts of the government to facilitate their engagement with the financial sector. The second axis (vertical) categorizes them according to the mechanism used: direct financing, which includes risk sharing mechanisms; or activities in support of the “enabling environment” that would facilitate the operation of a sustainable financial system. . 12 Financial Policy and Regulation Public authorities—including governments, central banks, regulators, supervisors, and other UN ENVIRONMENT – WORLD BANK GROUP bodies—are taking legislative, policy, regulatory, and supervisory steps to achieve a range of objectives linking sustainability and the financial system, such as: ¢¢ Enhancing market practice, including efforts that mainstream environmental factors into financial decision making and correct for market failures (such as unpriced environmental externalities); 1 For a detailed description of certain types of interventions see, for example, Morgado and Lasfargues 2017. Figure E.2 Typology of Public Finance Interventions in Support of Sustainable Finance Support Area Financial Sector Real Sector Financing / Risk Sharing –– Matching grants –– Grants –– Guarantees and other risk sharing –– R&D subsidies instruments –– Tax exemptions –– Long-term credit lines –– National procurement policies –– Innovative transactions –– Direct fiscal stimulus –– Government investment guidelines(central bank, pension funds) –– Tax-advantaged provisions for Mechanism financial instruments I II III IV Enabling Environment –– Capacity building for financial –– Development, dissemination, sector stakeholders and training on disclosure rules –– Data provision and other standards related to sustainable finance –– Capacity building Source: UN Environment/WBG Roadmap Team. ¢¢ Supporting market growth, including policy frameworks and standards that promote the issuance of green financial products (that is, green bonds and securities), the development of new market platforms (that is, crowdfunding and fintech), or the competitiveness of financial centers; ¢¢ Promoting transparency and efficiency, by improving flows of sustainability information through the financial system through voluntary guidance, labeling schemes, or mandatory requirements; ¢¢ Strengthening risk management, often by integrating environmental factors (such as physical and transition-related climate risks) into the prudential oversight of FIs, supervising financial markets, and providing sector and system-level stress testing; ¢¢ Facilitating flows and services, with investment and lending to priority sectors, restrictions or limitations on financing, insurance requirements, or the provision of financial services as a way to promote inclusion and support development; ¢¢ Clarifying legal frameworks, including the fiduciary responsibilities of FIs, with respect to long-term risks and opportunities (such as climate change); and ¢¢ Enhancing conduct and behavior, with codes of conduct and guidelines for environmental issues and compacts with FIs. .13 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM National Roadmaps A growing number of countries are developing sustainable financial system policy frameworks. However, these are often not joined up or focused in a strategic way. National sustainable finance roadmaps have been launched in many countries over the past year. These identify system-wide needs, barriers to scaling up, and priority actions. Examples of these countries include Argentina, China, Indonesia, Italy, Mongolia, Morocco, Nigeria, Singapore, and South Africa. The specific mix of policy-led, market-led, and public-private initiatives in each country is a function of national development priorities and, as such, varies considerably. However, all have at their core the development of long-term, systemic plans to enhance the ability of the financial system to mainstream sustainability factors into decision making and to mobilize predominantly private capital for sustainable investment. Based on an analysis of existing national roadmaps as well as engagement with stakeholders in other countries currently undertaking this process, roadmaps for sustainable finance are more likely to enjoy broad support and increase their opportunity of success if they include key components grounded in a systematic assessment of overall needs, estimation of required financing, identification of barriers, and identification of suitable policy measures whose progress and impact can be readily measured. INTERNATIONAL COORDINATION AND SUSTAINABLE FINANCE Meaningful global action requires global principles that can guide concerted international, national, and market-driven progress toward a sustainable financial system. Achieving sustainable development is, by its own nature, a global challenge because no country can be on a long-term sustainable path alone given the interconnectedness of problems such as climate change, communicable diseases, and biodiversity loss. International collective action is therefore critical to ensuring the alignment of ongoing efforts to support the development of sustainable finance. Maximum impact can be accomplished by embedding sustainability considerations into existing financial sector principles and standards. Global Coordination and Principles Establishing general principles does not imply standardization but rather an alignment of efforts. It is important to emphasize that agreeing on certain principles is very different from . 14 trying to standardize measures to develop a sustainable financial system across countries or even across different parts of the financial sector. Certainly the needs of developed countries with deep financial markets are very different from those of developing countries UN ENVIRONMENT – WORLD BANK GROUP with substantial financially underserved populations. Similarly, efforts to develop sustainable banking in the retail segment are very different from efforts targeting large institutional investors and capital markets. The aspects to be considered in developing these principles (Box E.1) aim to follow the approach previously used in other components of the financial sector to guide and facilitate the development of initiatives and policies aligned toward a common global goal. Agreement on these principles does not imply the creation of new standards but rather the incorporation of sustainability consideration into existing ones. Box E.1 Key Considerations for Developing Principles of Sustainable Finance System-wide ¢¢ Make a statement defining the long-term objective of the financial sector in the context of sustainability. ¢¢ Agree on an approach to incorporate sustainability considerations to ensure the effectiveness, efficiency, and soundness of the global financial system. Disclosure ¢¢ Establish approaches and methodologies to disclose the sustainability impact, opportunities, and risks arising from financial sector activities as well as the sustainability risks affecting the financial sector. ¢¢ Consider including sustainability information from the financial sector into the policy-making process to ensure that both the financial sector and the other relevant sectors (for example, environment, education, and so on) are directed toward sustainability objectives. Business practices ¢¢ Price sustainability impacts, risks, and opportunities and incorporate them into financial institutions’ strategies, governance, and business decision-making processes. ¢¢ Develop transition plans toward sustainable finance, with financial institutions identifying activities to be increased as well as business lines that need to be reoriented toward sustainability. Financial instruments ¢¢ Agree on criteria to identify financial instruments and specific transactions aligned with sustainability objectives. ¢¢ Define mechanisms to promote innovative financial mechanisms, including through active regulatory encouragement, to increase the depth of sustainable financial markets. Collaboration and alignment of efforts ¢¢ Develop mechanisms to promote and allow collaboration and sharing of information between financial sector participants on approaches, methodologies, and business practices for sustainable finance. ¢¢ Seek alignment of international and national policies, standards, and results measurement to ensure consistent global approaches that fit national needs .15 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Results Measurement To deliver the required transformation in the financial system, a performance framework is needed so progress can be measured. This framework would allow governments, IFs, and citizens to identify successful approaches, as well as areas lagging behind, thereby laying the basis for strategic adjustments in both policy and practice. Over the past five years, increasing efforts have been placed on how to measure the contribution of the financial system to sustainable development, specifically in the environmental dimension. Measuring progress to a sustainable financial system involves gaining an understanding of three core performance characteristics: 1. Effectiveness. The degree to which the market prices sustainability factors in asset valuations 2. Efficiency. The costs of running the financial system that delivers the flows of finance aligned with sustainable development requirements 3. Resilience. The strength of the financial system in the face of disruptions related to unsustainable development such as air pollution, climate change, or water scarcity Understanding performance against these characteristics requires a focus on three key dimensions: 1. Architecture. This covers the principles, norms, standards, rules, regulations, and policies that directly or indirectly contribute to the sustainable development of finance. Metrics are needed that measure the degree to which the “rules of the game” are aligned with sustainable development needs. 2. Markets. This covers the behavior of market participants and the degree to which they are integrating environmental, social, and governance factors into their activities and the transparency with which they describe their sustainability efforts. 3. Flows and stocks. This covers the allocation of capital and financial services to both sustainable and unsustainable assets. . 16 NEXT STEPS Maintaining the momentum of the ongoing transition toward sustainable finance requires UN ENVIRONMENT – WORLD BANK GROUP concrete actions to support the implementation of many of the measures described in each one of the chapters. This process is anchored in a continuing consultation process over the next 24 months combined with a series of actions that will benefit from that process, leverage ongoing initiatives, and support the design and implementation of new ones. Some of these initiatives will be coordinated by UN Environment and the World Bank Group, while in some other cases, part of the consultation process aims to identify the international, regional, and national institutions that may be better placed to lead each activity. Table E.1 summarizes the vision of the outcomes associated with each one of the areas discussed in the Roadmap along with an outline of proposed next steps to achieve those outcomes and their expected timing. Short-term initiatives are expected to be completed by the end of 2018. Medium-term initiatives will be completed within the next 24 to 36 months. Table E.1 Summary of Next Steps and Timing Area Short-term initiatives Medium-term initiatives Products, • Leverage existing partnerships to • Design and execute a set of key information, develop and implement methodologies transformational transactions that can and to identify green assets. trigger new sustainable finance products. technology • Support embedding market-relevant • Establish “challenge prizes” or other sustainability information into the types of innovation funds to stimulate financial data ecosystem. the development of new products and • Support additional research into the technologies in support of sustainable risk performance of green assets. finance. • Support the implementation of the TCFD recommendations in a pilot group of countries. • Establish a cooperative platform and/or industry task force of leading fintech companies, working with others to influence enabling business, policies, and standards to effectively connect fintech and sustainable development. Business • Leverage existing market-led initiatives— models, such as the Sustainable Banking capabilities, Network—or create new ones, to expand and the skills of FIs necessary to embed incentives sustainability considerations overall strategy and into day-to-day operations. • Develop a framework to align institutional incentives within FIs to sustainability considerations, including developing an understanding of the needs of financial sector users. National • Review and classify different types • Incorporate sustainability considerations public policy of fiscal and policy interventions into national fiscal frameworks, including actions to create a framework to diagnose a review of the effectiveness of fiscal market failures and identify responses interventions and subsidies in support at the national level. of green activities and expenditures in unsustainable activities, including fossil fuel subsidies. National • Support the development of national roadmaps roadmaps in key countries. Global • Launch a consultation process to • Promote the inclusion of sustainability coordination converge in the next 24 months in a considerations into global financial sector principles set of global principles for sustainable oversight and cooperation frameworks. finance. Results • Develop a results measurement measurement framework for sustainable finance. • Promote the inclusion of sustainability data as part of global financial reporting frameworks (for example, central bank reporting to the IMF). Note: FIs = financial institutions; IMF = International Monetary Fund; TCFD = Task Force on Climate- related Financial Disclosures. .17 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM UN ENVIRONMENT – WORLD BANK GROUP 1 CONTEXT AND SCOPE OF THE ROADMAP Organizing Framework Roadmap’s Vision A financial system that integrates • Background and objective sustainability considerations into its • Context operations, including incorporating costs • Scope  and benefits of externalities to reorient the • Organization of the document flow of resources toward more inclusive and sustainable activities. 1.1 BACKGROUND AND OBJECTIVE OF THE ROADMAP Historically the financial system has responded to the needs of the time. From the development of industrialization and international trade starting in late 18th century Britain, to the massive industrial and infrastructure growth in East Asia in the last 50 years, the financial system has been fundamental to facilitating the structural transformation of economies. Today's society needs the financial system to help move the global economy toward sustainable development. A global consensus has arisen that sustainable growth will be one of the greatest challenges of the 21st century, as demonstrated by the United Nations Sustainable Development Goals (SDGs) adopted as part of its 2030 Agenda for Sustainable Development, along with the measures to combat climate change and adapt to its effects that are part of the Paris Agreement. As in previous structural transformations, the financial system needs to play a major role in this process: the full potential of the financial system needs to be harnessed to serve as an engine in the global economy’s transition toward sustainable development. The financial system is already transitioning to create, value, and transact financial assets in ways that shape real wealth to serve the long-term needs of an inclusive and more sustainable economy (UN Environment Inquiry 2015, 2016a). Shifting to a sustainable financial system does not imply a change of the traditional functions of the financial sector. Rather, these functions can be realigned toward sustainable goals to ensure the growth of a more inclusive and sound financial sector, one that intermediates resources, enables payments, and facilitates risk management with increased efficiency and effectiveness. Developments in sustainable financial markets are taking place very rapidly. The complexity of challenges such as achieving the SDGs and addressing climate change requires aligning disparate initiatives to maximize the effectiveness and efficiency of these measures and to accelerate further this transformation. Until a few years ago, sustainable finance in its many forms—climate and green finance being probably its most discussed area—was an area of .19 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM interest mainly to a subset of practitioners in the financial sector. Today, sustainability is regarded as a fundamental component of the financial sector, essential to its soundness and effectiveness in fulfilling its intermediation role and contributing to a more inclusive world by providing broader access to financial services. The objective of this Roadmap is to propose an integrated approach that can be used by all financial sector stakeholders—both public and private—to accelerate the transformation toward a sustainable financial system. This approach can bring policy cohesiveness across ministries, central banks, financial regulators, and private financial sector participants to focus efforts. This approach should also contribute to a broader cultural change, which would be evident in: ¢¢ For financial sector stakeholders. Understanding sustainability issues as an integral part of their business and an essential component to ensure the integrity, long- term growth, and soundness of financial markets, not a niche matter circumscribed to a smaller subset of investors and practitioners such as the impact investment community. This broader understanding will require embedding sustainability principles both in global regulatory and oversight frameworks, including the standards and principles that bodies such as the Financial Stability Board (FSB) oversee, and in other market-driven principles such as the UN-supported Principles for Responsible Investment (PRI) and the Green Bond Principles. ¢¢ For sustainability stakeholders. Seeing the financial sector, not just certain parts of it (such as national and multilateral development institutions and other specialized institutions), as a critical element in building a new sustainable economy. The ultimate vision that the Roadmap seeks to reach is a financial system that integrates sustainability considerations into its operations, including the full costing of positive and negative externalities that sustainability implies, leading to a reorientation of the flow of resources toward more inclusive and sustainable activities. The Roadmap seeks to provide a framework that can support the development of the broader agenda of sustainable finance. Sustainable finance, at a broad level, includes “green” finance,2 as well as finance for education, social development, health, and other aspects of sustainable development as defined by the 2030 Agenda and the SDGs. However, this document primarily focuses on climate and environment sustainability factors as they relate to finance—that is, green . 20 finance. For most countries, focusing on green finance can generate important lessons that can be expanded to cover other areas of sustainable finance. To facilitate this process, this first chapter discusses the characteristics of a sustainable financial system at large and then UN ENVIRONMENT – WORLD BANK GROUP puts green finance in the context of other types of sustainable financing. 1.2 CONTEXT: CHARACTERISTICS OF A SUSTAINABLE FINANCIAL SYSTEM Building on the work carried out by the UN Environment Inquiry (UN Environment Inquiry 2015, 2016a), this transition can be defined in terms of eight characteristics: 2 The G20 Green Finance Study Group defines green finance as the “financing of investments that provide environmental benefits in the broader context of environmentally sustainable development” (G20 Green Finance Group 2016). ¢¢ From a government and regulatory perspective: –– Policy alignment. Ensuring that the international, national, regional, and subnational financial regulators are aligned with long-term sustainable policy goals –– Financial stability. Ensuring financial system resilience in the face of environmental and climate-related pressures and other sustainability risks –– Public finance effectiveness. Ensuring the effective use of scarce public finance to catalyze sustainable finance ¢¢ From a private financial markets perspective: –– Principles, cultures, and beliefs aligned to sustainability. Ensuring that the financial system is sensitized, responsive to, and rewarded for environmental stewardship and sustainability considerations –– Market integrity. Ensuring effective transparency and accountability to underpin financial sector behavior with regard to its impact on sustainability –– Innovation and dynamism. Ensuring that innovative financing instruments and business models are aligned to the financial system’s purpose –– Long-term horizon. Ensuring that financing decisions take into account longer-term risks and opportunities associated with the environment and sustainability –– New information and capabilities. Ensuring the effective flow and use of market-relevant sustainability information 1.3 TRANSITIONING TOWARD SUSTAINABLE FINANCE Moving successfully toward a sustainable financial system requires changing course from business-as-usual practices and avoiding transition pitfalls. Achieving a financial system exhibiting the characteristics mentioned above implies a transition process with risks along the way. Table 1.1 describes the transition process needed to achieve each one of these characteristics. Table 1.1 Transitioning toward Sustainable Finance Characteristic Business-as-usual Transition risks New sustainable model Policy • The sustainability • In response to the drive • The role of the financial alignment agenda is primarily toward sustainability, sector is an integral part driven by ministries of multiple policies arising of the development environment, health, from different parts and execution of and education. of the financial sector sustainability policies. • Financial sector may be developed with • Incorporating authorities are not limited coordination and sustainability involved in developing within policy silos. considerations and executing and the risks and sustainability policies. opportunities that they entail becomes part of the financial sector culture, business, and regulation. .21 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Table 1.1 Transitioning toward Sustainable Finance (continued) Characteristic Business-as-usual Transition risks New sustainable model Financial • In the best of cases, • Increased risk-aversion • Both short- and long- stability only short-term may occur as the term sustainability environmental and broader long-term risks are measured, social risks associated sustainability risks priced, and managed with specific projects begin to be considered, with respect to specific are considered as measured, and financial transactions having an impact on managed. and systemically. sector stability. Public finance • Interventions are • Momentum may be • Integrated interventions effectiveness ad-hoc, with limited lost behind innovative are focused on measurement of costs/ approaches as a removing barriers to benefits and scale-up result of increased sustainable finance. viability. selectiveness of interventions. Principles, • Sustainability • As the understanding • Incentives across all cultures, and considerations are of the concept behind stakeholders of the beliefs aligned absent or limited to sustainability increases, financial system will be to sustainability niche subsectors in the stakeholders may focus aligned toward long- financial system. excessively on risks, not term sustainability. opportunities. Market integrity • Sustainability impact • Multiple disclosure • Disclosure standards is not disclosed and/or initiatives lacking are implemented and integrated into prices. common standards may incorporated as part • Disclosure initiatives are damage the credibility of standard financial undertaken on certain of emerging initiatives. markets’ integrity segments only. practices. Innovation and • Financial innovation is • At times of change and • Financial technology dynamism limited and focused on experimentation, many (fintech) and other sustainability. initiatives are bound to mechanisms of financial fail before successful innovation redefine ones are identified, the relationship tested, and rolled out. among financial sector stakeholders with a focus on sustainable finance. Time horizon • Focus is on short-term • Inherent uncertainty of • Standards to measure sustainability risks. long-term sustainability and manage long-term risks may discourage sustainability risks risk-taking. and opportunities are adopted. . 22 New • Know-how on • Disjointed efforts to • Common information information and sustainability and develop sustainability metrics are used capabilities its implication for information and broadly across the the operation of the capabilities lead to a financial system and UN ENVIRONMENT – WORLD BANK GROUP financial system is mismatch of practices stakeholders have limited within the across the financial the know-how to financial sector. system. incorporate such Limited market- information into day- relevant sustainability to-day operations and information is integrated long-term strategy into the financial system. formulation. 1.4 THREE DRIVERS OF CHANGE The ongoing transition toward a sustainable financial system is taking place through the interaction of three types of initiatives: 1. Market-based initiatives. Through the development of collective initiatives such as the Sustainable Banking Network (SBN) and the United Nations Environment Programme – Finance Initiative (UNEP FI), private and public finance institutions (FIs) have worked to integrate environmental and social risks and opportunities into their business lines and approaches. 3 Through these initiatives, market participants are building on frameworks initially developed for certain types of institutional investments and risk management—such as, respectively, the PRI and the Equator Principles— and are increasing their environmental risk assessment capabilities, allocating funds to specific green lending and asset classes, and making commitments to decarbonize their portfolios. 2. National initiatives. The initial momentum for sustainable finance has been driven by country-level initiatives that, in many cases, arose from national planning processes to implement climate change policies or other long-term strategic development initiatives. National policy makers and regulators, in coordination with their private sectors, are increasing their support and promoting efforts in sustainable finance, with many introducing measures to promote capital reallocation, improve risk management, and enhance reporting. About two dozen countries are already implementing national roadmaps for sustainable finance. 3. International initiatives. Cooperative efforts carried out by the G20, the G7, the UN, and the FSB have all addressed different aspects of sustainable and green finance while at the same time increasingly involving the private sector. This effort has been complemented by the multilateral development banks (MDBs) and other international financial institutions (IFIs) that are continuing to actively promote sustainable finance with initiatives ranging from the adoption of sustainable practices in their core financial activities to the launching of new products aimed at driving capital to sustainable and green applications. 1.4.1 Examples of Interaction among These Types of Initiatives The creation and growth of green bond markets and the development of approaches to disclose climate-related financial information are examples of how national, international, and market-driven initiatives interplay. Green bonds were created in response to demand from institutional investors and led to the initial involvement of IFIs—the World Bank and the European Investment Bank in particular—in the pioneering transactions that triggered the development of these instruments. As market demand grew, international standards were developed and other financial infrastructure players (rating agencies, verifiers, and so on) further contributed to this asset class growth. A new step change in the market is taking place through the development of national standards (for example, China) that has led to a 3 In this document, FI refers to a variety of financial institutions such as universal banks, investment banks, private equity funds, venture capital funds, microfinance institutions, and leasing and insurance companies, among others. .23 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM substantial increase in issuance. Similarly, a bottom-up approach—starting with country-level market and regulatory initiatives and later strengthened through international cooperative arrangements—has contributed to the development of guidelines for incorporating climate risks into the calculation and disclosure of financial information (TCFD 2017a). 1.5 ROADMAP: DEFINITIONS, SCOPE, AND STRUCTURE For purposes of the approach proposed in this Roadmap, the definition of sustainable finance will be broad enough to capture the different approaches being used around the world (Box 1.1). Appendix A presents a discussion of the approach used to converge on this working definition and facilitates its understanding by discussing other related concepts. This definition refers to the “system” at large, which is composed of all the stakeholders involved in sustainable finance—including government agencies, public and private sector financial entities, and users (that is, savers and borrowers). As the process of consultation on these proposed principles moves forward, this definition will be refined to reflect the views gathered in this process. Box 1.1 Sustainable Financial System: A Working Definition A sustainable financial system is stable and creates, values, and transacts financial assets in ways that shape real wealth to serve the long-term needs of a sustainable and inclusive economy along all dimensions relevant to achieving those needs, including economic, social, and environmental issues; sustainable employment; education; retirement financing; technological innovation; resilient infrastructure construction; and climate change mitigation and adaptation. 1.6 STRUCTURE The Roadmap document is structured in five chapters that use the three drivers of transformation toward sustainable finance as its organizing principle (Figure 1.1). . 24 UN ENVIRONMENT – WORLD BANK GROUP Figure 1.1 Roadmap Structure Context Next Market National International and scope Steps Products, Global National public information, and coordination and policy actions technology principles Business models, National Results capabilities, roadmaps measurements and incentives Source: UN Environment/WBG Roadmap Team. .25 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM UN ENVIRONMENT – WORLD BANK GROUP 2 MARKET-DRIVEN TRANSFORMATION Organizing Framework Conclusions The process of market transformation • Markets have led the development of needs to be accelerated to meet global sustainable finance products, information, sustainability demands. This will require and technological innovations. enhanced coordination with national and • Financial institutions are now turning to  international initiatives to lower costs to adapt their business models, skills, and financial institutions transitioning toward incentives to embed sustainability into sustainable finance as well as additional their core strategy. regulatory prodding to increase the pace of change. 2.1 MARKETS HAVE LED THE INITIAL TRANSFORMATION TOWARD SUSTAINABLE FINANCE The initial stage of transformation toward sustainable finance has been driven by a virtuous cycle of financial innovation that has facilitated the allocation of capital to real sector activities aligned with sustainability considerations (Figure 2.1). For example, institutional investors and international financial institutions (IFIs) were instrumental in creating green bond markets. The real sector’s increased demand for sustainable finance led to a substantial growth in the depth of green bond markets. As this chapter notes, a similar path is bein+g followed in the development of other financial instruments, but it will require continued financial innovation by market participants accompanied by an increased availability of market-relevant information, new approaches to leverage emerging financial technology (fintech), new business models, and upgrades to the financial sector infrastructure and skills. 2.2 PRODUCTS, INFORMATION, AND TECHNOLOGY 2.2.1 Financial Products Sustainability considerations are transforming the real economy and the financial sector is evolving to respond to that reality. These changes are affecting the financial structure and the financing needs of entire industries, from gas and oil to transportation. For example, the growth of renewable energy and energy efficiency projects are shifting investments toward higher capital expenditures and relatively lower operating expenditures than those needed in traditional energy projects. Financial institutions (FIs) are responding to the new financing needs arising from these changes. In 2016, the International Finance Corporation (IFC) conducted a survey with its FI clients in emerging markets to understand their strategy .27 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Figure 2.1 The Virtuous Cycle of Market-Driven Sustainable Finance Financial sector innovation ¢¢ Institutional investors ¢¢ Green bonds and green project finance ¢¢ Banks, credit unions, and insurance companies ¢¢ “Greening” of existing products (for example, mortgages, car insurance) Real sector financing demands ¢¢ Capital-intensive sustainable projects, including renewable energy and mass transport increasingly developed as public-private partnerships requiring market finance ¢¢ Growth of energy service companies (ESCOs) requiring financing for energy efficiency projects with longer-term payout periods Source: UN Environment/WBG Roadmap Team. and approach to climate risks and opportunities. Over 60 percent of the 135 respondent FIs are already active in financing climate-related and green projects. In addition, another 9 percent of institutions expressed interest in pursuing investment opportunities in this space (IFC 2016a). Renewable energy and energy efficiency topped the list, with 61 percent and 54 percent respectively (Figure 2.2). Figure 2.2 IFC Survey among Clients: Percentage Active in Climate/Green Finance Renewable energy (solar, wind, hydro, etc.) Energy e ciency (cogeneration, smart grid, etc.) Waste (recycling, waste management, etc.) Transport (urban rail/metro, electric, hybrid, etc.) . 28 Green products and materials Green buildings UN ENVIRONMENT – WORLD BANK GROUP Water (water e ciency, wastewater treatment, etc.) Adaptation (conservation, bio-system adaptation, etc.) Environment protection (pollution control, prevention and treatment, etc.) 0% 10% 20% 30% 40% 50% 60% 70% Source: UN Environment/WBG Roadmap Team. For FIs, the size of the sustainable finance business will continue to grow. In part because the definition of sustainable or green financing is still evolving, there is not yet a global, systematic estimate of the size of this market. However, some specific estimates do exist for regions and/ or sectors. A review of the Nationally Determined Contributions (NDCs)4 and other policies in 21 developing countries that represent 48 percent of global greenhouse gas (GHG) emissions finds an initial investment opportunity of US$22.6 trillion from 2016 to 2030 in key sectors. A significant portion of this estimate is for green buildings, and this is probably an underestimate— there are large data gaps for important sectors such as climate-smart agriculture and transportation (IFC 2016b). In specific sectors, such as renewable energy, US$7.4 trillion of global investments are expected through 2040 (BNEF 2017). Although these estimates refer to levels of investments, most of these resources are intended to flow through the financial sector as bank lending, project finance, institutional investing, or equity investing. For the insurance industry, the increase in climate-related perils has increased the protection gap to US$100 billion per year according to ClimateWise, a network of 30 large global insurers (ClimateWise 2016). Banks are realigning existing products as well as creating new ones to match the risk-reward and maturity needs of sustainable investments. In many cases, realigning business activities toward sustainable sectors can be achieved with existing products adapted to the specific needs of new sustainable markets and, to ensure broad acceptability, with an accompanying set of standards that can facilitate origination processes. For example, in 2016 the European Mortgage Federation, along with the European Covered Bond Council, launched a mortgage financing initiative to support energy efficiency improvements in buildings by creating a standardized approach and market benchmark. This initiative will develop a standardized European instrument that takes into consideration the positive impact that retrofitting for energy efficiency has on buildings’ value, thus increasing the underlying value of the collateral. It also provides the potential for lower default rates for this type of mortgage as a result of the decrease in energy costs.5 Similarly, sustainable finance energy products are built on traditional project finance for renewable energy projects, and on corporate or small and medium enterprise (SME) finance for energy efficiency equipment and retrofitting. In the case of retail finance, FIs are offering consumer loans to finance efficient electrical appliances and heating/cooling systems as well as to retrofit housing for increased energy efficiency—a critical development because about 20 percent of global energy consumption goes to residential and business buildings’ heating, lighting, and appliances (EIA 2016). In capital markets, the development of green bonds is addressing the need for longer-term financing that is generally required by sustainable projects. Green bonds are now being used to raise funds across multiple sectors (Figure 2.3). The European Investment Bank was the first issuer of a climate awareness bond in 2007, followed by the World Bank’s first labeled green bond in 2008. Since then a market for bonds designated as “green” has emerged. This market was initially dominated by multilateral development banks (MDBs), but has grown significantly since then and now includes a much broader universe of issuers. In 2016, green bond issuances reached US$80 billion, almost double the total issuance of 2015. Green bond issuances of financial institutions registered the highest growth, a seven-fold increase from 2014 to 2015, making up half of the corporate issuance in 2016 (Figure 2.4). 4 Nationally Determined Contributions spell out the actions countries intend to take to address climate change, in terms of both adaptation and mitigation. Further details can be found at http://unfccc.int/focus/indc_portal/items/8766.php 5 Additional details on this ongoing initiative can be found in the European Mortgage Federation and European Covered Bond Council webpage, www.hypo.org .29 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Figure 2.3 Use of Green Bond Proceeds: 2016 Issuance Agriculture and forestry Adaptation 2% 6% Waste management 6% Water 14% Energy 38% Transport 16% Building and industry 18% Source: UN Environment/WBG Roadmap Team based on Climate Bonds Initiative (2017) data. Figure 2.4 Evolution of Green Bond Market, 2007–16 . 30 Source: UN Environment/WBG Roadmap Team. UN ENVIRONMENT – WORLD BANK GROUP Despite their impressive growth in recent years, green bonds remain a small and nascent segment of the overall bond market, which currently stands at almost US$100 trillion. The momentum of demand for green bonds is expected to help drive more capital to low- carbon and climate-resilient infrastructure projects, including renewable energy projects. For investors, green bonds can achieve attractive risk-adjusted financial returns along with environmental benefits, in addition to meeting allocations for climate-aligned investment and green investment mandates without the need for time-consuming due diligence. Green bonds can also offer a hedge against carbon transition risks in a portfolio that includes emissions-intensive assets. For issuers, green bonds help diversify the investor base, attracting new intuitional investors with green or climate mandates. The bonds can also demonstrate and implement an issuer’s approach to environmental, social, and governance (ESG) issues and deliver reputational benefits, enhancing the issuer’s corporate sustainability strategy and its environmentally friendly brand. The upfront and ongoing transaction costs of the labeling and associated monitoring of a green bond, as well as the costs of reporting, verification, and tracking the use of its proceeds, can be offset through improved internal governance structures and environmental and social management systems. Insurance companies are playing a double role in the development of sustainable finance products. As institutional investors they have been crucial in fostering the demand for green bonds as well as other long-term instruments to match their liabilities. They also play a more direct role by creating products to facilitate the management of risks. For example, their role in developing and providing the analytics to price catastrophe bonds can be used to promote investments in resilience by issuers (Kahn, Casey, and Jones 2017). At the retail level, products such as index-based weather insurance can facilitate the process of adaptation to climate change. 2.2.2 Market-Relevant Information Is Essential to Increase the Supply of Sustainable Finance Further growth in the supply of sustainable finance requires addressing important information gaps. Financial markets depend on information to ensure a process of allocating resources that leads to efficient prices and effective risk management, and more generally to minimize information asymmetries that prevent markets from developing. Two elements to the concept of sustainable finance information are relevant to financial markets: ¢¢ Disclosure. This refers to the public availability of market-relevant sustainability information arising from real and financial sector entities, financial institution associations, stock markets, regulators, and other stakeholders of the financial sector. This information is also essential for investors to select portfolios aligned with sustainability criteria, for shareholders to monitor companies’ compliance with sustainable strategies, and for policy makers and society at large to measure progress toward sustainable finance objectives. ¢¢ Embedding of disclosed as well as non-public information into market-relevant information flows. There is a well-established subset of financial infrastructure entities whose role is to increase market efficiency by collecting, processing, and making available information relevant to financial sector stakeholders. These include credit rating agencies, credit bureaus, credit registries, research houses, property and other collateral registries, and financial data providers. This information is essential for FIs to develop and appropriately price financial products and to manage risks, and for other market participants and regulators to assess FIs’ performance with respect to strategic objectives and legal and regulatory requirements related to sustainability considerations. .31 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM 2.2.3 Disclosure Diverse approaches and evolving toolkits. Current efforts to move to a more advanced disclosure paradigm are uneven across asset classes and jurisdictions, but consensus is building around methodologies for the disclosure of certain types of information (such as the carbon footprint of investment portfolios). Emerging approaches can be grouped into five categories: 1. Process. Information relating to the operational processing of sustainability factors, such as ESG integration into investment disclosure and the overall mix of products aligned with sustainability considerations. Key tools include disclosure of investment policies. 2. Performance. Information relating to the performance of financial portfolios with respect to different green indicators or policy objectives (for example, decarbonization). Key tools include benchmarking against indices and exposure assessment (for example, exposure to fossil fuel holdings). 3. Impact. Information relating to positive impact achieved on sustainability objectives within the real economy, such as pollution abated or green jobs created. Key tools involve life-cycle assessment, monitoring, and evaluation. 4. Scenario/strategic alignment. Information relating to alignment with a low-carbon future, specifically examining exposure and performance of an institutional portfolio over a two-degree future scenario for the economy. Key tools involve scenario analysis and the use of asset-level data. 5. Identification. Information relating to the environmental characteristics of all financial assets. Key tools involve the tagging of green assets or the use of established data registries. Linking across levels. Consistency in information is needed across multiple levels in the financial system to enable effective decision making (Figure 2.5). As risk assessment becomes more sophisticated, financial institutions and third-party service providers are being challenged with a range of issues in their efforts to translate financial risks to individual . 32 assets to the institutional level. Alignment across sources of data, classifications, analytical methodologies, and scenarios will be necessary to enable each successive level of analysis to be useful for corporations, FIs, and regulators. The main elements of alignment include: UN ENVIRONMENT – WORLD BANK GROUP ¢¢ Asset/project. The specific climate challenges facing a new project or investment; ¢¢ Corporate entities. The implications for a specific firm as requested by a growing number of investors; ¢¢ Corporate sectors. Enabling a comparative view across companies in the same sector; ¢¢ Investment portfolios. Providing the basis for a cross-sectoral analysis at the portfolio level; ¢¢ Financial institutions. Portfolio implications aggregated across an entire financial institution; ¢¢ Financial sector. For supervisors, the overall implications for the insurance sector; ¢¢ Financial system. Exploring potential for firm-level disruptions to spiral into system- level impacts on financial stability; and ¢¢ Macroeconomy. Finally, the potential for financial system disruption to impact macroeconomic factors such as growth, prices, fiscal and trade balances, social inequality, and environmental health. Figure 2.5 Linking Disclosure Levels Source: UN Environment Inquiry 2017. Sustainability information is being integrated into accounting standards and other mechanisms that are essential to ensure markets’ integrity. This can involve reporting not only on the impact on sustainability of a firm’s operations (for example, in terms of GHG emissions), but also on the levels of revenue that are associated with green businesses, an effort in which the Sustainability Accounting Standards Board (SASB) is involved in the context of facilitating the identification of firms that could be considered as eligible for ESG investors. The guidance from the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) is providing further impetus to both the real sector and FIs to develop a coherent and consistent approach to incorporate climate-related risks into their decision-making process (TCFD 2017a). Stock markets and institutional investors have played a key role in encouraging disclosure in the real sector. Stock exchanges are important in encouraging improved environmental disclosure by corporations, including through listing requirements. Momentum is increasing— the Sustainable Stock Exchanges (SSE) Initiative now includes over 60 stock exchanges, representing more than 70 percent of listed equity markets and some 30,000 companies with a market capitalization of over US$55 trillion. Notable frameworks released within the last year include: .33 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM ¢¢ The Singapore Exchange launched “comply or explain” reporting rules covering environmental policies and performance in June 2016, covering all listed companies by 2018. ¢¢ In February 2017, the London Stock Exchange Group (LSEG) released ESG guidance incorporating recommendations of the TCFD.6 ¢¢ Following from the release of its first green bond in 2014 (JSE 2014), the Johannesburg Stock Exchange is developing green bond listing requirements in line with international best practice. ¢¢ In China, different public and private bodies have launched seven green bond indices since mid-2016 to complement the 19 existing green equity indices (UN Environment Inquiry 2017c). ¢¢ In Italy, Borsa Italiana has looked to build markets for securities beyond the corporate level by releasing a framework for green and social “mini-bonds” listing in March 2017.7 Market institutions are also advancing the information agenda through partnerships and coalitions. Market institutions are working together to help enhance flows of sustainability information, including through disclosure of investment policies, portfolio allocation, and alignment with a low-carbon future. Reporting and disclosure is a key aspect of the Principles for Responsible Investment (PRI), the world’s largest coalition of institutions sharing sustainable investment priorities—which has increased by over 185 members since June 2016 and now represents 50 percent of global assets under management. Launched in 2014, the Montreal Pledge has reached more than US$10 trillion in assets under management with over 120 investors committed to measure and publicly disclose the carbon footprint of their investment portfolios on an annual basis.8 The Portfolio Decarbonization Coalition, a multistakeholder coalition of investors committed to reducing the carbon footprints of investment portfolios, releases information detailing the decarbonization approaches and strategies of its members.9 New market coalitions are looking beyond basic information on environmental performance (that is, in terms of carbon emissions) to build awareness of impacts achieved in the real economy. The Principles for Positive Impact Finance was launched in January 2017, supported by 19 global banks and investors totaling US$6.6 trillion . 34 in assets.10 UN ENVIRONMENT – WORLD BANK GROUP 6 Additional information can be found at http://www.lseg.com/resources/media-centre/press-releases/london- stock-exchange-group-launches-guidance-esg-reporting 7 Information about Borsa Italiana can be found at http://www.borsaitaliana.it/obbligazioni/greenbonds/socialbonds. en.htm 8 The Montreal Carbon Pledge is available at http://montrealpledge.org/ 9 Information about the Portfolio Decarbonization Coalition can be found at http://unepfi.org/pdc/latest-annual- report-27-investors-representing-over-600bn-in-decarbonization-commitments-detail-progress-made/ 10 Details about the Principles for Positive Impact Finance are available at http://www.unepfi.org/positive-impact/ positive-impact/ 2.2.4 Embedding Sustainability Information into the Financial Sector Information relevant to sustainable finance will be critical to ensure the alignment of incentives, results measurement, proper valuation of assets, and effective risk management. Information asymmetry is in fact one of the main obstacles to developing a sustainable financial system. A broad set of sustainability data providers arose in response to ESG investors’ needs. These data providers include both the large international ratings agencies and specialized firms providing ESG ratings, indices, and other specific reporting such as governance and proxy voting reporting (Novethic 2013). ¢¢ ESG ratings. Rating agencies assign a score or rating to companies based on different types of criteria that may include exposure to ESG risks and their ability to manage them (for example, MSCI ESG ratings) and their ability to incorporate ESG considerations into business opportunities and other financially material issues (for example, RobecoSAM Corporate Sustainability Assessment). ¢¢ Inclusion of ESG factors into credit ratings. More recently, with support from the PRI and the UN Environment Inquiry, leading rating agencies have started to incorporate ESG considerations into the development of their credit ratings. This arises from the recognition that ESG risks are material and directly affect the long-term viability of firms. Nine rating agencies are signatories of the Statement on ESG in Credit Ratings and are undertaking a consultation process, to be finalized in 2018, to adapt their rating methodologies to include ESG parameters.11 ¢¢ Financial data providers. A broad set of financial data providers aggregate information such as ratings, financial statements, material news, and other relevant market data; these data providers have developed ESG modules. For example, Bloomberg, one of the largest data providers, collects ESG data on more than 10,000 publicly listed companies. ¢¢ ESG indices. Indices, many of them developed by rating providers, select companies based on ESG criteria and can be used to select investments and compare the performance of ESG portfolios using the index as benchmark. A broad range of ESG indices can select for criteria as specific as low-carbon footprint, fossil fuels– free status, and gender equality in addition to those using broader criteria with parameters for each one of three ESG pillars. More recently, regional indices have been developed. These include an ongoing initiative between S&P Dow Jones Indices, IFC, RobecoSAM, and the Stock Exchanges of the Mercado Integrado Latinamericano (MILA) to develop an ESG index covering public companies in Chile, Colombia, Mexico, and Peru. Mainstreaming sustainability across the financial data ecosystem is needed. At a higher level, recognition is building of the need to mainstream sustainability consideration across the existing ecosystem of information infrastructure within the financial system— including data sources and methodologies used by institutions to evaluate risk profiles 11 For additional details on this initiative, see https://www.unpri.org/press-releases/credit-ratings-agencies-embrace- more-systematic-consideration-of-esg .35 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM of real economy investments and financial assets. Critical here is the role of credit rating agencies (CRAs), some of which have begun to integrate ESG factors into in mainstream credit risk analysis. Recent research undertaken by the PRI has confirmed progress within several leading agencies (such as S&P and Moody’s), but identifies major differences in consideration of the materiality of ESG factors across different CRAs, and asymmetries between CRAs and investors (Beeching, Nuzzo, and Adams 2017). Beyond rating agencies, there are multiple other sources of information where sustainability factors have not yet been extracted—including credit bureaus, credit registries, and property registries. For example, including information regarding compliance with energy efficiency standards in property registries can facilitate the tagging of mortgages and potentially lead to lower financing costs for green investments. Investments in data infrastructure for the financial sector will be critical for the green economy. There is an opportunity for significant improvement in the tracking and measurement of green finance, particularly in bank lending, by improving the way loans are tagged and by developing standards to identify green loans in each economic sector. Generating sustainability data has impact at multiple levels, as the ongoing process to develop green tagging of bank portfolios shows. IFC published a bottom-up methodology (IFC 2017) to track green finance by banks that provides a definition of green at a project level, based on the intended use of the investment in the real economy. This approach estimates the green share per project type and then aggregates flows at an industry and country level. The World Bank Group (WBG) is leading efforts to develop an approach to identify green assets within banks (Box 2.1). This process is also referred to as green finance tagging. The exercise undertaken will potentially provide multiple benefits: ¢¢ Facilitating the development of longer-term capital markets products by providing valuable information on the portfolios of green/climate-smart loans that could be packaged as asset-backed securities into green bonds. ¢¢ Contributing to measure the existing level of green finance and manage exposure to “non-green” or “brown” sectors. This effort would lead to a leap in market transparency on the flows of finance to green/climate smart assets and products.12 This is particularly important in the banking sector where no criteria equivalent to that in debt markets—such as the Green Bond Principles managed by the International Capital Market Association—exists to identify green assets. . 36 ¢¢ Facilitating the identification of the risk characteristics of these portfolios. Green tagging could provide the basis for evaluating the financial performance of green/ UN ENVIRONMENT – WORLD BANK GROUP climate-smart loans relative to their inefficient alternatives, including an appropriate level of capital charges. For example, initial evidence suggests that green assets may have lower default rates and higher valuations than other similar assets of otherwise identical risk characteristics (Principal 2017; Sahadi, Stellberg, and Quercia 2013). 12 IFC Definitions and Metrics for Climate Related Activities can be accessed at https://www.ifc.org/wps/wcm/ connect/8ea3b242-c6bb-4132-82b1-ee4bd7007567/IFC+Climate+Definitions+v3.0.pdf?MOD=AJPERES Box 2.1 Green Tagging Green tagging, or green finance tracking, is the process of identifying, tracking, and reporting the green share of a financial institution (FI)’s portfolio committed per year or accumulated in a given period. Based on the range of green percentages or shares, individual transactions can be tagged as: (a) green, (b) partially green, or (c) non- green—that is, brown. The approach leverages, whenever feasible, existing industry standard classification codes and certification and asset classification systems, such as the Energy Star rating system, green building standards, and agri-certification standards. Existing Initiatives Several new bottom-up approaches for tracking/tagging green finance are being piloted by various institutions.a With Climate Strategies, the UN Environment Inquiry has launched an initiative with 10 of the largest European banks to explore the “state of the art” in linking lending to the real estate sector with energy performance standards. The European Investment Bank has also kick-started an initiative to align taxonomies for green projects following the IFI Framework for a Harmonized Approach to Greenhouse Gas Accounting.b This includes the taxonomy developed by China to regulate the Chinese green bond market, and that developed by the Climate Bonds Initiative (CBI) for certifying green bonds.c New World Bank Group Initiative The proposed World Bank Group initiative on green tagging seeks a broader approach to ensure that bank loans are being consistently and comprehensively tagged at the appropriate levels. To track and filter green transactions, the process primarily uses existing standard industry classification (SIC) codes to identify the industry to which the borrower belongs, not necessarily the type of activity that is being financed. For transactions that could be tagged as “partially green” based on SIC codes, additional information will be required to determine the green share of activities financed by the loan. Various standards, often sector/activity-specific, already exist in a growing number of countries that attribute “greenness.” This initiative will bring these standards into a collective framework in a way that is aligned with the needs and operating practices of the financial system. The key steps proposed under this initiative are summarized in Table B2.1.1. The proposed approach will require developing an analytical framework that outlines the industry sector classification and green sectors. It will be necessary to leverage the existing initiatives, including certification schemes for agricultural commodities, small and medium enterprise loans, green building standards, and so on, and to work with external data providers. External data providers and credit bureaus could be relied on to implement this approach, and transform the existing data collected by FIs that use a paper form or that have inconsistent or missing industry classifications. .37 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Box 2.1 Green Tagging (continued) Table B2.1.1 Steps of the World Bank Group Initiative on Green Tagging Key IFIs National Private FIs Data providers milestones regulators and standard setters Short term • Analyze clients’ • Understand • Improve the • Increase demand for green market players’ application of awareness of the finance. current practice use-of-proceed need to integrate • Convene efforts of green finance classifications, green finance into at national and tracking. where already existing data sets. international levels • Understand and used, for better • Engage with to establish green articulate national identification of peers to set a finance typologies needs for green project purpose. consistent green and standards finance. • Integrate existing finance typology, consistent with • Promote ESG criteria and harmonize policy targets. transparency and into investing unique company consistency in decisions. identifiers financial data sets. and industry classifications. Medium • Implement • Develop new • Build on the • Advocate for term pilot analysis regulations for green bonds better data on comparing supply banking, bonds, experience to green activities at and demand for and institutional develop clear the company level selected countries investors. definitions/ by building green with clear policy • Build on tracking revenue share data plans. lessons learned mechanisms into corporate • Implement from peers, per financial reporting recommendations such as China’s instrument. procedures, for emerging from green banking • Integrate data example. international regulations, on green revenue • Develop new groups to put in Nigeria’s share per company services for clients place green finance sustainable into decision supplying or typologies and banking principles, making. demanding green standards. and so on. finance data. • Link bottom-up approaches on green finance with top-down research. Next Steps: Testing the Proposed Approach The approach will be piloted with a few FIs. At minimum, FIs included in the study are . 38 expected to comply with the Equator Principles.d The selection of participating FIs will ensure economic and geographic diversity with at least one developed market and one developing market institution included, with a view that these institutions are planning UN ENVIRONMENT – WORLD BANK GROUP to issue a green bond in the short to medium term. Note: a. Tracking Green Finance in the Banking Sector in IFC (2017), https://www.ifc.org/wps/wcm/ connect/48d24e3b-2e37-4539-8a5e-a8b4d6e6acac/IFC_Green+Finance+-+A+Bottom-up+Approach+to+Track +Existing+Flows+2017.pdf?MOD=AJPERES b. See the International Financial Institution Framework for a Harmonized Approach to Greenhouse Gas Accounting, November 2012, http://www.ifc.org/wps/wcm/connect/518623004dc5f53c8e36aeab7d7326c0/ IFI+Harmonisation+Framwwork+for++GHG+Accounting_Nov+2012.pdf?MOD=AJPERES c. CBI is working to estimate sectors emissions thresholds that are compatible with low emission pathways. d. For more information on the Equator Principles, please visit http://www.equator-principles.com/ 2.2.5 Technology Digital finance, or innovative financial technology—fintech—has emerged as a powerful disruptor that is rapidly reshaping the real economy and the financial sector on a global scale. By changing the way people pay, lend, and invest, digital finance could substantially change financial sector architecture and policies. Furthermore, it has the potential to advance sustainable finance and transform the future of the financial system, and to align it with policy goals such as those embodied in the 2030 Agenda for Sustainable Development and the Paris Agreement on climate change. Broadly defined, digital finance is the evolving process by which technologically enabled financial innovation results in new business models, applications, processes, and products with an associated material effect on financial markets and institutions and on the provision of financial services (Bank of England 2017). These innovations include, for instance, digital payment solutions, e-commerce, crowd lending and aggregation platforms, equity crowdfunding, Internet-based services in the insurance industry, roboadvisors and gamification in the investment space, and peer-to-peer lending (GreenInvest 2017). Moreover, digital finance is part of a wider digital ecosystem that includes artificial intelligence, big data, cryptocurrencies, the Internet of Things, and a wide range of nonfinancial applications of blockchain technology. Digital finance has the potential to deliver environmental outcomes and support a transformation in financing for sustainable development by, for instance, mobilizing capital for critical priorities and mainstreaming social and environmental factors throughout the financial system. For example, the Kenya-based M-KOPA, the Swedish start-up Trine, and the U.S.-based SolarCoin have all used a combination of crowd-sourcing, payment platforms, cryptocurrencies, and clean technology to mobilize capital and deliver distributed solar energy options to remote communities in Sub-Saharan Africa and elsewhere (GFDA 2017). Recognizing that collaboration with industry peers and key stakeholders is important, the Green Digital Finance Alliance (GDFA) was established at the World Economic Forum’s annual meeting in Davos in January 2017 by UN Environment and Ant Financial Services Group. The mission of the GDFA is to realize the potential for digital finance to help deliver environmental sustainability by deepening understanding, stimulating innovation, and facilitating collaboration (Box 2.2). However, the emergence of such transformative technologies is not without potential consequences and implications. Unintended consequences may be greater than the planned, or even the foreseen, consequences. While many digital finance entrepreneurs set out with the vision that a profitable start-up could have major social or environmental benefits, few have fully explored the negative implications it may bring. From common cyber security risks and regulatory gaps of understanding fintech development to the potential of automation and displacement of labor, the downside implications of fintech development should also be considered by policy makers and financial regulators. .39 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Box 2.2 The Green Digital Finance Alliance (GDFA) and Ant Financial Services Group The Green Digital Finance Alliance was created to address the potential for fintech- powered business innovations to reshape the financial system in ways that better align it with the needs of environmental sustainability. The GDFA’s participants comprise innovative financial institutions committed to using digital technology to advance green finance in lending, investment and insurance. The GDFA draws in allies from across the worlds of environment and finance whose expertise, insights, and networks can contribute to collaborative actions with timely and scaled potential (GDFA 2017). Ant Financial Services Group—a related company of the Alibaba Group and parent company of Alipay, and a leading online and mobile payment platform—is a member of the GDFA. It is focused on serving small and medium enterprises as well as individuals (GDFA 2017). Ant Financial is dedicated to building an open ecosystem of Internet thinking and technologies while working with other financial institutions to support the future financial needs of society. The main businesses operated by Ant Financial include Alipay, Ant Fortune, Zhima Credit, and MYbank. Ant Financial has also initiated the world’s first large-scale pilot aimed at greening citizens’ consumption behavior through the use of mobile payment platforms, big data, and social media. The Ant Forest app encourages users to reduce their carbon footprint through a three-part approach: providing individualized carbon savings data to people’s smartphones, connecting their virtual identify and status to their earnings of “green energy” for reduced carbon emissions, and providing carbon offset rewards through a physical tree planting program. As of January 2017, the first six months of the Ant Forest pilot has resulted in 200 million people across China joining voluntarily—about 40 percent of Ant’s user base in China—and resulted in an estimated 150,000 tons of cumulative avoided carbon emissions and over 1 million trees planted. Ant is dedicated to building up a measurable carbon account for its 450 million users, promoting the development of personal avoided carbon emissions, establishing a green and open platform, and encouraging green and low-carbon activities. Ant next steps include improving and standardizing carbon methodology; establishing an open green platform, and driving a multipurpose green financing platform that will use its . 40 big data and other capabilities to build and operationalize voluntary emission reduction methodologies, including by helping small and medium enterprises in particular to enter the carbon trading market and reward carbon reduction activities. UN ENVIRONMENT – WORLD BANK GROUP Ultimately, the impact of digital finance will depend on a number of policy and regulatory innovations that enable scaling and minimize its negative unintended consequences. Some of these interventions are not specific to particular sustainable development considerations, but are good practice in enabling fintech innovations. Policy interventions can therefore be active on both the digital finance supply-side and on the manner in which financial system development is aligned to sustainable development (UN Environment Inquiry 2016a). These steps can include: ¢¢ Ensuring that digital finance is an integral part of financial system development plans and roadmaps focused on financing sustainable development, particularly at the national level, and especially for developing countries, ¢¢ Establishing a platform of leading digital finance companies, working with others to influence the right enabling business, policies, and standards to effectively connect fintech and sustainable development, and ¢¢ Incentivizing fintech to align with sustainable development, for example by supporting venture capital and social impact funds to fund start-ups with specific sustainable development ambitions. Another alternative would be to establish a challenge fund, similar in nature to the Longitude and X-Prizes, which seek to create a global community of purpose that can pilot and create replicable solutions over time.13 2.3 BUSINESS MODELS, CAPABILITIES, AND INCENTIVES 2.3.1 Business Models Sustainability considerations should be established as a key strategic pillar by shareholders and the senior management of FIs. Sustainable finance requires a strong commitment from owners and managers to make sustainability considerations a primary component of business strategy, not a niche area associated with other initiatives that—while also important, such as corporate social responsibility and environmental risk management— are not at the core of most FIs’ business strategies. Putting sustainability considerations front and center requires incorporating sustainability strategies into the process to allocate resources—both the firms’ own capital and intermediated resources—in support of creating new sustainable businesses lines, fostering the growth of existing ones, and moving away from activities not aligned with sustainability. For example, the TCFD’s emphasis on strategic and governance considerations related to climate-related financial disclosures highlights the need to embed sustainability into the core business model of organizations. There is already substantial interest in ensuring that sustainability strategies cascade down to day-to-day decision making through metrics that align incentives. Institutions have started looking at internal carbon pricing as a key tool to aid them in the process of deciding how they allocate their resources. By incorporating such internal prices, investments in carbon- emitting businesses become less attractive. According to the CDP, 65 FIs currently disclose the use of an internal carbon price and 68 more are expected to have this in place by the end of 2018 (CDP 2016). Nearly all of these institutions are applying a price to their operational emissions (for example, building energy use, employee travel, and so on). However, with the release of the TCFD report, the move by some governments (for example, France and the Netherlands) asking financial institutions to “stress test” their investment portfolios to address climate risk, and a growing number of investors looking into climate risk, banks are beginning to explore how to apply a carbon price to their investment decisions as a way to identify and manage climate risk. 13 The Longitude Prize is a £10m prize fund that will reward a competitor that can develop a diagnostic test that will conserve antibiotics for future generations and innovate the delivery of global healthcare (additional information is available at www.longitudeprize.org). The X-Prize Foundation supports competitions to meet challenges in a broad set of areas, including education, health, and technological innovation (see www.xprize.org). .41 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Developing standards and addressing methodological issues is essential to ensure broader adoption of metrics such as carbon pricing. Although approaches to applying internal carbon prices vary in scope and methodology, many FIs are facing the same challenges in moving this forward around internal awareness-building and stakeholder management and by setting appropriate price levels, methodological challenges associated with corporate loans and equity investments, and capacity constraints. Institutional investors are also increasingly interested in ensuring the emergence of standards that could facilitate the process of the decarbonization of portfolios and the selection of investments for ESG portfolios. New business models in FIs require effective metrics to assess their alignment with sustainability considerations. Assessing the level to which the business model of an FI is moving toward sustainable finance requires a review along several dimensions. In the case of green financing, current efforts, driven primarily by nongovernmental organizations, have focused on reviewing portfolios to assess banks’ level of financing directed toward emissions incentive activities.14 This approach is partly driven by the fact that, by reviewing industry sectors in portfolios, it is easier to identify brown assets than green ones (the next section of this report reviews approaches to address this data gap). A more comprehensive approach to identify a financial institution as green would require a review along four dimensions: 1. Environmental and social (E&S) risk management. An assessment of how E&S risks standards and practices in the sector are applied in the conduct of business to assess the E&S impact of the financial institution’s activities. This would encompass a review of the internal processes to categorize and incorporate into business decision-making these risks as well as approaches to develop risk mitigation strategies, ensure their application, and measure their success. 2. Green assets. Measurement of the institution’s business intent and actual results in building and maintaining a green portfolio is needed. 3. Brown assets. Measurement of the institution’s level of business-as-usual intent and actual results in reducing, building, and maintaining brown assets is needed. Although a formal definition of brown assets does not exist, existing initiatives associate them with the financing of emission-incentive activities (for example, oil and gas). . 42 4. Internal footprint. This term refers to how the financial institution conducts its business operations to minimize its environmental footprint (for example, energy efficiency of facilities, water and paper consumption). UN ENVIRONMENT – WORLD BANK GROUP 2.3.2 Capabilities in Financial Institutions The capacity of financial sector stakeholders to use sustainability information needs to be enhanced. Differences in the familiarity, understanding, and capabilities of practitioners related to sustainability factors affect the capacities of institutions to appropriately consider 14 See, for example, the Banking on Climate Change Fossil Fuel Finance Report Card 2017 prepared by the Rainforest Action Network, Banktrack, Sierra Club, and Oil Change International at www.ran.org/banking_on_ climate_change and act on risks and opportunities stemming from sustainability factors. Gaps in skills, inadequate institutional frameworks, and a lack of clear leadership signals can hinder efforts to respond to dynamic market conditions, changing client demand, or new regulatory requirements, potentially posing competitive disadvantages. Because skills upgrading can pose significant costs to institutions, a lack of understanding of a clear business case for engagement on sustainability issues can further compound capacity issues. Capacity issues related to sustainable finance are also a pressing challenge for public authorities, including financial supervisors, regulators, and governments. Finally, a lack of understanding of the financial dimensions of sustainability challenges—such as investments in energy efficiency— can constrain consumer demand for sustainable finance products. The capabilities and skills gap among financial practitioners may be exacerbated by a number of different issues. Surveys of global financial institutions show that only a very small percentage of staff would be capable of appropriately managing sustainability information to use it in decision making either as a strategic driver of the business or, for example, to incorporate this information into regular due diligence of loans and overall risk management (IFC 2014). Some of the causes of this gap include: ¢¢ A lack of clear consensus on how to consider or evaluate risks within financial decisions (for example, standard approaches for discounting over time), ¢¢ Disagreements on the materiality of sustainability factors with long-term impacts, ¢¢ Inadequate impetus on the part of investors to build internal capacity on sustainability issues stemming from a lack of clear sustainability mandates, and ¢¢ A lack of mechanisms to catalyze skills upgrading through investment chain interaction (that is, regulations targeting buy-side stimulating a demand for specific capabilities or products from the sell-side) Industry associations are leading many of the efforts to increase sustainability capabilities within the financial sector. With new emphasis being placed on sustainable banking approaches, capacity building efforts and the provision of technical guidance have been essential to assisting banks to build internal know-how and systems. The Sustainable Banking Network (SBN)—a grouping of banking regulators and associations from 31 emerging markets focused on enabling frameworks for environmentally and socially sustainable lending, supported by IFC—is, for example, supporting training and knowledge exchange among its members. Support ranges from training and workshops to technical guidance and sector-specific guidelines and checklists. Countries that exhibit recent activities include: ¢¢ Brazil. The Brazilian Central Bank (BACEN) and IFC partnered to provide capacity building for Central Bank supervisors in order to strengthen knowledge of E&S risk management and support the implementation of the Resolution on E&S Responsibility for financial institutions. ¢¢ China. Following the launch of the Green Credit Guidelines in 2012, the China Banking Regulatory Commission (CBRC) and the China Banking Association (CBA) .43 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM have led efforts to disseminate best practices and sector-wide capacity building, including a Green Credit training book and trainings. The CBRC has also led a series of awareness raising activities among banks, as well as dialogues with multiple ministries, to channel information and technical know-how to banks to enable green lending. ¢¢ Mongolia. The Mongolian Bankers Association (MBA), representing all Mongolian banks, launched the Mongolia Sustainable Finance Principles and Sector Guidelines in December 2014, which took effect in January 2015. All participating banks have since developed internal E&S policies and procedures and have hired full-time E&S staff. The sector guidelines provide guidance to participating banks on how to assess potential E&S risks and opportunities in the agriculture, mining, manufacturing, and construction sectors, and assess the ability of clients to manage E&S issues. They also include guidance on E&S risk rating criteria for assessing and categorizing E&S risks, and encourage the adoption of relevant industry international standards and best practices. Financial industry organizations are also incorporating sustainability into their capacity building programs. The CFA Institute, the global association of investment professionals, is currently working to implement content on sustainability issues in the Level 1 CFA qualification, and is beginning to develop content at Levels 2 and 3 of the qualification exam, which address integration into valuation processes and portfolio decision making. Actions are also underway to integrate sustainability issues into the CFA Institute’s Certificate in Investment Performance Measurement (CIPM) to ensure integrity in performance measurement in addition to valuation. 2.3.3 Aligning Incentives in Financial Institutions Ultimately, the success of efforts to effectively integrate sustainability information into financial decision making is significantly influenced by the incentives that shape practice within FIs. If information is available, and readily understood by practitioners, transformation is contingent upon the core values, culture, and policies of firms—which at their core are motivated by incentive structures. Increased sustainability disclosure in financial markets contributes to help align incentives . 44 across participants in the financial system. Taking advantage of the momentum gained from the work carried out by the Financial Stability Board (FSB)’s TCFD, continued action is needed to support voluntary disclosure standards and climate risk assessments for UN ENVIRONMENT – WORLD BANK GROUP banks and FIs, helping to better manage emerging physical and transition risks. Moreover, transparency lends itself to more consistent definitions for sustainable finance and green lending, bringing clarity for more innovative financial products. Although a number of banking regulators, central banks, and banking associations have introduced such definitions tailored to national context and reflecting international experience, more work in mainstreaming transparency can still be done. This approach will ensure the alignment of incentives between customers, investors, shareholders, and governments seeking to promote sustainable developments and financial institutions. The cultural change needed in the transition to sustainable finance also requires an appropriate alignment incentive within financial institutions. Although the first driver of any cultural change is the mandate and strategy set by financial institutions’ senior management, adequate mechanisms need to be in place to ensure that an orientation toward sustainability permeates the organization. This requires incorporating sustainability targets into the usual business key performance indicators to which officers in the institution are held accountable, as well as ensuring that initiatives such as internal carbon pricing are used to direct business units’ behavior. Aligning compensation to sustainability targets is another powerful mechanism to align incentives internally. For example, the use of risk-adjusted compensation in banking can be expanded to incorporate sustainability risks and therefore ensure staff are provided with the right incentives in their business development activities. This can be expanded to other levels of the institution, not just business units, so that corporate procurement or facilities management units’ performance measurement would include green indicators. Different approaches and instruments are being used to correct for a short-term bias, but many are relatively new—with unclear and inconsistent impacts on behavior. Approaches to aligning incentives are still relatively new and include: ¢¢ Public policy action. In recent years, an increasing number of central banks, financial regulators, and policy makers have started working to align the rules governing the financial system with broader social purpose—including tackling incentive issues, but not from a sustainability perspective. ¢¢ Market leadership. Linking core business models and strategies to broader societal mandates will help address incentive issues in an inclusive manner. Lessons can be obtained from the experience of ESG institutional investors. ESG investors seek to tie compensation of their investment managers to the ESG performance of their portfolios. More importantly, investment managers may use the alignment of executive compensation to ESG considerations as screening criteria for investments. In 2012, the PRI identified the linking of executive pay to ESG performance as critical to achieving the PRI’s mission of fostering responsible investments; it recommended tying compensation to clear metrics and disclosing the rationale and approach used to incorporate such ESG metrics into executive pay. Using this framework, the PRI reviewed how ESG metrics are incorporated into executive compensation in global utility and extractive industries, a sector particularly at risk of unsustainable activities. Its analysis showed that, although more than 80 percent of the firms analyzed (84 extractive and utility companies included in major stock indices in North America, Europe, and Australia) in some manner tied ESG issues to compensation, only 28 percent did this using disclosed metrics and 37 percent had claw-back provisions (PRI 2016). 2.4 CONCLUSIONS The process of developing new products and greening existing ones in support of sustainable finance will have to be accelerated to meet the increasing needs of the global economy. Addressing information gaps will be essential to that process, with enhanced emphasis on forward-looking information. The focus of disclosure has shifted from .45 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM presenting only historic results and past performance to emphasizing the centrality of forward-looking material, which will be critical to enabling clients, investors, and other stakeholders to understand how well the institution is grappling with competing future trajectories. One striking result from the consultation undertaken by the TCFD was that “96% of respondents see scenario analysis as a key component of disclosure” (TCFD 2016, p. 8). A growing focus on the delivery of sustainability information by FIs themselves—for instance, disclosure of climate risks to investment portfolios—is broadening the base of end users beyond clients and shareholders. More and more, financial supervisors are requesting such information from firms as a way to better inform their view of safety and soundness in the face of environmental hazards and shocks. Information on environmental performance is also becoming increasingly important for consumers of financial services, who are seeking to align their savings and investments with a low-carbon future—a development exemplified by the reputational risks facing firms invested in high-carbon assets. Finally, such disclosure can be relevant for policy makers who are looking to glean insights into potential real economy implications of asset allocations, such as consequences for fiscal policy, as well as the effectiveness of energy, environmental, and economic policy. To accelerate the transformation of the financial system and the real economy toward a more environmentally friendly and sustainable path, fintech and various technological innovations will play a critical role. Regulators and financial policy makers will need to ensure that the development of fintech will continue to allow for disruption of inefficient and fossil fuel– intensive business models, products, and services, and instead offer products and services that are integrated with sustainability standards and meet consumer demand while providing platforms that help aggregate and reinforce the positive feedback loops. Additionally, to manage the potential downside risks and unintended consequences of fintech, regulators and financial policy makers need to start by engaging with innovators within the industry and begin identifying barriers to the successful scaling up of sustainability and fintech. FIs are changing the manner in which they operate to internalize sustainable finance into their business models and upgrade the sets of skills and incentives of staff to embed sustainability considerations into their culture. Although this may also require a certain level of regulatory prodding, current market-driven initiatives are moving in the right direction, and the increased transparency that enhanced information will provide will also boost the . 46 incentive for FIs to move along this path. UN ENVIRONMENT – WORLD BANK GROUP 3 NATIONALLY DRIVEN INITIATIVES TOWARD SUSTAINABLE FINANCE Organizing Framework Conclusions A systematic approach is necessary to • Market failures in sustainable financial select government interventions; this can markets require government actions. be accomplished through the development • Mechanisms of government intervention  of national sustainable finance roadmaps include fiscal and policy measures. with broad support across all parts of government and the private sector. 3.1 NATIONAL PUBLIC POLICY ACTIONS The multiplicity of market failures that constitute barriers to sustainable finance require governments to kick-start, sustain, and accelerate its development. In its seminal analysis of climate change economics, Stern (2007) referred to climate change as “the greatest and widest-ranging market failure ever seen.” To the degree that unsustainable growth paths arise from externalities, governments have a role to play in addressing market failures that prevent sustainable financial markets from developing. 3.1.1 Five Basic Types of Market Failures A full analysis of market failures associated with climate change and sustainability is beyond the scope of this Roadmap, but it is important to highlight the shape that these failures, and their associated costs, take with respect to financial markets. ¢¢ Negative externalities. This is the market failure most directly associated with climate change because the negative impact of marginal emissions is incorporated into prices. In the case of the financial system, this could lead to underpricing loans for activities contributing to climate change or could result in other impacts leading to unsustainable growth. In the case of climate change, these externalities are generally intertemporal (that is, the effects of emissions are cumulative so that the marginal negative effect will occur in the future)—unlike the negative externalities associated with pollution or some externalities associated with biodiversity destruction. ¢¢ Positive externalities. In both adaptation and mitigation activities, there is scope for substantial positive externalities. For example, agriculture projects can be structured to ensure that they also lead to carbon sequestration, thus mitigating their impact on .47 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM climate change (Sakuyama and Stringer 2006); or they can promote the management of certain crops in ways that reduce landslide risks arising from new weather patterns (Tompkins and Eakin 2012). However, the additional efforts needed to achieve these benefits are, in fact, costs that would decrease a project’s overall return on investment and that could lead to its rejection by potential financiers. ¢¢ Information asymmetries. Particularly in credit markets, information asymmetries are both the raison d’être and a source of costs for the financial sector. Although many new types of information asymmetries are found in climate financing, a key example is the lack of financing for new firms with innovative approaches to climate change mitigation, such as battery technology firms and energy service companies (ESCOs). In the case of ESCOs—firms that provide other companies with know-how and technologies to increase energy efficiency—they or their customers have difficulty accessing financing because banks do not have the expertise to analyze project proposals, firms generally lack physical assets that can be used as collateral, and there is the perception that the materialization of extra resources (that is, cash flows from energy savings) still depends on unproved technologies (Econoler 2011). ¢¢ Coordination costs. Institutional investors’ growing interest in environmental, social, and governance (ESG) approaches as a mechanism to influence real sector companies reflects an effort to overcome coordination costs, which in the past have prevented institutional investors from being involved in the management of firms (Black 1998). Additional efforts to develop disclosure standards would further facilitate this process. Similarly, coordination costs can prevent the development of long-term financing, particularly in developing countries that have weaker creditor rights. Given the long-term nature of many climate change mitigation projects, such as green energy generation, this leads to credit constraints in this sector. ¢¢ Incentive problems. Bank managers and asset fund managers tend to be judged on short-term results, a situation that further exacerbates the bias against longer-term projects related to sustainable finance.15 3.1.2 Intervention Types: Public Finance and Policy Governments can support the development of sustainable finance through the use of public . 48 finance or through policies and regulations. Though these two types of actions are not completely independent, the rest of this section divides government measures into these two categories. UN ENVIRONMENT – WORLD BANK GROUP 3.2 PUBLIC FINANCE MEASURES Government responses with fiscal implications can be categorized into four categories depending on the area of involvement and instruments. Figure 3.1 categorizes government interventions in support of sustainable finance that imply financial outlays or revenues forsaken. This is not meant to be a full catalog of potential interventions, but a categorization 15 Martinez Peria and Schmukler (2017) present a discussion and literature review of the impact of coordination costs and incentives on the availability of long-term financing. that can guide the development of specific national approaches.16 The first (horizontal) dimension refers to whether or not actions are taken directly in support of the financial system or whether they seek to support the real sector of the economy or other parts of the government to facilitate their engagement with the financial sector. The second axis (vertical) categorizes them according to the mechanism used: direct financing, which includes risk sharing mechanisms; or activities in support of the “enabling environment” that would facilitate the operation of a sustainable financial system. Figure 3.1 Typology of Public Finance Interventions in Support of Sustainable Finance Support Area Financial Sector Real Sector Financing / Risk Sharing –– Matching grants –– Grants –– Guarantees and other risk sharing –– R&D subsidies instruments –– Tax exemptions –– Long-term credit lines –– National procurement policies –– Innovative transactions –– Direct fiscal stimulus –– Government investment guidelines(central bank, pension funds) Mechanism –– Tax-advantaged provisions for financial instruments I II III IV Enabling Environment –– Capacity building for financial –– Development, dissemination, sector stakeholders and training on disclosure –– Data provision rules and other standards related to sustainable finance –– Capacity building Source: UN Environment/WBG Roadmap Team. Quadrant I: Financing and risk sharing in the financial sector. These interventions are aimed at directly addressing market failures that prevent the development of complete markets that allocate resources to sustainable finance activities. In many cases, this is done through public financial institutions that provide longer-term financing than is otherwise available in private markets; act as second-tier institutions, providing resources for on-lending to banks and specialized financial institutions (blended finance); or facilitate the leveraging of balance sheets of financial providers through the issuance of guarantees and other risk sharing mechanisms. Rather than providing direct financing, the government can also provide matching grants that are then leveraged by financing from private financial institutions (FIs). This category also includes governments’ use of their resources to facilitate innovative transactions that are meant to serve as “proof-of-concept” and trigger the development of new instruments. Governments can also foster the development of new instruments by providing tax-advantaged treatment of interest and other income received by investors when proceeds are used for eligible sustainable activities. 16 For a detailed description of certain types of interventions see, for example, Morgado and Lasfargues 2017. .49 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Quadrant II: Financing and risk sharing outside the financial sector. This category includes programs that, while not directly tied to the financial sector, indirectly facilitate recipients’ access to financing, contribute to building assets that can be used as collateral, and generally stimulate demand for green assets—thus contributing to increased financial sector involvement with producers and consumers of those assets. Examples include development grants for research and development for small and medium enterprises providing greening services such as ESCOs, tax exemptions associated with investments in green assets such as installing of household photovoltaic energy systems, and government procurement policies providing preferential treatment to suppliers committed to energy efficient practices. Quadrant III: Support to the financial sector enabling environment. Governments can also support the development of elements of the sustainable finance infrastructure that have some characteristics of public goods or that private sector stakeholders may not be willing to develop because they do not see sufficient returns on their investment. For example, governments can work jointly with national banking associations to develop training programs for commercial loan officers to review and underwrite new financial sustainable financial instruments such as green mortgages (that is, mortgages associated with energy- efficient buildings) or to structure bankable green projects. Quadrant IV: Support to the enabling environment outside the financial sector. This category of intervention is generally geared toward addressing information asymmetry problems and coordination costs not necessarily within the financial sector. For example, governments aggregate and make available information that would facilitate green project underwriting, such as weather and climate data and real estate transaction information associated with green buildings. This type of intervention also includes supporting ongoing efforts to define disclosure standards of environmental risks in the real sector, where the government could subsidize the process of developing and disseminating such standards. 3.2.1 The Role of Government Entities Selecting the appropriate government entity to execute these interventions is key to success. Governments play different roles in the financial system. Besides their role as regulator and supervisor—discussed in the next section—governments are also owners of financial institutions. This role is particularly important for Quadrant I interventions, which are carried out through existing institutions or, particularly in countries lacking an established . 50 development or policy-oriented government bank, new green banks. Governments are also institutional investors through their role as central bankers and, in some cases, as managers of pension funds or sovereign wealth funds whose actions can contribute to facilitate UN ENVIRONMENT – WORLD BANK GROUP the flow of funds toward sustainable activities. Finally—in what is probably their most obvious role—governments are service providers, and in that role they can channel much of the nonfinancial support described above. Close coordination between financial sector authorities and line ministries is essential to achieve results. For example, developing and rolling out criteria to identify green mortgages requires the close involvement of housing and construction government agencies to ensure that standards requirements are technically sound, verifiable, and aligned with global criteria. 3.2.2 The Role of International Financial Institutions in Facilitating National Public Policy Interventions International financial institutions (IFIs) also play a key role in supporting governments in deploying resources in support of sustainable finance. Governments also can rely on IFIs to support them in the design and execution of policies in support of sustainable finance, leveraging their multiple roles. IFIs can play four roles in support of these interventions: ¢¢ Facilitating the development of the enabling environment for sustainable finance. Both internationally and nationally, IFIs have played a key role in developing and strengthening elements of the financial infrastructure, including credit bureaus and registries, payment systems and remittances, and standards of financial information. Integrating sustainability considerations into financial infrastructure is essential to successfully mainstream sustainable finance. For example, the initiative on green tagging described in Box 2.1 could be the basis for identifying green assets in credit reporting; this would facilitate the development of credit ratings and efficient pricing, and ultimately would help boost an increase in the origination of this type of asset. ¢¢ Providing long-term financing bundled with technical support. IFIs are providing long-term financing, which is needed to meet the maturity required for sustainable projects. Unlike commercial lenders, IFIs can also accompany governments as providers of technical advice during the entire project cycle, from the development of requests for proposals and technical requirements to its operation and evaluation. ¢¢ Supporting innovative transactions. IFIs have been instrumental in kick-starting some of the sustainable finance markets. For example, the World Bank and a private Swedish bank, SE Banken, responded to demand from institutional investors to structure and issue one of the first green bonds in 2008. The World Bank has since continued to expand the range of financial instruments related to climate financing, including by establishing regional facilities for disaster insurance in the Caribbean and the Pacific and supporting Malaysia in issuing the first Sharia-compliant green bond in June 2017. ¢¢ Global knowledge sharing and convening. IFIs also play an important role facilitating the process of scaling up successful interventions and sharing experiences among countries. 3.2.3 Approach to Selecting Public Finance Interventions The process of developing national roadmaps should include an approach to select public finance interventions. The selection of needed government interventions should depend on an assessment that identifies unmet needs of the real sector, market failures that prevent the development of sustainable finance, and the level of development of national financial systems. Additionally, countries need to assess the level of fiscal space available to support interventions and the capacity of existing government institutions to design and manage programs to ensure that the appropriate agencies are involved. Figure 3.2 summarizes this approach, highlighting the type of analysis and questions that need to be addressed at each step of the process. .51 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Figure 3.2 Selecting Public Finance Interventions Identify unmet needs in the ––What are the needs not met by financial service providers? real sector Identify market failures ––Why are these services or instruments not being provided? Relate market failures to ––What type of public finance intervention can trigger the supply of this public finance instrument to service? address it ––Are they appropriate to the overall level of local financial system development? ––For how long would government intervention be needed? Identify fiscal space and ––What resources are available or can be redirected to address this need? prioritize ––What are the priorities to achieve the objectives of the national sustainable finance roadmap? Match interventions to ––What existing agency is better positioned to managed the intervention? government agency/vehicle ––Is a new agency needed? ––What inter-agency structure is needed to ensure success and how it would interact with private sector and other stakeholders? Design and roll-out ––What additional partners, such as IFIs are to be involved? ––What is the eligibility criteria? ––How are results going to be measured and assessed? Source: UN Environment/WBG Roadmap Team. 3.2.4 The Other Side of Public Finance: Addressing Flows to Unsustainable Activities This section has discussed approaches to using public resources to facilitate the flow of capital toward sustainable activities. However, it is equally important to assess the role that governments can play in the opposite direction by allocating resources to unsustainable activities, which have other public policy objectives. The most salient of these is the provision of fossil fuel subsidies. In addition to multiple drawbacks particularly related to equity and efficiency associated with fuel subsidies, the resultant decrease in fossil fuel prices leads to their overconsumption and to a resulting disincentive to develop green . 52 projects, particularly with respect to low-emissions energy (Merrill et al. 2015). There is substantial momentum to address this issue, and the recent decrease in oil prices has facilitated this process (Kojima 2016)—not only as a measure to improve fiscal sustainability UN ENVIRONMENT – WORLD BANK GROUP but also as part of the process of reducing greenhouse gas emissions, with 13 countries mentioning fossil fuel subsidy reform in their NationallyDetermined Contribution (NDC) submitted in the run up to the Paris Agreement (Terton et al. 2015). In addition to fossil fuel subsidies, governments are already undertaking a broader review of their public expenditures to identify and address flows to unsustainable activities, in many cases with technical support of the International Monetary Fund. The World Bank has also developed an approach to this process for climate change–related activities that is being incorporated into the public expenditures reviews carried out periodically by its member countries (World Bank 2014). 3.3 FINANCIAL POLICY AND REGULATION Around the world, public authorities are deepening efforts to align financial systems with sustainable development. 3.3.1 The Rationale for Policy and Regulatory Action Public authorities—including governments, central banks, regulators, supervisors, and other bodies—are taking legislative, policy, regulatory, and supervisory steps to achieve a range of objectives linking sustainability and the financial system, such as: ¢¢ Enhancing market practice, including efforts that mainstream environmental factors into financial decision making and correct for market failures (such unpriced environmental externalities); ¢¢ Supporting market growth, including policy frameworks and standards that promote the issuance of green financial products (that is, green bonds and securities), the development of new market platforms (that is, crowdfunding and fintech), or the competitiveness of financial centers; ¢¢ Promoting transparency and efficiency, by improving flows of sustainability information through the financial system through voluntary guidance, labeling schemes, or mandatory requirements; ¢¢ Strengthening risk management, often by integrating environmental factors (such as physical and transition-related climate risks) into the prudential oversight of financial institutions, supervising financial markets, and providing sector and system-level stress testing; ¢¢ Facilitating flows and services, with investment and lending to priority sectors, restrictions or limitations on financing, insurance requirements, or the provision of financial services as a way to promote inclusion and support development; ¢¢ Clarifying legal frameworks, including the fiduciary responsibilities of financial institutions, with respect to long-term risks and opportunities (such as climate change); and ¢¢ Enhancing conduct and behavior, with codes of conduct and guidelines for environmental issues and compacts with FIs. 3.3.2 Categories of Public Action Public action on sustainable finance priorities can be broken down into two main categories: ¢¢ Enhancing the alignment of financial institutions and markets with sustainability outcomes, looking across environmental (that is, climate and pollution), economic (that is, sustainable growth), and social (that is, financial inclusion and livelihoods resilience) dimensions; and .53 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM ¢¢ Understanding and managing the impacts of sustainability factors (such as climate risks and opportunities) on financial institutions, markets, consumers, and the macroeconomy. 3.3.3 The Fundamental Relevance of Sustainability Factors There is growing awareness of the fundamental relevance of sustainability factors to the core statutory obligations and mandates of financial authorities (Table 3.1). At the same time, there is increasing recognition of the critical importance of financial sector alignment for the achievement of sustainable development objectives across real economy policy frameworks, from small and medium enterprise finance to infrastructure planning. In developing countries, public authorities are leveraging the financial system to achieve national development objectives, including abatement of pollution, financial inclusion, and disaster resilience. In developed countries, an increasing number of supervisors, regulators, and central bank governors have publicly recognized the potential for sustainability factors—such as climate change—to hold implications for the resilience of firms and functioning of markets. 3.4 THE GLOBAL POLICY AND REGULATORY LANDSCAPE OF SUSTAINABLE FINANCE Public intervention in the financial sector to promote sustainability has a long history. Instances of public interventions started with early frameworks for ethical and socially responsible investment in the 1990s, and included basic guidelines for the disclosure of environmental information in corporate reporting. Following the financial crisis, a growing number of public authorities began taking action on sustainability, leading to a steady expansion in the number, scope, and typologies of measures. Research conducted by UN Environment has found nearly 300 policy and regulatory measures in place as of October 2017, implemented in over 60 countries.17 Growth in measures has averaged roughly 20 percent year on year since 2010—with an increase of roughly 30 percent since July 2016. One of the most significant changes in recent years has been a major increase in system- level measures—including major policy packages to advance sustainable finance across asset classes. Of particular note are China’s 2016 Green Finance Guidelines (PBoC 2016b), which set out specific provisions to incentivize and promote green loans, green bonds, green funds, green insurance, and mandatory environmental information disclosures. Recent . 54 years have seen a marked increase in international measures, as sustainable finance has been taken up by international standard-setting institutions and regional bodies such as the European Commission. In addition, there has been a major increase in policy measures UN ENVIRONMENT – WORLD BANK GROUP focused on specific asset classes (that is, securities markets), which are relevant to a broad range of financial stakeholders—a key example being efforts to support the development of green bond markets by providing guidance and standards. 17 UN Environment Inquiry internal database. Table 3.1 The Relevance of Sustainability Factors for Financial Authorities Agent/ Implications of sustainability Examples from practice Mandate factors Increasing evidence suggests that United Kingdom: The Bank of sustainability factors, such as climate England has set out an integrated change, can pose significant risks to strategy on climate change, the safety and soundness of firms including engaging with firms Central bank/ and the resilience of markets. facing climate risks (in insurance and banking), research, and Financial stability enhancing financial system resilience by supporting a smooth transition (Scott, van Huizen, and Jung 2017). Monetary policy operations dictate Bangladesh: Bangladesh Bank has risk/return expectations, affecting used monetary policy instruments Central bank/ deployment of capital and the speed (including concessional refinancing) and smoothness of a transition to a to promote the extension of Monetary policy low-carbon economy. credit for climate resilience and sustainability objectives. Sustainability factors can influence Brazil: In 2014, the Brazilian Central Banking regulator/ the range of credit, market, Bank introduced requirements for operational, and reputational risks all banks to have environmental and Safety & soundness, facing banks. These risks have social risk management systems in consumer protection impacts at asset, institutional, and place. market levels. Increasing natural disasters and United States: In 2012, state physical climate trends are having regulators, working through the Insurance regulator/ increasing impacts on the insurance National Association of Insurance industry. The safety of insurance Commissioners, provided guidance Safety & soundness, sector investments may be impacted on questions to ask insurers consumer protection by transition factors affecting regarding any potential impact of financial markets. climate change on solvency. Pension and other investment South Africa: The South African Pension regulator/ regulations are designed to protect Pensions Act has clarified that savers’ interests and ensure prudent prudent investors must consider Fiduciary duties & management. Climate change environment factors that may obligations can impact this in multiple ways, materially affect long-term particularly over the long term. performance. Sustainable development policies— such as infrastructure strategies, economic development plans, Nonfinancial ministries/ and disaster risk management frameworks—require financial sector Sectoral policies involvement but are developed and implemented by parts of the government not directly related to the financial sector. Source: UN Environment/WBG Roadmap Team. 3.5 NATIONAL-LEVEL ACTIONS This section considers elements of risk, reallocation, and responsibility for national-level actions. .55 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM 3.5.1 Disclosure Approximately 30 percent of all policy and regulatory measures on sustainable finance implemented by public authorities are focused on disclosure.18 Governments in leading financial economies—such as the United Kingdom—were first movers in setting out mandatory corporate environmental reporting as part of exchange listing requirements. Over the last two years, public authorities have scaled up action, implementing frameworks across asset classes. The majority of these efforts have been either to build the information base necessary for green finance markets to develop or to build transparency on future risks and evaluate alignment with the low-carbon transition (Box 3.1). Box 3.1 Enhancing Disclosure on Climate Risk in France and California France: In August 2015, France set out the world’s most ambitious disclosure regime under Article 173 of the French Energy Transition Law. The provisions of its Article 173 require institutional investors (more than 800 entities) to disclose information on their risk management of climate change consequences and to take into account their environmental footprint in their investment policy. In addition, larger institutions should notably describe how their investment policy has been affected by the outcome of the analysis process, and how it will contribute to the overall objective of limiting global warming. The French government implemented these requirements with considerable freedom for firms in their responses, considering flexibility to be a supportive element for the institutional innovation necessary to meet the complex challenges inherent in examining alignment with the low-carbon transition. In October 2016, global insurer AXA received the top award for the best investor climate-related disclosures, in a competition organized by the French Ministry of Environment (AXA Group 2016). An assessment by the government of the new disclosure framework regarding insurance companies is planned by the end of 2018. California: In the United States, the California Department of Insurance was instrumental in the decision by the National Association of Insurance Commissioners to introduce the world’s first climate risk disclosure survey for the insurance sector in 2009. In 2016 California Insurance Commissioner Dave Jones implemented the Climate Risk Carbon Initiative, which set out new requirements for insurance firms to disclose their investments in fossil fuel enterprises (including thermal coal, oil, gas, and utilities). . 56 3.5.2 Risk UN ENVIRONMENT – WORLD BANK GROUP There is increasing recognition across jurisdictions that sustainability factors—such as climate change—may be material for the solvency of firms, safety of markets, and stability of the financial system as a whole. Public authorities are responding to these challenges in different ways, including by assessing exposure to sustainability risks, integrating environmental factors into the oversight of firms and markets, and implementing new requirements. For example: 18 UN Environment Inquiry internal database. ¢¢ Australia. The Australian Prudential Regulation Authority stated its views on climate change as a “material” physical and transition risk that it will consider much more closely in its monitoring of banks, insurers, and asset managers (Summerhayes 2017). ¢¢ Brazil. BACEN, the Brazilian Central Bank, issued guidelines on integrated risk management—including environmental risk—at the end of March 2017, building on its 2014 requirements for firms to have environmental and social risk system in place. ¢¢ China. Environmental risk analysis is a key component of China’s “Guidelines for Establishing the Green Financial System,” with a focus on stress testing led by the Green Finance Committee of China Society for Finance and Banking (PBoC 2016b). ¢¢ France. In February 2017, a synthesis report by DG Trésor, Banque de France and Autorité de Contrôle Prudentiel et de Résolution was published on climate-related risks assessment in the banking sector with a view to providing banks with a framework and guidance on how to develop their expertise going forward (French Treasury 2017). ¢¢ Germany. In 2016, the Federal Ministry of Finance released a commissioned research report on the potential impact of climate change on financial market stability (German Finance Ministry 2016). ¢¢ Netherlands. Since 2014, the Dutch central bank has considered financial and macroeconomic risks related to climate change in its assessment of soundness of major financial institutions (Box 3.2). 3.5.3 Reallocation Action by public authorities to promote capital reallocation toward sustainable investments has been widespread, with instruments ranging from policies that support the growth of green financial markets to policy-directed lending. Efforts to enhance information are often a key component. A key example is the new frameworks for development and issuance of green financial products in countries such as China and Japan (MOEJ 2017); and also in subnational levels, such as California (Chiang 2017). Recently, in India, the Securities and Exchange Board of India (SEBI) issued disclosure requirements for the issuing and listing of green debt securities (SEBI 2017), while in Indonesia, regulator OJK announced it will launch a framework and introduce regulation for green bond issuance in Indonesia in 2017 (Jong 2017). The evolution of secondary markets is now coming into focus, with France authorizing the launch of the first green bonds as well as an ETF (Exchange-Traded Fund) tracking a portfolio of 116 investment grade green bonds in March 2017 (Lord 2017). One interesting focus emerging for policy makers is at the consumer interface, seen in instruments to build awareness and transparency around sustainable investment option for everyday consumers. In France, the “the energy and ecology transition for climate” label was launched in November 2016 to help identify green investment funds, linked to broader policy package implemented under Article 173 (see Box 3.1). .57 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Box 3.2 Examining the Impacts of the Energy Transition in the Netherlands DNB, the Dutch central bank, first examined financial risks relating to climate change in 2014, in response to a request from the Dutch parliament. In 2016, it completed a deeper assessment of the macroeconomic implications of the energy transition—considered by DNB to be “one of the greatest challenges that the economy faces in the long term.” For the study, DNB undertook primary research based on survey data from three major banks, five insurers, and three pension funds dominant in each market segment. Gathering these data enabled DNB to quantify the capital exposure of financial firms to carbon-intensive sectors, looking across asset equity, debt, and other holdings (Figure B3.2.1). Chart 4 Exposures to carbon-intensive sectors vis-à-vis the balance sheet total 35 and broken down by sector and asset type Figure B3.2.1 Results of DNB Exposure Analysis Exposures to carbon-intensive sectors vis-à-vis total assets % change (2016) Exposures analysed by sector and asset types from 2015 Banks 1,898 EUR billion Fossil 2.6% Fossil fuels 48.9 EUR billion + 23 Energy generation 12.0 EUR billion +3 Heavy industry 30.1 EUR billion +4 Transport 42.6 EUR billion -13 Carbon- Agriculture 75.5 EUR billion +14 intensive Insurers 8.4% 800 EUR billion Fossil Fossil fuels 10.2 EUR billion +10 1.2% Energy generation 10.7 EUR billion -2 Heavy industry 6.3 EUR billion +15 Carbon- Transport 3.8 EUR billion +41 intensive Agriculture 5.3 EUR billion -10 3.3% Pension funds 790 EUR billion Fossil Fossil fuels 43.7 EUR billion +16 5.5% Energy generation 18.0 EUR billion +13 Heavy industry 17.8 EUR billion +32 Transport 10.1 EUR billion +46 Carbon- Agriculture 8.3 EUR billion -34 intensive 6.9% Exposures (as a % of total assets) Loans Bonds Shares Commodities Other Source: Regelink et al. 2017, Chart 4, p. 35. Source: DNB. In its study, DNB advocates a long-term policy ensuring a timely and controlled Notes to the sectors: The fossil fuels sector comprises exposures to oil, gas and coal producers as well as direct suppliers transition and highlights the importance of increasing transparency on climate risks— generation sector comprises exposures to fossil fuel-based electricity generation; The heavy industry sector comprises exposures to the chemical, cement, metal and wood/paper industries; The transport sector comprises exposures to air, . 58 road unambiguous requiring and maritime transport and broadly (rail transport applied is not included, asstandards. 2-intensity its CO Detailed is low); carbon The agriculture footprint sector comprises exposures to agricultural (arable and livestock farming) producers and packaged foods producers (fishery is not included, reports and energy transition plans will make it easier for financial institutions to factor as its CO 2-intensity is low). Notesrisks in climate and to the asset will help categories: a realistic putcategory The loans price comprises on corporate such risks. traditional loans as well as trade finance to parties UN ENVIRONMENT – WORLD BANK GROUP trading in fossil fuels; The shares category comprises investment in shares, equity investment funds and derivatives; The bonds category comprises corporate bonds and bonds issued by state-owned enterprises; The commodities category comprises direct commodity investments, futures contracts and commodity plan assets; The ‘other’ category primarily Currently, DNB is advancing new research into the impacts of physical and transition-related comprises investments in private equity, hedge funds and public/private infrastructure investments. climate risks for financial institutions and supervision. This includes a report on climate risks to the financial sector investigating both transition and physical elements. On transition risks, it includes a data request into exposures of financial institutions, supplemented by a qualitative survey that asks institutions what risks they perceive and how they are managed. With respect to physical risks, DNB conducts a weather stress test for insurers and assesses the impact of flooding scenarios on financial assets of banks and institutional investors. 3.5.4 Capacities Public bodies are also making efforts to increase sustainability capabilities in the financial sector. National governments are acknowledging the importance of skills and capabilities in supporting broader processes to align financial systems with sustainable development: ¢¢ Certain countries have specifically identified the importance of practitioner training to support the success of broader green finance initiatives. For example, in China, the People’s Bank of China (PBoC) has specifically recommended training for investors and the promotion of green investment education as a central objective for a proposed Green Investor Network (UN Environment Inquiry and PBoC 2015). ¢¢ In France, a 2013 White Paper on Financing the Ecological Transition puts forward a range of measures to “re-centre the behavioural set of stakeholder practices around the objectives of ecological transition and funding,” including action to train fund trustees and financial intermediaries in technological and environmental risk assessment methodologies (Ministry of Economy & Ministry of Ecology and Sustainable Development 2013). ¢¢ Other countries are taking steps to improve the professional capacities of regulators with regard to climate and sustainability issues. In Indonesia, the financial services authority (OJK) has prepared a Roadmap for Sustainable Finance Implementation Plan that specifically identifies “the provision of environmental analysts trainings” as a roadmap action; a target of training 1,000–2,000 members of financial services institutions (FSIs), OJK officials, and OJK supervisors between 2015 and 2019 has been set (OJK 2014). ¢¢ In Switzerland, the Swiss government has recognized that “an indispensable and transversal requirement for facilitating the alignment of the financial system with sustainable development is a paradigm shift in business, economics and finance education” (Swiss Confederation 2015). 3.5.5 Financial Institutions’ Fiduciary Duties An increasing number of public authorities are considering ways in which environmental factors may relate to the core responsibilities and duties of financial institutions to shareholders and consumers. Legislators are re-examining how the frameworks governing these responsibilities may constrain the capacity of institutions to act, which is leading to clarifications and reforms. For example, the United Kingdom followed a multiyear process that began with an independent legal commission examining ESG consideration within fiduciary duties (The Law Commission 2014). The Pensions Regulator clarified in July 2016 that ESG material issues, including environmental issues, should be taken into account by pension fund trustees (The Pensions Regulator 2016). Recently, the Canadian Association of Pension Supervisory Authorities amended its guidance in February 2017 to list ESG issues as typical risks to be evaluated by pension trustees (Thomas 2017). Other examples include: .59 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM ¢¢ China. The Securities Regulatory Commission publicly encouraged Chinese investors to become Principles for Responsible Investment (PRI) signatories in October 2016. ¢¢ Germany. The federal state of Berlin introduced a sustainability index to reallocate its pension fund investments as of 2017. ¢¢ Singapore. The Monetary Authority of Singapore supported the development of the Stewardship Principles for Responsible Investors, which were launched in November 2016 (Stewardship Asia 2016). Aligning the fiduciary duties of FIs with sustainability considerations in fact highlights the close interaction of market- and nationally driven initiatives. For example, a number of real sector corporations and FIs are seeking to align their activities with the successful implementation of the Sustainable Development Goals (SDGs) and the Paris Agreement with particular emphasis on reviewing the sustainability of its supply and production chains. Others are using results-based financing to “crowd-in” private financing into climate change financing (World Bank 2017). 3.6 NATIONAL ROADMAPS A growing number of countries are developing sustainable financial system policy frameworks. However, these are often not joined up or focused in a strategic way. Furthermore, action to deliver the SDGs and the Paris Agreement on climate change will need to involve a systemic approach to the financing challenge. For example, Agenda 2030 identifies the need for “integrated national financing frameworks.” As part of the implementation of the Paris Agreement, the Intended Nationally Determined Contributions (INDCs) submitted in 2015 will need to be translated into more granular climate investment plans or green finance strategies. National sustainable finance roadmaps have been launched in many countries over the past year. These identify system-wide needs, barriers to scaling up, and priority actions. Examples of these countries include Argentina, China, Indonesia, Italy, Mongolia, Morocco, Nigeria, Singapore, and South Africa. The specific mix of policy-led, market-led, and public-private initiatives in each country is a function of national development priorities and, as such, varies considerably. However, all have at their core the development of long-term, systemic plans to . 60 enhance the ability of the financial system to mainstream ESG factors into decision making and to mobilize predominantly private capital for sustainable investment. UN ENVIRONMENT – WORLD BANK GROUP Case studies highlight different national approaches to sustainable finance roadmaps. A diversity of approaches to roadmap design is evident in the case studies compiled for this Roadmap, despite their common goal of mobilizing new sustainable investment and mainstreaming sustainability considerations into financial decision making. For example, Brazil has focused on building broad coalitions in support of sustainable finance, China has reinforced early private sector momentum with a comprehensive public policy framework, and Russia has made extensive use of public-private partnerships to build new markets in areas such as energy efficiency. In most cases, the national roadmaps have been anchored to a broader policy objective (Figure 3.3) that has facilitated the process of policy design and contributed to building a broad coalition in support of the transformation to sustainable finance. A summary of these national roadmaps is in Appendix B at the end of this document. Figure 3.3 National Roadmaps of Selected Countries Policy Objective Anchor àà Build broad coalition in support of Economic sustainable finance growth and Brazil àà Close coordination between government financial markets policy, financial regulators, public financial, development and market actors àà Strongpublic policy guidance Green financial àà Fosterreallocation of resources towards system to support China green activities through a broad set of green industrial channels (capital markets, banks) policy àà Move from deployment of public finance to Sustainability as a EU policy measures tied to risk management driver of a sound and disclosure financial system financial measures to policies in sectors àà Tie Economic growth India particularly relevant to sustainable finance, with emphasis on such as energy renewable energy àà Linksustainable financial to strategic Develop financial Morocco financial development objectives markets àà Establishpublic-private partnerships to Targeted markets Russia trigger development of specific markets development Source: UN Environment/WBG Roadmap Team. The emerging practice of developing national roadmaps indicates an increasing focus on how financial system reform can support the sustainability transition in the real economy. Countries are starting to make explicit links between action in the financial system and the realization of broader goals for sustainable development. What began as a series of tactical steps in response to specific sustainability issues has started to become more strategic. Traditionally, sectoral policies to deliver sustainability (for example, in clean energy or in agriculture) have largely ignored the need to consider the complementary role that financial reform can play to deliver effectiveness. The emergence of national sustainable finance roadmaps points to a change in this worldview. National sustainable finance roadmaps encompass 10 broad components. Based on an analysis of existing national roadmaps as well as engagement with stakeholders in other countries currently undertaking this process, roadmaps for sustainable finance are more likely to enjoy broad support and increase their opportunity of success if they include the following key components: .61 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM ¢¢ Identifying the narrative. This section of the roadmap outlines why a national financial system needs to be aligned with national sustainable development outcomes. Countries will have different starting points linked to national priorities; different individual, institutional, or structural drivers of change; and different capacities. A new narrative that has sustainability at its core can also be a response to factors that include global nudges from international bodies; bottom-up initiatives at subnational, national, or regional levels; or disruption caused by new technologies or business models. The narrative should clearly set out the opportunity a sustainable financial system can help deliver as well as the scope of key terms such as financial system and sustainable development in a national context. ¢¢ Assessing overall needs. This section describes the national sustainable finance requirements over a particular time period, as well as the magnitude of business-as- usual flows to high-carbon sectors. The needs assessment will also cover the broad financial characteristics of each major component—such as infrastructure or energy efficiency—within the national sustainable financing requirement such as the ratio of public to private finance, debt to equity ratios, and the tenor of finance required, as well as typical transaction sizes. ¢¢ Estimating necessary flows. To understand the magnitude of the challenge, this element estimates sustainable finance stocks and flows to generate a directional estimate of the investment gap. It is unlikely that these data will come from any single source; proxies and approximations will also probably be required. ¢¢ Identifying potential barriers. Barriers can hinder the flow of sustainable finance and investment at the level of the financial system or the enterprise. At either level, they can either be generic (such as underdeveloped capital markets or remuneration policies that incentivize short-termism) or they can be specific to sustainable finance (such as a lack of clarity over sustainable finance definitions, or information about sustainable projects and sectors might be poor). ¢¢ Aligning with international experience. Any sustainable finance roadmap would be firmly aligned with national priorities and would involve clear domestic leadership. Where appropriate, however, evolving international practice in sustainable financial system development could be considered. . 62 ¢¢ Building scenarios. The financial system is in a constant state of flux. This fluidity makes predictions about its future path risky. However, failing to take into account UN ENVIRONMENT – WORLD BANK GROUP possible future scenarios for the financial system means potentially failing to take into account possible risks and opportunities. Change can be driven by many factors, including changes to the national or international governance of the financial system or from disruption caused by digital innovation. ¢¢ Identifying suitable measures. The specific measures that might make a national financial system more effective, efficient, and resilient are a function of a number of factors. Structurally, the architecture of the national financial system will theoretically determine what might be most appropriate, but international experience indicates that factors such as capacity, ease of implementation, and the identification of an individual or institutional champion will also determine what measures are prioritized. Common measures include those related to disclosure, business practices, financial instruments, and knowledge-sharing networks. ¢¢ Sequencing of measures and priorities. Pivoting from tactical innovation to a more systemic approach to sustainable financing at a national level will reveal sequencing issues. Clear definitions or criteria might need to be agreed upon through a multistakeholder process before relevant financial instruments can be scaled up, for example. Similarly, consideration should be paid to trade-offs between ease of implementation and the potential effectiveness of a particular measure that might lead to the prioritization of certain measures. ¢¢ Building capacity. Aligning the financial system with sustainable development will require capacity building because new competencies and capabilities will need to be developed in key areas. New institutional configurations, such as those related to the scope of financial policy makers’ and regulators’ mandates, along with their interface with other policy institutions, might need to be addressed. ¢¢ Measuring progress. There is growing recognition that progress toward aligning the financial system with sustainable development must be measured. Existing data are often fragmented, incomplete, and do not allow for effective analysis within a country or between countries. An effective framework for measuring progress can help highlight areas for market, policy, or regulatory improvement and can also help assess the effectiveness of measures that have been introduced. There is no single formula for developing national sustainable finance roadmaps. However, all have at their core an inclusive multistakeholder process spanning the public sector, private sector and civil society. Working groups consisting of subject experts examining measures related to specific topics are also a common feature of the process. The UN Environment Inquiry has developed an online Sustainable Finance Diagnostic Toolkit with embedded resources to help countries develop the core material for each of the 10 components outlined above (see also Box 3.3). 3.7 CONCLUSIONS The richness of national initiatives in support of sustainable finance reflects a broad commitment to facilitate its development and promote government involvement to address structural obstacles. Most of these initiatives have had the support of far-reaching coalitions of multiple government agencies and other public and private sector financial sector stakeholders. However, governments lack a systematic approach to identifying market failures and designing viable policy and fiscal interventions to trigger the development of sustainable finance markets. The development of national roadmaps, which several countries are already implementing, constitutes an opportunity to more strategically— and systematically—approach the design of sustainable financial systems. The design of a framework to prepare these roadmaps will be critical to facilitate their design and adoption by a larger number of countries. .63 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Box 3.3 An Online Sustainable Finance Diagnostic Toolkit Since 2014, the UN Environment Inquiry has built up a body of knowledge on how countries are aligning the rules that govern the financial system with sustainable development. The 2016 Inquiry annual report identifies more than 200 separate measures in 60 countries across banking, capital markets, insurance, investment, and the financial system as a whole. With the demand rising, the Inquiry has pulled together the experience to date in systematic form, which has led to the development of the Sustainable Finance Diagnostic Toolkit. This can be used by stakeholders at the start of the process of developing a national sustainable finance toolkit. The toolkit can help develop a sustainable finance status report, structured using the 10-step framework described above. This status report can be a key input that will feed into the discussions around the development of national sustainable finance roadmap. The Sustainable Finance Diagnostic Toolkit is designed to be a flexible platform and will be regularly updated as ongoing work brings to light new knowledge, approaches, and data. More information on the Sustainable Finance Diagnostic Toolkit can be found at http://unepinquiry.org/diagnostic-toolkit/. . 64 UN ENVIRONMENT – WORLD BANK GROUP 4 INTERNATIONAL COORDINATION AND SUSTAINABLE FINANCE Organizing Framework Conclusions • Benefits from global coordination and International collective action is critical establishing principles on sustainable to ensure alignment of ongoing efforts to finance support the development of sustainable • Characterization of existing global finance. Maximum impact can be initiatives accomplished by embedding sustainability • Potential elements of a set of global  considerations into existing financial sector principles on sustainable finance principles and standards. • Role of international coordination on measuring results of sustainable finance initiatives 4.1 GLOBAL COORDINATION AND PRINCIPLES Meaningful global action requires global principles that can guide concerted international, national, and market-driven progress toward a sustainable financial system. Achieving sustainable development is, by its own nature, a global challenge because no country can be on a long-term sustainable path alone given the interconnectedness of problems such as climate change, communicable diseases, and biodiversity loss. The transition to sustainable finance is driven by country-level initiatives; continued transformation along this path should remain anchored in such bottom-up approaches to ensure that the ultimate structure of sustainable financial systems and the pace of change are adapted to country needs and the current state of development of national financial systems. However, agreeing on key global guiding principles can contribute to keeping the momentum of the ongoing transformation of the financial system and can magnify the efficiency and effectiveness of ongoing and future national, international, and market-driven initiatives. Potential benefits from agreeing on a set of global principles include the ability to: 1. Guide the design and implementation of national roadmaps to sustainable finance. National initiatives have been developed in relative isolation from each other, and there have been limited opportunities for cross-pollination between countries and/or markets while lessons are being learned. Building a sustainable financial system needs to be driven by the needs of society at large, and therefore the process involves a very broad set of stakeholders that go beyond financial sector policy makers and institutions. This makes the development of national roadmaps a complex process that could benefit from broad principles .65 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM to guide their development and facilitate the process of bringing together stakeholders with very different backgrounds. 2. Facilitate coordination across multiple international efforts to expedite the creation of a global sustainable financial system. Global cooperative efforts to create a sustainable financial system include initiatives to establish principles that have generally targeted specific parts of the financial sector (such as banks or stock exchanges) or that respond to the needs of a subset of stakeholders (for example, institutional investors). However, these efforts lack a comprehensive approach that can bring together all components of the financial system and ensure alignment of efforts and synergies that ultimately will lead to an increase in sustainable financial flows. For example, the issuance of green bonds by international financial institutions (IFIs) whose returns are tied to environmental, social, and governance (ESG) indices—such as the World Bank’s Green Growth Bonds19—contribute to not only increase the flow of sustainable finance to the issuer but more broadly promote the growth and importance of ESG equity indices. 3. Facilitate the integration of sustainable finance considerations into existing international finance oversight and regulatory frameworks. General global principles have been used successfully to develop other aspects of the financial sector, including banking supervision, capital adequacy, payment systems, and remittances. A sustainable financial system will have to be embedded in many of these initiatives and the existence of global principles can facilitate this process. Ongoing initiatives such as the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) and the efforts of the International Association of Insurance Supervisors (IAIS) to assess climate change–related risk in the insurance sector are already part of this process. 4. Contribute to establishing a common definition of sustainable finance and some of the different forms it can take. The concept of sustainable finance is relatively new and its definition is still evolving, with different organizations and initiatives having different understandings of the concepts that it encompasses. In many cases, the differences between the terms sustainable, green, and climate finance, and between ESG (environmental, social, and governance) investment criteria and impact investment are not fully understood. Clarifying the differences . 66 and relationship between these concepts can contribute to aligning national, international, and market-based efforts. UN ENVIRONMENT – WORLD BANK GROUP 5. Enhance the credibility of market-driven innovation and measurement of progress. The establishment of global principles can contribute to ensuring a common understanding of the policy and market developments that need to take place to meet the sustainability challenges the world faces. Such principles are also critical to ensuring the credibility of policies and instruments to be developed and to aggregating national actions to measure global results in the transition to a sustainable financial sector. For example, savers, investors, financial 19 Financial details on the Green Growth Bonds issuance can be found at http://treasury.worldbank.org/cmd/htm/ WorldBankissuedtwomoreGreenGrowthBonds.html institutions, and financial regulators across the world require assurance that labels such as green bonds or ESG investment fund share key common principles across multiple jurisdictions. Establishing general principles does not imply standardization but rather an alignment of efforts. It is important to emphasize that agreeing on certain principles is very different from trying to standardize measures to develop a sustainable financial system across countries or even across different parts of the financial sector. Certainly the needs of developed countries with deep financial markets are very different from those of developing countries with substantial financially underserved populations. Similarly, efforts to develop sustainable banking in the retail segment are very different from efforts targeting large institutional investors and capital markets. The approach to develop these principles presented in this section aim to follow the one previously used in other components of the financial sector to guide and facilitate the development of initiatives and policies aligned toward a common global goal. Agreement on these principles does not imply the creation of new standards but rather the incorporation of sustainability consideration into existing ones. Examples of such existing principles include the Basel Core Principles for Effective Banking Supervision, the Core Principles for Systemically Important Payment Systems, and the G20 Principles for Innovative Financial Inclusion.20 4.1.1 Existing International Initiatives Related to Sustainable Finance Principles In 2016, both the G20 and the Financial Stability Board (FSB) had raised the issue of sustainability to the forefront of the international financial sector dialogue. The policy dialogue at such bodies has focused on enhancing flows of sustainability information within the financial system, setting out new voluntary standards and policy options with immediate relevance for firms and public authorities. Under its 2016 G20 Presidency, China launched the Green Finance Study Group (GFSG) to develop options for how to enhance the ability of the financial system to mobilize private capital for green investment. At the 2016 Hangzhou Summit, G20 heads of state for the first time recognized the need to “scale up green finance” and endorsed a set of options to achieve this goal—with information elements, such as product standards, established as a core aspect of frameworks to promote the development of markets for green assets (such as green bonds). In 2017, the GFSG concentrated its efforts on the information agenda with two specific research tracks: Enhancing Environmental Risk Assessment in Financial Decision- Making (UN Environment Inquiry 2017a), and Improving the Availability and Usefulness of Publicly Available Environmental Data for Financial Analysis (UN Environment Inquiry 2017b). In addition to the GFSG, the G20 has also advanced work on energy efficiency finance, with a G20 Energy Efficient Investment Toolkit launched in 2017 (G20 Energy Efficiency Finance Task Group 2017). The FSB launched the Task Force on Climate-related Financial Disclosures (TCFD) in December 2015. The TCFD is a market-led effort mandated to develop voluntary, 20 The Financial Stability Board keeps a compendium of these standards, which can be found at http://www.fsb. org/what-we-do/about-the-compendium-of-standards/key_standards/ .67 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM consistent climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers, and other stakeholders (FSB 2015). The TCFD’s final recommendations were published in June 2017 (TCFD 2017a), setting out a framework for climate-related financial disclosures structured around four thematic areas: Governance, Strategy, Risk Management, and Metrics and Targets (Figure 4.1). As part of its recommendations, the TCFD released supplementary guidance for the implementation of the recommendations within different real economy and financial sectors, with specific guidance for banks, insurance companies, asset owners, and asset managers (TCFD 2017b). Figure 4.1 Recommendations of the Financial Stability Board (FSB)’s Task Force on Climate- related Financial Disclosures (TCFD) Governance Strategy Risk Management Metrics and Targets Disclose the Disclose the actual and Disclose how the Disclose the metrics organization’s potential impacts of organization identifies, and targets used to governance around climate-related risks assesses, and manages assess and manage climate-related risks and opportunities on climate-related risks. relevant climate-related and opportunities the organization’s risks and opportunities businesses, strategy, where such information and financial planning is material. where such information is material. Recommended Disclosures a) Describe the board’s a) Describe the a) Describe the a) Disclose the oversight of climate- climate-related risks organization’s metrics used by the related risks and and opportunities processes for organization to assess opportunities. the organization has identifying and climate-related risks identified over the assessing climate- and opportunities in short, medium, and related risks. line with its strategy long term and risk management process. b) Describe b) Describe the impact b) Describe the b) Disclose Scope management’s role of climate-related risks organization’s 1, Scope 2, and, if in assessing and and opportunities on processes for managing appropriate, Scope 3 managing climate- the organization’s climate-related risks. greenhouse gas (GHG) related risks and businesses, strategy, emissions, and the opportunities and financial planning. related risks. c) Describe the c) Describe how c) Describe the resilience of the processes for targets used by the organization’s identifying, assessing, organization to manage strategy, taking into and managing climate- climate-related risks . 68 consideration different related risks are and opportunities and climate-related integrated into the performance against scenarios, including a organization’s overall targets. UN ENVIRONMENT – WORLD BANK GROUP 2°C or lower scenario. risk management. Source: TCFD 2017a, p. 14. Existing global, national, and market-driven initiatives point out the key elements that sustainable finance principles could have. Figure 4.2 summarizes the leading sustainable finance global initiatives, segmented into different thematic areas. A review of existing efforts to define standards and principles and more broadly support the development of sustainable finance can be divided into (a) disclosure policies, (b) business practices, (c) knowledge-sharing networks, and (d) financial instruments. Some of these initiatives explicitly define high-level principles for specific parts of the financial sector (for example, the UN Principles for Responsible Investment), while others propose specific methodologies to define certain financial instruments as “green” (Green Bonds Standards) or disclose emissions related to financing activities (CDP). A review of the main thrusts of these initiatives presented in Table 4.1 identifies about a dozen key tasks that could be applied more broadly to the entire financial system. Figure 4.2 Leading Sustainable Finance Global Initiatives BU SI NE RE SS SU O FSB Task Force on Climate- PR CL related Financial Disclosures AC S DI T Natural Capital Finance Alliance IC ES Carbon Disclosure Project Principles for Responsible Investment Global Reporting Initiative International Integrated Equator Principles Reporting Council UN Environment Sustainability Accounting Inquiry Standards Board G20 Green Sustainable Sustainable Finance Study Banking Insurance Group Network Forum Green Bond CROSS-CUTTING Standards Sustainable Stock Exchange Initiative KS Green Digital OR FIN Finance Alliance TW AN NE CI G AL N N RI ST A I RU H -S ME D GE NT S LE OW KN Source: UN Environment/WBG Roadmap Team. 4.1.2 Additional Issues Identified by National Roadmaps National roadmaps have identified additional issues that could be part of global principles. About two dozen countries have developed these roadmaps, in many cases with technical support of some of global initiatives mentioned above. Some countries, such as China, have also implemented detailed policy standards with respect to financial instruments, including national green bonds and green portfolios criteria. Box 4.1 summarizes some of the key actions that are common to many of these roadmaps, which are discussed in more detail in the following section. Box 4.2 summarizes the key considerations that could be covered by an eventual set of global principles. These are meant to be consistent with the previously mentioned efforts and seek to provide financial sector constituencies with a set of high-level topics that can be further developed as part of a broader consultation process. .69 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Table 4.1 Key Thrusts of Global Initiatives on Sustainable Finance Focus Key tasks Cross-cutting • Embed sustainability considerations into existing international financial standards. Disclosure • Maximize the measurement and disclosure of the sustainability impact of real sector firms along their supply chain as the basis through which to measure and disclose the sustainability impact, risks, and opportunities of the financial sector. • Ensure that the financial sector plays a pivotal role in ensuring its clients measure, manage, and disclose sustainability risks and opportunities. • Facilitate the development of a mechanism to account for the use, maintenance, and restoration of natural resources in the global economy. Business • Incorporate measured and disclosed sustainability risks into financial institutions’ Practices risks management practices, governance framework, strategy, and business decision-making process (including origination processes). Financial • Adopt definition standards, adapted to national needs, to increase the depth of Instruments sustainable capital markets instruments. • Adopt standards to identify sustainable portfolios in banks to characterize their risk parameters, measure the sector’s transformation toward sustainability, and align prudential regulation with sustainability risks. • Leverage technology to facilitate changes in the intermediation process to increase the effectiveness and efficiency of financial services. Knowledge- • Establish public and private sector organizations’ partnerships to aggregate and Sharing disseminate information on approaches, methodologies, business models, and Networks other successful sustainable finance practices. • Create knowledge-sharing partnerships between financial sector participants. Box 4.1 Characteristics of National Roadmaps that Can Inform the Development ofSustainable Finance Principles ¢¢ Convene a very broad set of stakeholders to ensure broad support and strong political buy-in for the initiative. This process should include not only financial sector stakeholders (for example, regulators, supervisors, central bankers, private sector institutions, associations of financial services users) but also real sector and sustainability stakeholders (for example, government agencies involved in climate change, social policy, energy, water, and other sectors critical to sustainability; and civil society organizations). ¢¢ Leverage existing market-driven initiatives. . 70 ¢¢ Design policies and targets with a long-term horizon but with expected initial measurable results in four to five years. This ensures that roadmaps have clear deliverables and are not only aspirational documents. UN ENVIRONMENT – WORLD BANK GROUP ¢¢ Align national roadmaps with sector policies, particularly in areas such as energy and water management, to maximize the impact of policies within the financial sector. ¢¢ Adapt emerging international standards, particularly with respect to financial instruments such as green bonds, to local market characteristics to attract both international and domestic investors. Box 4.2 Key Considerations for Developing Principles of Sustainable Finance System-wide ¢¢ Make a statement defining the long-term objective of the financial sector in the context of sustainability. ¢¢ Agree on an approach to incorporate sustainability considerations to ensure the effectiveness, efficiency, and soundness of the global financial system. Disclosure ¢¢ Establish approaches and methodologies to disclose the sustainability impact, opportunities, and risks arising from financial sector activities as well as the sustainability risks affecting the financial sector. ¢¢ Consider including sustainability information from the financial sector into the policy-making process to ensure that both the financial sector and the other relevant sectors (for example, environment, education, and so on) are directed toward sustainability objectives. Business practices ¢¢ Price sustainability impacts, risks, and opportunities and incorporate them into financial institutions’ strategies, governance, and business decision-making processes. ¢¢ Develop transition plans toward sustainable finance, with financial institutions identifying activities to be increased as well as business lines that need to be reoriented toward sustainability. Financial instruments ¢¢ Agree on criteria to identify financial instruments and specific transactions aligned with sustainability objectives. ¢¢ Define mechanisms to promote innovative financial mechanisms, including through active regulatory encouragement, to increase the depth of sustainable financial markets. Collaboration and alignment of efforts ¢¢ Develop mechanisms to promote and allow collaboration and sharing of information between financial sector participants on approaches, methodologies, and business practices for sustainable finance. ¢¢ Seek alignment of international and national policies, standards, and results measurement to ensure consistent global approaches that fit national needs .71 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM 4.2 RESULTS MEASUREMENT To deliver the required transformation in the financial system, a performance framework is needed so progress can be measured. This framework would allow governments, financial institutions, and citizens to identify successful approaches, as well as areas lagging behind, thereby laying the basis for strategic adjustments in both policy and practice. Traditionally, the performance of financial systems has been measured across four key dimensions: ¢¢ Financial depth. The size of financial institutions and markets; ¢¢ Access. The degree to which individuals can and do use financial institutions and markets; ¢¢ Efficiency. The efficiency of financial institutions in delivering financial services; and ¢¢ Stability. The stability of financial institutions and markets. Over the past five years, increasing efforts have been placed on how to measure the contribution of the financial system to sustainable development, specifically in the environmental dimension. Measuring progress to a sustainable financial system involves gaining an understanding of three core performance characteristics: ¢¢ Effectiveness. The degree to which the market prices sustainability factors in asset valuations; ¢¢ Efficiency. The costs of running the financial system that delivers the flows of finance aligned with sustainable development requirements; and ¢¢ Resilience. The strength of the financial system in the face of disruptions related to unsustainable development such as air pollution, climate change, or water scarcity. Understanding performance against these characteristics requires a focus on three key dimensions already covered in this Roadmap: ¢¢ Architecture. This covers the principles, norms, standards, rules, regulations, and . 72 policies that directly or indirectly contribute to the sustainable development of finance. Metrics are needed that measure the degree to which the “rules of the game” are aligned with sustainable development needs. UN ENVIRONMENT – WORLD BANK GROUP ¢¢ Markets. This covers the behavior of market participants and the degree to which they are integrating environmental, social, and governance factors into their activities and the transparency with which they describe their sustainability efforts. ¢¢ Flows and stocks. This covers the allocation of capital and financial services to both sustainable and unsustainable assets. This dimension addresses both the annual flows of finance as well as the overall stocks of assets held by banks and institutional investors and enables decision makers to assess progress toward meeting sustainable finance needs. This could be accomplished by leveraging existing frameworks such as the periodic reporting of financial sector information from national authorities to the International Monetary Fund (IMF) to include green flows and stocks. For a comprehensive picture of progress to be developed, metrics need to be chosen in each of these three dimensions at the system level, as well as in key sectors such as banking, debt capital markets, equity capital markets, institutional investment, and insurance. Currently only limited data are available to measure performance. However, signs of progress are emerging that now need to be consolidated so that a globally consistent framework can be developed using the limited but growing pools of data available. At the system level, there is a growing understanding of policies and measures in place to promote sustainable finance, but much less is known about either the effectiveness or the efficiency of policy interventions. In the banking sector, the measurement of green financial flows was initially driven through local efforts now scaled up through international collective action. For example, in Brazil, the Brazilian Federation of Banks, FEBRABAN, has completed one of the world’s first estimates of the number of loans and credit financing for the green economy. At the end of 2015, 17 percent of total corporate loans were allocated to the green economy, with sustainable transport the largest category.21 The Sustainable Banking Network (Box 4.3) is currently assessing the progress made by banking regulators in developing countries on integrating environmental and social factors. Capital markets are perhaps the area where the most transparency that could facilitate results measurement is available. It is now possible to compare levels of disclosure on ESG factors across the world’s stock exchanges. In addition, estimates of the flows of green revenues of the companies listed on different exchanges are available from data providers such as FTSE Russell. The value of issuance of green bonds is also available across countries: expressing the results as the share of total bond issuance in a given country helps to put these data into context. A growing volume of data on the practices of institutional investors is also available. Signatories to the Principles for Responsible Investment (PRI) now manage over US$70 trillion in assets under management. As part of their commitment, signatories are required to report on implementation and are then assessed on an A-E grading system across 12 modules (Box 4.4). A comprehensive Report on Progress is then made public to present the overall reports along with the individual reports from the signatories.22 Internationally, there is growing interest in developing a flexible but consistent approach to measuring progress. At the September 2016 Hangzhou Summit, G20 heads of state welcomed seven broad financial sector options, “for voluntary implementation by countries in light of national circumstances,” to help scale up green financing (G20 Green Finance Study Group 2017). Improving “the measurement of green finance activities and their impacts” was one of these. In its 2017 Green Finance Progress Report, the UN Environment Inquiry concluded that 21 For further information about FEBRABAN and the green economy, see https://portal.febraban.org.br/ pagina/3114/43/en-us/financial-system-green-economy 22 For information on the PRI Reporting Framework 2016 Overview and Guidance, see https://www.unpri.org/report .73 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Box 4.3 Measuring Progress in Sustainable Finance: Innovation by Emerging Markets About the Sustainable Banking Network (SBN) The SBN (www.ifc.org/sbn) is a knowledge and capacity building platform comprised of financial sector regulators and banking associations from emerging markets committed to developing national sustainable finance frameworks to advance the sustainable financial market development, based on national priorities and leveraging international good practice. Launched in 2012, the SBN achieved a critical mass in 2016, reaching 34 member countries,a and representing 85 percent of the banking assets across emerging markets. Fifteen of these countries have already launched national policies, guidelines, principles, or roadmaps on sustainable finance. A Member-Led Initiative to Track and Support Progress SBN members have identified measurement as a top priority in order to benchmark country progress and support countries in designing effective roadmaps that leverage lessons and good practice from other jurisdictions. With this in mind, in December 2016 the SBN launched the first member-led technical Working Group that focuses on measurement. The goal of the Working Group is to develop a methodology and tools to support SBN members to develop effective and fit-for-purpose measurement mechanisms for assessing the progress and impact of sustainable finance adoption at national level. The objectives of the Working Group include: 1. Analyze the approaches and indicators currently being used to measure sustainable finance adoption and impact; 2. Provide options to members in designing nationally appropriate measurement frameworks to assess progress in areas such as: –– mainstreaming of environmental and social consideration into risk management and business operation, –– financial flows to green projects, –– environmental and social impacts, and . 74 –– effectiveness of different strategy choices; and 3. Design benchmarking tools to assist members to track progress, assess UN ENVIRONMENT – WORLD BANK GROUP outcomes, and compare approaches. A First Comprehensive Assessment Tool for National Sustainable Finance Efforts in Emerging Markets Supported by the SBN Secretariat, the Working Group has developed a comprehensive draft measurement framework and indicators to assess country-level progress in designing and implementing national roadmaps for sustainable finance (Figure B4.3.1 and Figure B4.3.2). India particularly relevant to sustainable finance, with emphasis on such as energy renewable energy à Link sustainable financial to strategic Develop financial Morocco financial development objectives markets à Establish public-private partnerships to Targeted markets Russia trigger development of specific markets development Box 4.3 Measuring Progress in Sustainable Finance: Innovation by Emerging Markets (continued) Figure B4.3.1 SBN Measurement Framework Identify unmet needs in – What are the needs not met by financial service providers? the real sector ing Environme abl n n services or instrumentstnot being provided? Identify market failures Ethese – Why are P ill a Relate market failures – What type of public finance intervention can trigger the 3 multipliers r to public finance supply of this service? instrument to address it – Are they appropriate to the overall level of local financial system development? – For how long would government intervention be needed? M a na Sustainable Identify fiscal space and – What resources are available or can be redirected to address Finance prioritize this need? Progression ging E&S – What are the priorities to achieve the objectives of the Matrix of 5 s Pi g ica & 7 llar national sustainable finance roadmap? rs 7 in su ica ore to co & ic stages ind rs re 12 ato Fl rack b- to ind 5 c in su rs Match interventions to – What existing agency is better positioned to managed the in di b- d ca government agency/ intervention? ce & T to ow Ris vehicle – Is a new agency needed? rs – What inter-agency structure is needed to ensure success k gs n and other and how it would interact with private sector gi n Pi ar ra a stakeholders? ll E ncou Fin Design and roll-out – – een are to be involved? What additional partners, such as IFIs What is the eligibility criteria?Gr – How are results going to be measured and assessed? Source: UN Environment/WBG Roadmap Team. Figure B4.3.2 SBN Progression Matrix State of Initiating Formative Emerging Advanced the art Commitment + Strategy + Policy action + Measuring +Behavior defined impact change The country is at the The country has The country early commitment developed strategic has induced a stage and wishes to framework or comprehensive support sustainable technical guidance change in behaviors finance initiatives, in order to help FIs and mindsets toward some committees to integrate E&S risk sustainable finance. have been set, or management into there is increasing their practices and collaboration to increase green between the different finance flows. actors, for instance if the regulator is willing to join industry led- initiatives. The country has The country has effectively decided to develop implemented the framework. Many a sustainable initiatives are in place and the banking framework banking industry is significantly and has started embarked. Beyond risks and to formalize a opportunities, the country has Framework. started to report on the impacts. Source: UN Environment/WBG Roadmap Team. The results of the first benchmarking exercise, including country case studies, will be published in an aggregate report in late 2017. Note a. The 34 members countries are Argentina, Bangladesh, Brazil, Cambodia, Chile, China, Colombia, Dominican Republic, Ecuador, Egypt, Fiji, Georgia, Ghana, Honduras, India, Indonesia, Jordan, Kenya, Lao PDR, Mexico, Mongolia, Morocco, Nepal, Nigeria, Pakistan, Panama, Paraguay, Peru, Philippines, South Africa, Sri Lanka, Thailand, Turkey, and Vietnam. .75 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Box 4.4 PRI Reporting Framework Reporting on Responsible Investment is one of the six Principles to which organizations commit when they become a signatory to the Principles for Responsible Investment (Principle 6: We will each report on our activities and progress towards implementing the Principles). Annual reporting ensures accountability of the PRI and its signatories, provides transparency through the use of a standardized tool for signatories’ reporting, and allows signatories to receive feedback from which to learn and develop. There are 12 reporting modules, two of which are “core” modules and the rest are asset class–specific, depending on the line of business of the signatory. The core modules are related to the organizational structure and the strategic approach to responsible investment being implemented by the organization. The rest of the modules describe the approaches to responsible investment undertaken for different asset classes. “there is no systematic methodology for assessing progress on the greening of the financial system and the number of initiatives in this space has been relatively small. Progress has been most pronounced in relation to improved reporting by financial institutions particularly on climate change” (UN Environment Inquiry 2017c, p. 25). 4.3 CONCLUSIONS International collective action is critical to ensure alignment and effectiveness of the multiple market- and national-driven initiatives in support of sustainable finance. In most cases, this can be accomplished through existing global cooperation and oversight frameworks for the financial sector. However, it will require a strong commitment from a broad coalition of international stakeholders to embed sustainability considerations into long-standing financial sector structures and, if necessary, develop new ones. . 76 UN ENVIRONMENT – WORLD BANK GROUP 5 NEXT STEPS Organizing Framework Conclusions Implementation of the proposed Roadmap • Proposed next steps in each of the areas involves not only UN Environment and the covered by this Roadmap  World Bank Group, but also a broad coalition of international and national partners. Maintaining the momentum of the ongoing transition toward sustainable finance requires concrete actions to support the implementation of many of the measures described in each of the chapters. This process is anchored in a continuing consultation process over the next 24 months combined with a series of actions that will benefit from that process, leverage ongoing initiatives, and support the design and implementation of new ones. Some of these initiatives will be coordinated by UN Environment and the World Bank Group, while in some other cases, part of the consultation process aims to identify the international, regional, and national institutions that may be better placed to lead each activity. Table 5.1 summarizes the vision of the outcomes associated with each one of the areas discussed in the Roadmap along with an outline of proposed next steps to achieve those outcomes and their expected timing. Short- term initiatives are expected to be completed by the end of 2018. Medium-term initiatives will be completed within the next 24 to 36 months. Table 5.1 Summary of Next Steps and Timing Area and vision Short-term initiatives Medium-term initiatives Products, information, • Leverage existing partnerships • Design and execute a set of key and technology to develop and implement transformational transactions methodologies to identify green that can trigger new sustainable Vision: assets. finance products. Sustainable finance • Support embedding market- • Establish “challenge prizes” or products and data relevant sustainability information other types of innovation funds are embedded into into the financial data ecosystem. to stimulate the development of financial information • Support additional research into the new products and technologies infrastructure that risk performance of green assets. in support of sustainable permits the appropriate • Support the implementation of the finance. pricing and identification TCFD recommendations in a pilot of green assets. group of countries. • Establish a cooperative platform and/or industry task force of leading fintech companies, working with others to influence enabling business, policies, and standards to effectively connect fintech and sustainable development. .77 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Table 5.1 Summary of Next Steps and Timing (continued) Area and vision Short-term initiatives Medium-term initiatives Business models, • Leverage existing market- capabilities, and led initiatives—such as the incentives Sustainable Banking Network— or create new ones, to expand Vision: the skills of FIs necessary Sustainability to embed sustainability considerations are considerations overall strategy embedded into the and into day-to-day operations. day-to-day business • Develop a framework to align models, strategies, and institutional incentives within FIs operations of financial to sustainability considerations, sector stakeholders. including developing an understanding of the needs of financial sector users. National public policy • Review and classify different types • Incorporate sustainability actions of fiscal and policy interventions considerations into national to create a framework to diagnose fiscal frameworks, including Vision: market failures and identify a review of the effectiveness Countries have a clear responses at the national level. of fiscal interventions and process for selecting subsidies in support of green policy instruments to activities and expenditures support sustainable in unsustainable activities, finance. including fossil fuel subsidies. National roadmaps • Support the development of national roadmaps in key countries. Vision: Countries can develop national roadmaps to sustainable finance with clear blueprints and a framework to adapt to their national needs and level of market development. Global coordination • Launch a consultation process to • Promote the inclusion of principles converge in the next 24 months sustainability considerations in a set of global principles for into global financial sector Vision: sustainable finance. oversight and cooperation Global principles frameworks. can guide concerted international, national, and . 78 market-driven progress toward a sustainable financial system. Results measurement Develop a results measurement UN ENVIRONMENT – WORLD BANK GROUP • framework for sustainable Vision: finance Clear, transparent • Promote the inclusion of frameworks and metrics sustainability data as part exist to measure results of global financial reporting in the path toward a frameworks (for example, sustainable financial central bank reporting to the system. IMF). Note: FIs = financial institutions; IMF = International Monetary Fund; TCFD = Task Force on Climate- related Financial Disclosures. The proposed next steps summarized in Table 5.1 are expanded below. 5.1 MARKET-LED INITIATIVES 5.1.1 Products, Information, and Technology ¢¢ Leverage existing partnerships to develop and implement methodologies to identify green assets. Based on a review of ongoing work, including initiatives led by UN Environment as well as by the International Finance Corporation (IFC), develop— in partnership with financial institutions (FIs) and other financial infrastructure stakeholders—a general methodology to identify green assets. The approach should be sufficiently flexible that it can be adapted to markets with different data environments, but it should be sufficiently robust to allow it to support market and regulatory decisions. ¢¢ Support embedding market-relevant sustainability information into the financial data ecosystem. Given the broad nature of the stakeholders involved—FIs, financial data providers, credit rating agencies, national financial regulators, and global financial sector oversight bodies—global coordination is required to develop a multiasset green finance data system. This would promote convergence around defining, tagging, measuring, and reporting green assets. It would aim to connect existing initiatives at the sector and national levels to ensure a connected approach across asset classes and markets. ¢¢ Support additional research into the risk performance of green assets. The rate of default of green loans in some markets has been observed to be lower than that of non-green loans with otherwise similar characteristics. Additional systematic research, taking advantage of increasing availability of data on green assets, is needed to confirm these results and allow FIs to incorporate these performance characteristics into their loan origination processes. ¢¢ Support the implementation of the Task Force on Climate-related Financial Disclosures (TCFD) recommendations in a pilot group of countries. This could be undertaken as part of the process of supporting countries to develop their national roadmaps for sustainable finance. ¢¢ Design and execute a set of key transformational transactions that can trigger new sustainable finance products. This may require the financial involvement of the international financial institutions (IFIs) and could explore innovative approaches to identify potential transactions, including requests for proposals or the use of innovation competitions. ¢¢ Establish “challenge prizes” or other types of innovation funds to stimulate the development of new products and technologies in support of sustainable finance. This approach can be explored initially to facilitate the development of innovative fintech solutions where the use of prizes and “hackathons” can focus the efforts of a large range of technical experts who may not otherwise concentrate on sustainable finance solutions. .79 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM 5.1.2 Business Models, Capabilities, and Incentives ¢¢ Leverage existing market-led initiatives—such as the Sustainable Banking Network— or create new ones, to expand the skills of FIs necessary to embed sustainability considerations overall strategy and into day-to-day operations. This could lead to the establishment of a Sustainable Finance Skills Initiative (SFSI). This would have a dual focus. The first focus would be to stimulate training and capacity building for financial supervisors, regulators, and policy makers. The SFSI would draw together the existing ecosystem of capacity building within multilateral development banks (MDBs)—for example, the Bank for International Settlements (BIS), the Financial Stability Board (FSB), the International Association of Insurance Supervisors (IAIS), the International Organization of Securities Commissions (IOSCO), and the Organisation for Economic Co-operation and Development (OECD)—and key sustainable finance initiatives such as the Sustainable Banking Network (SBN), Sustainable Investment Forum (SIF), and the Toronto Centre—to develop and deliver harmonized capacity building on key topics (sustainability risk, green financial products, and so on). The second focus would be to convene and encourage professional bodies, trade associations, universities, and financial institutions to develop and deliver effective capacity building for finance sector employees on sustainable finance. ¢¢ Develop a framework to align institutional incentives within FIs to sustainability considerations. The starting point for this initiative would be a review of the lessons learned by the Principles for Responsible Investment (PRI) on aligning incentives of investment managers with responsible investment considerations. This work could also be expanded to review the needs of consumers (individual, corporate, and government) to ensure the alignment of incentives also with respect to their interests. This would require exploring mechanisms to enhance consumer engagement in a sustainable financial system—that is, consumer literacy, information, costs, and so on—and use this to design incentives and financial products to better meet consumer needs and thereby drive demand. 5.2 NATION-LED INITIATIVES 5.2.1 Public Policy Actions . 80 ¢¢ Review and classify different types of fiscal and policy interventions to create a framework to diagnose market failures and identify responses at the national level. UN ENVIRONMENT – WORLD BANK GROUP This methodology could be developed as part of the process of supporting the preparation of national roadmaps. ¢¢ Incorporate sustainability considerations into national fiscal frameworks, including a review of the effectiveness of fiscal interventions and subsidies in support of green activities and expenditures in unsustainable activities, including fossil fuel subsidies. This would require developing a methodology to assess national fiscal measures that may have an impact on flows toward sustainable activities. It would include an approach to carrying out an inventory of direct and indirect subsidies, including risk sharing schemes that exist in support of activities that have a positive or deleterious impact on promoting the flow of resources toward sustainable activities, as well as approaches to prioritize fiscally sound policy measures that facilitate the transition toward sustainable finance. 5.2.2 National Roadmaps ¢¢ Support the development of national roadmaps in key countries. This could be part of a broader approach to develop a general framework that can be adapted to each country’s needs and level of economic and financial markets development. Selecting the countries to be part of this initial set of roadmaps would be demand-driven but would also seek to include a balanced mix of levels of markets development and readiness to ensure that lessons learned through this process can enrich subsequent roadmaps. 5.3 INTERNATIONAL INITIATIVES 5.3.1 Global Coordination and Principles ¢¢ Launch a consultation process to converge in the next 24 months in a set of global principles for sustainable finance. A strong consultation process incorporating the views of all stakeholders of the financial system is essential for ensuring that any principles that are adopted can be used as a blueprint to design and implement global, regional, and national sustainable financial systems. Following the approach undertaken in the process of developing and adopting other global financial standards, the Roadmap team will convene five different working groups—one of each one of the five types of principles—to further develop these concepts. Membership of the working groups will reflect a broad range of international, national, and market participants’ views. ¢¢ Promote the inclusion of sustainability considerations into global financial sector oversight and cooperation frameworks. Public authorities are seeking to deepen their understanding of how sustainability factors may be relevant to their core mandates, including the safety and soundness of markets. There are leadership groups of regulators working together in these areas (for example, the SIF and the SBN), and global efforts are linking activities across asset classes in order to develop best practice guidance on the integration of sustainability risks into supervisory frameworks. The groups of regulators also consider sustainability factors in the design of regulatory reform and policy interventions. The promotion of sustainability standards would be broadly applicable across jurisdictions and relevant across asset classes, including banking, insurance, investment, and securities. Initial efforts, many in the form of pilots, could include developing and testing a sustainable finance module for the Financial Sector Assessment Program (FSAP), reviewing the impact on fiscal analysis frameworks such as the World Bank’s Public Expenditure Review and the International Monetary Fund (IMF)’s Article IV methodologies, and their relevance to investments of large pools of official assets such as pension and sovereign wealth funds. .81 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM 5.3.2 Results Measurement ¢¢ Develop a results measurement framework for sustainable finance. This could be done as part of the consultation process for global principles and the preparation of national roadmaps. ¢¢ Promote the inclusion of sustainability data as part of global financial reporting frameworks (for example, central bank reporting to the IMF). This effort would be crucial to ensuring that the results of multiple ongoing initiatives can be measured using common metrics. 5.4 IN CLOSING: A BROADER PERSPECTIVE WILL BE REQUIRED TO ADDRESS ALL ELEMENTS OF SUSTAINABLE FINANCE This Roadmap focuses on green finance, but the challenge posed by the 2030 Agenda for Sustainable Development is much broader and touches all the Sustainable Development Goals (SDGs). Many of the areas discussed in this Roadmap with respect to green finance are applicable more broadly to developing a financial system that supports the attainment of the SDGs. They are also applicable to addressing some of the systemic issues identified in 2015 at the Addis Ababa Action Agenda (United Nations 2015) endorsed by the United Nations General Assembly, such as the need for a sound, inclusive, and resilient financial system and increased cooperation among international organizations to attain global objectives. Implementation of elements of this Roadmap can generate some of the pieces to develop a broader plan of action to support the 2030 Agenda and address systemic issues hindering the development of a financial system that can facilitate sustainable development in the three dimensions identified in Addis Ababa: promoting inclusive economic growth, protecting the environment, and promoting social inclusion. . 82 UN ENVIRONMENT – WORLD BANK GROUP APPENDIX A: SUSTAINABLE FINANCE AND RELATED CONCEPTS: A SHORT REVIEW Converging on a definition of sustainable finance can be facilitated by understanding related concepts, including some developed before the idea of sustainable finance began to be used. A subset of institutional investors emerged seeking a socially responsible investment (SRI) approach that used a negative list screening approach to exclude investments in certain sectors (for example, tobacco, alcohol). SRI investing initially remained a niche area of primary interest to investment funds associated with religious organizations in the United States. SRI investing growth was triggered from the 1970s onward in response to pressure on large institutional investors in the United States and Western Europe to divest from certain industries, such as armaments, and to refrain from supporting investments in apartheid South Africa. From the 1990s onward, a broader set of investors sought to use environmental, social, and governance (ESG) criteria to select investments (Knoll 2002). This type of “new SRI” is generally known as ESG investing or responsible investing, a concept that is defined by the Principles for Responsible Investment as “an approach to investing that aims to incorporate ESG factors into investment decisions, to better manage risk and generate sustainable, long-term returns.”23 No standards exist to define the three types of ESG criteria. For example, the PRI considers climate change impact, resource depletion, waste pollution, and deforestation as examples of environmental criteria. ESG investing has benefitted from the wide range of indices and other financial information that has become available. Financial data information providers have more strict criteria to, for example, screen companies to decide whether they can be placed into ESG equity indices. Thomson Reuters, for example, uses three types of environmental indicators to screen companies to be included in ESG indices: resource use, emissions, and product innovation. ESG investing could be considered to be a traditional type of investing because it seeks to maximize risk-adjusted returns, as traditional investors would—but it uses ESG criteria as a screening tool to achieve that objective. In the 2000s another set of institutional investors sought to move from the passive negative screening (that is, excluding certain types of companies or projects from investment portfolios) associated with early SRI investing to a more active approach that seeks to support specific outcomes along with (or even in lieu of) financial returns. This investment approach is known as impact investing. Figure A.1 illustrates these concepts. It is important to understand these concepts because several definitions of sustainable finance rely on them (BlackRock 2016). SUSTAINABLE FINANCE DEFINED Sustainable finance can be understood as a broad concept defined by the use given to resources raised and allocated. Although the definition of concepts such as ESG and impact investing relies on approaches used to select investments and investors’ objectives, the definition of sustainable finance and concepts such as climate and green finance refer to the use given to financial resources. Sustainable finance is a broader and newer concept whose meaning is still evolving. Table A.1 presents a selection of definitions used by different organizations. 23 This definition and additional background on the PRI is provided in www.unpri.org/about/what-is-responsible- investment .83 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM Figure A.1 Investment Approaches: ESG and Impact Investing OBJECTIVE Traditional Investment Investment approach Maximize risk-adjusted financial returns Approach Maximize risk-adjusted financial returns ESG Investing using ESG investment criteria Achieve specific social, environmental or Impact Investing other outcomes along with (or in lieu of) financial returns Source: UN Environment/WBG Roadmap Team. Table A.1 Selected Definitions of Sustainable Finance Definition Source Sustainable financial system is […] one that creates, values and The UN Environment Inquiry transacts financial assets in ways that shape real wealth to serve Report: The Financial System We the long-term needs of an inclusive, environmentally sustainable Need (UN Environment Inquiry economy. 2015) Financial flows—public or private—that are allocated in a Homi Kharas and John McArthur – way that simultaneously promotes sustainable development, Brookings Institution (Kharas and including its economic, social and environmental imperatives. McArthur 2016) Sustainable finance refers to any form of financial service Swiss Sustainable Finance integrating environmental, social and governance (ESG) criteria Initiative (as defined in the into the business or investment decisions for the lasting benefit glossary presented in http://www. of both clients and society at large. sustainablefinance.ch/) Three definitions (from narrow to broad): 1. Integrating ESG EU High-Level Expert Group factors in financial decisions; 2. Finance fostering sustainable on Sustainable Finance. Interim economic, social and environmental development; 3. A financial Report, July 2017 (EC HLEG 2017) system that is stable and tackles long-term education, economic, social, environment issues, including sustainable employment, retirement financing, technological innovation, infrastructure construction and climate change mitigation. . 84 Sustainable finance in Indonesia is defined as comprehensive Indonesian Financial Authority support from the financial service industry to achieve sustainable Roadmap for Sustainable Finance development resulted from a harmonious relationship between in Indonesia 2015–2019 (OJK 2014) economic, social and environmental interests. UN ENVIRONMENT – WORLD BANK GROUP SUBSET OF SUSTAINABLE FINANCE: CLIMATE FINANCING AND GREEN FINANCING Further clarification of the meaning of sustainable finance can be obtained by defining a subset of sustainable finance; these definitions sometimes, erroneously, are used interchangeably. The UN Environment Inquiry prepared a Background Note on Definition and Concepts seeking to illustrate some of the components of sustainable finance (Figure A.2). Sustainable finance supports investments across a broad set of sectors that are required to build an inclusive, economically, socially, and environmentally sustainable world. The UN SDGs in fact define multiple areas—from health to resilient infrastructure—that are required to create a sustainable world. Driven particularly by the immense challenge posed by climate change, there has been a substantial interest and increase in climate change financing. The United Nations Framework Convention on Climate Change (UNFCCC) defines climate financing as “local, national or transnational financing, which may be drawn from public, private and alternative sources of financing … to significantly reduce emissions, notably in sectors that emit large quantities of greenhouse gases … and to adapt to the adverse effects and reduce the impacts of climate change.”24 Several terms are used for financing for emissions reduction (that is, mitigation, in the terms used by the UNFCCC) including zero-emissions, low-carbon, low-emissions, and clean energy financing. It is important to differentiate climate financing from the term green financing, which, in addition to climate, includes other areas necessary to support environmental sustainability, including biodiversity and other resources conservation. Furthermore, the term green financing is increasingly associated with financial flows from private institutions. Figure A.2 Elements of Sustainable Finance Sustainable Finance Environmental Social Economic ... other SDGs Use of financial flows Climate change Climate change Other mitigation adaptation environmental Low carbon Climate Green Sustainable Source: Adapted from UN Environment Inquiry 2016b. 24 This definition and additional background for the UNFCCC’s view of climate finance can be found at http:// unfccc.int/focus/climate_finance/items/7001.php .85 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM UN ENVIRONMENT – WORLD BANK GROUP APPENDIX B: CASE STUDIES CASE STUDY: BRAZIL – STEPS TO SUSTAINABLE FINANCE Brazil has a long tradition of harnessing its financial system for sustainable development. This process has involved a powerful dynamic between government policy, financial regulators, public financial institutions, and market actors (Vendramini, Belinky, and Monzoni 2015). This stretches back to the launch of the Corporate Sustainability Index by the B3 market in 2005, which has since outperformed the traditional benchmark.25 The Banco Central do Brasil (BACEN) took its first steps to address socio-environmental risk factors in 2008. Following the Paris Agreement, the country is now developing a strategic approach to mobilizing private capital for climate action and sustainable development. Importantly, sustainable finance offers one route out of the country’s current economic difficulties. The emerging recovery is “investment led and sustainability shaped,” with green and sustainable finance offering a way of mobilizing capital for high-quality vital agri-business and infrastructure projects. Over the past decade, key steps in Brazil’s move toward a sustainable financial system include: ¢¢ Strengthening risk management. Beginning in 2008, Brazil’s central bank introduced new requirements limiting landowner access to subsidized rural credit to those who can demonstrate compliance with environmental legislation. In 2014, BACEN introduced requirements for socio-environmental factors to be mainstreamed into the governance of risk by banks and other financial institution and published guidelines for financial institutions to implement Social and Environmental Responsibility Policies (SERP) regulations. ¢¢ Measuring green lending. The Brazilian Federation of Banks, FEBRABAN, has completed one of the world’s first estimates of how much lending has been provided for the green economy. At the end of 2015, 17 percent of total corporate loans were allocated to the green economy, with sustainable transport the largest category.26 This exercise is rooted in a low-carbon economy database that provides the foundations for more comprehensive green tagging of loans in Brazil. The most recent edition of the study “Measuring Financial Resources Allocated to the Green Economy” accounted for 87 percent of the total credit loans of the banking sector (FEBRABAN 2017). The full report presents the methodology used to measure the volume of financial resources allocated to sectors of the green economy as well as to sectors that have the potential to cause environmental damage. In 2015, a total of R$51 billion was invested in projects for the generation of renewable energy, representing less than 2.3 percent of total financing for corporate clients (R$2.1 trillion). 25 For more information about the Corporate Sustainability Index (ISE), see http://www.bmfbovespa.com.br/en_us/ products/indices/sustainability-indices/corporate-sustainability-index-ise.htm 26 For more information about FEBRABAN, see https://portal.febraban.org.br/pagina/3114/43/en-us/financial- system-green-economy .87 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM ¢¢ Integrating sustainability into the investor and insurance sectors. A growing number of Brazil’s major asset owners and asset managers have a good awareness of ESG issues. The Superintendence of Private Pension Funds (PREVIC) could strengthen this trend by ensuring that the consideration of material environmental, social, and governance (ESG) factors is part of the primary analysis of a prudent investment process (PRI 2017). In 2016, the Superintendence of Private Insurance surveyed the insurance sector to better understand the integration of sustainability factors. It is now considering a range of actions including improving disclosure, incentivizing green investments, and integrating environmental risks into underwriting policy. ¢¢ Mobilizing the green bond market. In 2016, FEBRABAN, along with the Brazilian Business Council for Sustainable Development (CEBDS), issued voluntary recommendations to grow the green bond market, based on global best practice tailored to Brazil’s circumstances (FEBRABAN 2016). Since the guidelines were brought out, the number of Brazilian issues has more than doubled. ¢¢ Designing a strategic investment plan. Brazil’s Council for Sustainable Market Development first came together in September 2016 to address the market challenges to leveraging green finance. It brings together Brazil’s public and private banks, private companies (in the energy, agriculture, and logistics sectors), asset managers, pensions, and insurers (Kidney 2017). The Council is working on a Strategic Investment Plan to identify the key opportunities, challenges, and solutions for green financing, both debt and equity. ¢¢ Carbon pricing. FEBRABAN is currently working on measuring the impact of carbon pricing in the financial system, which is expected to lead to the development of a methodology for pricing carbon and related distressed assets within the banking sector. CASE STUDY: CHINA – ESTABLISHING THE GREEN FINANCIAL SYSTEM The understanding and exploration of green finance has been a gradual, evolving process in China. For a long period after the “reform and opening-up” policy in 1978, economic development was central to the Chinese government; environmental factors, on the other hand, were not considered to be important variables that could affect the decision making . 88 of financial institutions. Until after the mid-1990s, China’s financial policies gradually imposed restrictions on certain high-pollution and energy-intensive industries in response to the central government’s requirements for economic restructuring and upgrading as well as UN ENVIRONMENT – WORLD BANK GROUP environmental protection (PBoC and UN Environment 2015). In 2007 China’s Banking Regulatory Commission (CBRC) began by developing Green Credit Guidelines that evolved from an initial, principle-based approach to a standardized, metrics- driven performance assessment. In 2014, the People’s Bank of China established a Green Finance Task Force that produced 14 recommendations across four broad themes: information flows, legal frameworks, fiscal incentives, and institutional design (UN Environment Inquiry 2016d). Following these key initiatives, and an estimate that an annual investment of at least 2 trillion yuan (US$320 billion) is needed to achieve China’s environmental targets during the 13th Five-Year Plan (2015–2020) (IISD 2015), China made rapid progress in developing a green financial system to demonstrate a systematic approach with a series of high-level policies. The aim of these policies was to address the enormous environmental challenges and ecological civilization as national strategic priorities. The CBRC introduced the Green Credit Statistics System in 2014; this system was among the first emerging market examples of regulatory guidance to define green loans. Green credit loans are classified into 12 categories with subcategories, reflecting consensus within industries on what projects are considered green. A tool has also been developed for banks to calculate the environmental benefits from green credit lending, including reduction in carbon emissions, water pollution (chemical organic demand, or COD), and savings on water use. With a standardized definition for green banking assets, it is easier for banks to issue green bonds or pilot other green banking products, such as asset-backed securitization. CBRC Green Credit Statistics also track data on loans with compliance issues on (a) environment, (b) safety, (c) deploying technologies mandated to be phased out, and (d) occupational health. At the end of 2015, CBRC’s green credit statistics for the top 21 Chinese banks (accounting for around 80 percent of total banking assets) show that (a) on the risk management side, the majority of the top 21 banks have adopted environmental and social (E&S) risk management practices at different levels; and (b) on the green loan origination side, the loan balance toward green credit exceeded US$1 trillion, representing 16 percent growth year-on- year, which is 2 percent higher than the overall lending growth rate. Green credit now makes up approximately 10 percent of these banks’ portfolios. The policy signal culminated in August 2017, right before the G20 Summit in Hangzhou. The China State Council approved the “Guidelines for Establishing the Green Financial System”— issued jointly by seven ministerial agencies including the People’s Bank of China—providing essential next steps for implementing the overall strategy of promoting ecological civilization and determining how to mobilize and incentivize more social (or private) capital to invest in green sectors, while restricting investment in polluting sectors. The Guidelines set forth 35 measures and incentives that can be grouped into the following nine action items (PBoC 2016a, 2016b): ¢¢ Establish the green financial system; ¢¢ Develop green lending; ¢¢ Enhance the role of the securities market in supporting green investment; ¢¢ Launch green development funds and mobilize social capital through public and private partnerships; ¢¢ Develop green insurance; ¢¢ Improve environmental rights trading market and develop related financing instruments; .89 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM ¢¢ Support local government initiatives to develop green finance; ¢¢ Promote international cooperation in green finance; and ¢¢ Prevent financial risks and strengthen implementation. The Guidelines also called for relevant government departments in China to adhere to the responsibilities assigned by the Guidelines, and faithfully implement all their requirements. There are follow-up documents for each of the key ministries on how to support and implement each of the action items. Key findings show some impressive progress being made in the Guidelines. This list is only a sample, as there are many other examples (UN Environment Inquiry 2017c): ¢¢ Green bond issuance (domestically and internationally) reached US$34 billion in 2016, up from US$1 billion in 2015, following the issuance of a domestic green bond catalogue and green bond guidelines. The China Security Regulatory Commission issued guidelines for green bonds issued by listed corporations in March 2017. ¢¢ Promoting environmental stress testing by financial institutions became a key component of the Guidelines. A seminar was held in Beijing in mid-July 2017 to discuss the scope, methods, and purpose of environmental risk analysis. This effort is led by the Green Finance Committee of China Society for Finance and Banking. ¢¢ The Securities Regulatory Commission publicly encouraged Chinese investors to become Principles for Responsible Investment (PRI) signatories in October 2016. ¢¢ Pilot zones will be set up in the Guangdong, Guizhou, Jiangxi, and Zhejiang provinces and the Xinjiang Uyghur autonomous region to boost green finance in China. The decision was made at the State Council executive meeting on June 14 to improve the green financial system (english.gov.cn 2017). CASE STUDY: EUROPEAN UNION – STEPS TOWARD A SUSTAINABLE FINANCIAL SYSTEM . 90 The European Union (EU) has often been at the forefront of efforts to promote green and sustainable finance, driven by civil society advocacy, financial institution efforts, and initiatives by Member State governments as well as by action taken at the EU level itself. UN ENVIRONMENT – WORLD BANK GROUP However, what has been missing has been an overarching strategy that responds to the scale of the financing challenge represented by the Paris Agreement and the Sustainable Development Goals. For this reason, the European Commission launched a high-level expert group in September 2016 to produce a roadmap for a sustainable financial system.27 The group brings together experts from across the financial system along with academics, civil society representatives, and public sector organizations. 27 For details about the European Commission’s work on this roadmap, see https://ec.europa.eu/info/business- economy-euro/banking-and-finance/sustainable-finance_en Until recently, EU action to promote sustainable finance focused mostly on the deployment of public finance through the European Investment Bank and the EU budget. This approach was given added importance with the launch of the EU’s plan for economic recovery following the financial crisis: at least 40 percent of the next phase of the European Fund for Strategic Investments is expected to be allocated to climate action. Increasingly, however, sustainability factors have also been incorporated into EU financial regulation, notably in terms of corporate disclosure and pension regulation. In addition, there has been growing interest in incorporating the sustainability dimension into the EU’s Capital Markets Union, which is designed to find new ways of mobilizing finance for infrastructure and small and medium enterprises (SMEs), for example, through fintech innovations (UN Environment Inquiry 2016e). The momentum for change built on increasing action at the national level to incorporate sustainability into financial system strategy. Key policy highlights include: ¢¢ France. The Energy Transition Law has a specific focus on finance, with new reporting requirements for financial institutions and investors on their alignment with climate goals. In addition, France has introduced labels for green financial products and Paris has launched a dedicated Finance for Tomorrow initiative.28 ¢¢ Italy. A one-year national dialogue on sustainable finance produced a comprehensive set of recommendations in February 2016. This has led to the establishment of a new national observatory, focusing on Milan as a center for sustainable finance and on ways to mobilize sustainable finance for the country’s reindustrialization plans (UN Environment Inquiry 2017d). ¢¢ Netherlands. The Dutch Central Bank (DNB) has led a national assessment of the implications of climate change for the economy and financial system. This has prompted the integration of environmental, social, and governance (ESG) factors into financial supervision as well as the formation of a sustainable finance platform with private sector institutions.29 ¢¢ Sweden. The government has made sustainable development a goal for the financial sector. This has been followed by initiatives to promote sustainability disclosure by pension funds, explore labeling for financial products, and scale up green bond issuance (Government of Sweden 2017). ¢¢ United Kingdom. The Prudential Regulatory Authority has investigated the implications of climate change for the insurance sector; this has been extended to the banking sector. The City of London has established its own Green Finance Initiative,30 and the government is promoting green finance in its international relations with Brazil, China, and India. 28 For further details about France’s Finance for Tomorrow initiative, see http://www.paris-europlace.com/en/our- priorities/sustainable-finance 29 For information about DNB’s Sustainable Finance Platform, see https://www.dnb.nl/en/about-dnb/co-operation/ platform-voor-duurzame-financiering/ 30 Information about the Green Finance Initiative can be found at http://greenfinanceinitiative.org/ .91 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM The interim report of the EU’s high-level expert group was published in July 2017. This identified a two-fold focus for sustainable finance: first, strengthen financial stability and asset pricing by improving the assessment of long-term sustainability factors; and second, mobilize capital to support the transition to sustainable development in the real economy, notably for households, SMEs, and infrastructure—identifying a gap of €180 billion per year in investment for climate action alone. Although many initiatives are underway across Europe, urgent action is still needed both to help stimulate economic recovery and to meet key environmental targets. To start with, a set of five principles was highlighted. These stressed the need for the financial system to consider full value, to be productive, to be resilient, to demonstrate alignment with sustainability, and to take a long-term perspective. Putting these principles into practice led to a series of early recommendations for reforms in the policy architecture and market infrastructure, including: ¢¢ The introduction of a classification system for green and sustainable assets, including an EU green bond standard; ¢¢ The establishment of a common set of principles for implementing fiduciary duty; ¢¢ Further strengthening of disclosure rules, notably to incorporate recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures; ¢¢ The introduction of “sustainability tests” for all future EU financial regulations and policies; ¢¢ Consideration of a Sustainable Infrastructure Europe to match-make between private investors and public authorities; and ¢¢ Positioning the European supervisory authorities—for banking, insurance, and securities—to respond to the sustainability challenge. A range of tough issues was identified for further discussion, including how to overcome market short-termism, how to integrate sustainability into credit ratings and market benchmarks, how to establish “capital raising plans” setting out investment pipelines, and . 92 how to involve society more actively in the development of sustainable finance. Following consultation, a final roadmap will be delivered by the expert group at the end UN ENVIRONMENT – WORLD BANK GROUP of 2017, followed by a formal response from the European Commission. Importantly, the exercise has already had results, bringing the sustainability agenda more fully into the Capital Markets Union and generating a positive debate on how finance can move from a post-crisis focus on stability to one emphasizing contribution to the wider economy. CASE STUDY: INDIA – DEVELOPING RENEWABLE ENERGY AND ENERGY EFFICIENCY MARKETS Financing India’s goals for inclusive and sustainable development requires more, lower cost, and longer-term capital. Raising incomes for the 800 million people living on less than US$2 per day, creating livelihoods for the 12 million people entering the workforce every year, and regenerating the natural resource base at a time of climate change requires innovative approaches to sustainable finance. The past two years have seen a marked shift in both market and policy efforts to rise to the challenge. In 2016, a joint report produced by the Federation of Indian Chambers of Commerce and Industry and the UN Environment Inquiry outlined a set of steps, which were welcomed by the government (UN Environment Inquiry 2016f). A set of interlocking actions have been taken to scale up finance for renewable energy: ¢¢ Priority sector lending. The Reserve Bank of India (RBI) requires banks to allocate 40 percent of their lending to priority sectors in the Indian economy, including agriculture, infrastructure, education, and small and medium enterprises (UN Environment Inquiry 2016f). In April 2015, the priority sector lending framework was expanded to include lending for decentralized renewable energy (RBI 2015). The aim was to encourage lending for renewables, which would increase access to energy and would not necessarily be financed through market forces alone. ¢¢ Market commitments. As part of its effort to increase India’s renewable energy capacity to 175 gigawatts (GW) by 2022, the Ministry of New and Renewable Energy has agreed to voluntary financing commitments with 40 banks to finance 78 GW of renewable energy capacity by 2019.31 This will require investments of approximately US$100 billion, US$70 billion of which would come from debt. ¢¢ Green bonds guidelines. As of July 2017, Bloomberg estimates that US$2.1 billion of green bonds were issued in India (compared to US$9.3 billion in China). Last year, the Indian market represented the 7th largest green bond issuer worldwide, with a total issuance of US$2.7 billion. A key factor in the growth of this market has been the role of the development of disclosure requirements by the securities regulator, the Securities and Exchange Board of India (SEBI).32 The guidelines build on international best practice, provide greater certainty for issuers and investors, and will be a catalyst for market development. L&T Infrastructure Finance Company raised R677 crore (US$103 million) in the first green bond approved by SEBI (Mahapatra 2017). The International Finance Corporation (IFC) provided the financing. While India may not be the largest national green bond market, it has been notably innovative. In 2016, IFC also invested in the country’s first green bond focused exclusively on green residential buildings with Punjab National Bank Housing Finance. Several financial institutions—both traditional banks and nonbank 31 Information about India’s Ministry of New and Renewable Energy commitments is available at https://re-invest.in/ about-re-investment/green-energy-commitments/# 32 The Securities and Exchange Board of India’s Circular No. CIR/IMD/DF/51/2017 describing Disclosure Requirements for Issuance and Listing of Green Debt Securities is available at http://www.sebi.gov.in/legal/circulars/ may-2017/disclosure-requirements-for-issuance-and-listing-of-green-debt-securities_34988.html .93 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM financial institutions—have used green bonds to access capital markets and attract new investors, both local and international. This market is expected to continue to expand quite quickly. Bloomberg New Energy Finance projects that there will be US$10 billion invested in India’s clean energy this year, with over 13 GW of renewable energy capacity added every year from 2017 onward. CASE STUDY: MOROCCO – A NATIONAL ROADMAP FOR SUSTAINABLE FINANCE At the 22nd Conference of the Parties (COP 22) in November 2016, Morocco launched a national roadmap for aligning the Moroccan financial sector with sustainable development (Bank Al-Maghrib 2016). Developed in collaboration with Bank Al-Magrib (Morocco’s central bank), regulatory authorities, and market associations, the roadmap sets out a strategic vision for Morocco’s financial center around five axes: ¢¢ Extending risk-based governance to social and environmental risks; ¢¢ Developing sustainable financial instruments and products; ¢¢ Promoting financial inclusion as a driver for sustainable development; ¢¢ Building capacity in the field of sustainable finance; and ¢¢ Ensuring disclosure (transparency and market discipline). Several Moroccan authorities are now seeking to take the recommendations of the roadmap and put them into practice. Insurance: ACAPS, Morocco’s supervisory and regulatory authority for insurance, is now designing a strategic approach to implement roadmap targets into the insurance market. At a high level, the roadmap confirms the importance of insurance firms as sources of sustainable finance instruments and as sources of capital for investments in development projects. ACAPS is now developing a strategy to achieve targets for the insurance sector in . 94 the roadmap alongside other priorities, including: ¢¢ Systematically assessing the sustainability impacts of financing and investment decisions; UN ENVIRONMENT – WORLD BANK GROUP ¢¢ Integrating sustainability factors into risk management and assessment systems; ¢¢ Assessing the potential for carbon risks to investment portfolios; ¢¢ Scaling up capital allocation toward green assets, with a projected target of MAD6 billion over a five-year timeframe; and ¢¢ Developing new insurance solutions for environmental risks, such as climate change. Financial center development: Incorporating sustainability considerations can facilitate the development of financial centers (UN Environment Inquiry 2017d). The Casablanca Finance City Authority is now working toward this goal by convening a first meeting of international financial centers working on sustainable finance, with the support of UN Environment (UN Environment Newscentre 2017). CASE STUDY: RUSSIA – CREATING MARKET FOR RESIDENTIAL ENERGY EFFICIENCY FINANCE The Challenge Over 140 million people live in Russia, with almost 100 million living in multifamily buildings (MFBs). Most of these buildings require energy efficiency repairs because little consideration for energy efficiency was given at the time these buildings were built (the average age of an MFB in Russia is 43 years). With the Russian housing sector being the second largest end- user of energy, Russia can significantly reduce its greenhouse gas (GHG) emission footprint (Russia is the world’s fifth-largest GHG emitter) by mobilizing private sector investment in the energy-efficient modernization of its housing stock. Despite this potential, little investment into MFB energy-efficient retrofits has taken place because of a range of barriers. These barriers can be categorized into three main groups: (a) an underdeveloped legal and regulatory environment, (b) a lack of financing mechanisms for MFB retrofits (despite a well-developed mortgage market to finance purchases of individual apartments/houses), and (c) the low level of awareness about energy efficiency among all stakeholders (government, financial institutions, and home owners). Addressing these barriers required a systematic approach and change. This case study describes how the Russian government, with support from the World Bank Group, has been addressing these challenges to create a new market for financing energy-efficient retrofits of MFBs. The key milestones on the way to a new market included: (a) the development of a new legal and regulatory framework for MFB retrofits, (b) the development of a corresponding institutional framework, (c) the launch of a state incentive program targeted at energy efficiency in MFBs, and (d) capacity building for all groups of stakeholders (the public sector, the financial sector, and the general public). In the four years since the Russian government has embarked on this reform agenda, a combination of policy actions, institutional development, and public finance measures has resulted in over US$4 billion mobilized for investment in MBF modernization across the Russian Federation. Key Milestones Russia lacked a basic legal framework for facilitating the capital renovation of MFBs. Putting this framework into place was a prerequisite for enabling energy-efficient renovation in MBFs. Therefore the first and most critical step toward reforming the housing sector was the adoption of the Law on Capital Repairs in 2013—a groundbreaking legislation that gave impetus to a new system for financing the renovation of MFBs. This law formed the basis for private sector participation in MFB retrofits: it made homeowners financially responsible for their building retrofits, created a mechanism for channeling funds from homeowners .95 ROADMAP FOR A SUSTAINABLE FINANCIAL SYSTEM into financial institutions, and created conditions for private sector players (for example, commercial banks, construction companies, energy efficiency equipment manufacturers) to work together to facilitate MFB renovation. The new system became functional as the law removed main risks that had precluded these players from entering this market. It has also enabled banks to create specialized savings and loans products. The new legal framework introduced the notion of special accounts—a bank account attached to an MFB with special features designed to accumulate and protect savings for building retrofits. As part of its strategy for the development of the housing sector, the Russian government has placed an emphasis on the transition to a special accounts system and the development of private sector financing for capital and energy-efficient repairs of MFBs. In four years since the start of a new system about 80,000 buildings have set up special accounts, having accumulated US$500 million. Once the basic framework for MFB renovation had been put into place, the Russian government took the next step on its housing sector reform path with a focus on energy efficiency. In 2017 the government piloted a state program that provides financial incentives to MFB homeowners for combining building retrofits with energy efficiency measures. The program is designed in a way that integrates private sector investment with public policy objectives. This program provides financial assistance to homeowners in exchange for achieving measurable reduction in buildings’ energy consumption. At the same time, the program aims to spur market growth in bank lending for MFB retrofits by providing access to bank loans on preferential terms. Early Signs of a New Market Developing The Russian market for residential energy efficiency financing is in an early stage of development but has already reach several milestones: (a) over US$4 billion in private savings have been mobilized over the last three years, (b) banks have made their entry into the sector by providing specialized savings and loan products, (c) a government program has been put into place that provides targeted financial incentives to promote energy efficiency, and (d) a multitude of private sector players are working together to make the Russian housing stock energy efficient. . 96 UN ENVIRONMENT – WORLD BANK GROUP Re fe ren ces AXA Group. 2016. Award on Investor Climate-related Disclosures. AXA Group. https://www- axa-com.cdn.axa-contento-118412.eu/www-axa-com%2Fcb46e9f7-8b1d-4418-a8a7- a68fba088db8_axa_investor_climate_report.pdf Bank Al-Maghrib. 2016. Roadmap for Aligning the Moroccan Financial Sector with Sustainable Development. 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