Speech Cindy van Oorschot - "Overcoming obstacles to sustainable finance"
Higher carbon pricing and phasing out fossil subsidies is crucial for improving the business case for green investment. That was emphasized by Cindy van Oorschot, Director of the Strategic Sustainable Finance Programme of De Nederlandsche Bank, at the Green Finance seminar hosted by the Netherlands and UK Embassies in Bangkok. It is one of the policy recommendations from the research report ‘Financing the Transition’ that DNB published last month
Datum: 7 juli 2021
Locatie: Green Finance seminar by the Netherlands and UK Embassy, Bangkok
Spreker: Cindy van Oorschot
It’s an honor and a pleasure to speak with you today on this important topic that concerns us all.
Both Thailand and the Netherlands are proud sovereign nations that have been independent for centuries. But our economies and our societies are not independent. They are constantly influenced by global developments. Look at the Covid crisis. And then there is that other global crisis: climate change.
I work for the Dutch central bank. Together with the European Central Bank, we are the monetary and financial stability authority, and the prudential supervisor in the Netherlands. We are also an economic advisor to the government. As a central bank we have come to recognize that climate change is a major threat to the economy, and to the stability of the financial system. And not only climate change, but also other ecological challenges. Dutch financial institutions alone have over half a trillion euro in exposures to companies that are highly dependent on a well-functioning ecosystem. That’s almost two-thirds of our gdp. Not just agriculture, but all kinds of companies whose business may be at risk due to biodiversity loss and other forms of environmental degradation.
In order to reach the Paris Agreement objectives and prevent catastrophic climate change, an energy transition is needed. A just and fair transition, that enables all countries around the world to make their economies sustainable. The longer we wait, the more expensive it gets. Based on data from the International Energy Agency, we need to invest an additional 8% of world GDP cumulatively over the next ten years to get the world economy on a sustainable path. The private sector will have to make the bulk of this investment. That is perfectly feasible. Yet, in many countries, including my own, current investment levels are insufficient. The question is why? And how can we scale up green investment?
Last month we published a research report called ‘Financing the Transition’, in which we tried to provide answers to exactly these questions. We wrote this report primarily from a Dutch perspective. Because there is still so much work to be done in my own country to make the transition to net zero. But other countries may wrestle with similar issues, so that’s why I bring it up here.
We identified three main obstacles to sustainable finance.
First of all, the business case for sustainable investments is still poor. Often the risks do not outweigh the returns compared to carbon-intensive investments. Key reasons for this are the lack of an effective carbon pricing system, and uncertainty about long-term government policies.
Second, investments are needed in new, and sometimes unproven, technologies and firms. These investments have a high risk profile. But often there is a lack of private equity or venture capitalists with a sufficient risk appetite to fund these investments.
Third, existing carbon-intensive companies still have insufficient financial incentives to invest in making their business more sustainable. This is largely because carbon pricing does not sufficiently reflect the true climate cost. But also because banks and other financial firms that fund carbon-intensive businesses still insufficiently take into account climate-related risks. For example, the risk that these businesses may not be economically viable in the long run.
What can policymakers do to reduce these obstacles to sustainable finance?
First of all, we need the price of carbon emissions and other greenhouse gasses to go up. That will make it far easier for firms and households to determine the future value of their assets and liabilities. This will alter their incentive framework. Then, market forces will drive things in the right direction. This ball lies squarely in the court of governments. Preferably on an international or regional level, to preserve a level playing field for business. Effective carbon pricing is the one thing that will make all the other things that we do, much more effective.
Next, better carbon pricing needs to be part of a consistent, long-term transition plan. A plan that provides answers to questions like: what emission targets will be met and when? What actions are needed to achieve these targets? What investments will the government make itself? A credible long term plan is needed, that is also still in place when the next government takes over. This gives investors a sense of where the country is going. It offers perspective, provides opportunities, and reduces investment risk.
A big obstacle that we highlighted in our report, and that was also mentioned by previous speakers, is the lack of good data on sustainability. It makes it more difficult for the financial industry to manage risk and assess investment opportunities. And it’s also an obstacle for supervisors and central banks. That is why internationally comparable and mandatory climate-related financial disclosures, that are subject to assurance, are an essential part of our transition to net zero. We therefore very much welcome the ongoing initiatives to develop international sustainability reporting standards quickly.
In summary, what is now needed to get climate investments going, in my own country but presumably in many other countries as well, is a combination of pricing, government support and regulation. Higher carbon pricing and phasing out fossil subsidies is crucial for improving the business case for green investment. Governments need to support innovative firms and technologies with subsidies, co-financing and guarantees. Take the example of wind energy in the Netherlands. Government support, combined with a clear roadmap for offshore wind parks, has led to substantial cost reductions. Due to a combination of a minimum price guarantee and construction of infrastructure, part of the uncertainty has been eliminated and private investment in wind turbines has increased greatly. The cost of offshore wind energy consequently fell by over 70 percent. As a result, this technology can now compete with fossil alternatives in the market without subsidies.
Most items on the to-do list are mostly a task for governments. But central banks and financial supervisors also have a role to play. As a supervisor, we at the Dutch central bank expect financial institutions under our supervision to manage their sustainability-related financial risks. As a welcome by-product, this will over time contribute to redirecting funds away from fossil-fuels and towards sustainable investments. Furthermore, central banks can contribute by greening their reserve management and monetary policy operations. In the global Network for Greening the Financial System, central banks and supervisors from around the world, including the Bank of Thailand and my own institution, work together by exchanging knowledge and experiences.
I’d like to end by saying a few words about the need for cooperation. What makes the transition to a carbon-neutral economy so complex is the detailed interaction between regulation, investment projects and available finance. Our experience is that financial institutions really want to play a part in financing the energy transition. But it’s often hard for them to find investible and scalable projects that meet their risk-return requirements. At the same time, developers of investment projects often can only make a good business case if the government introduces regulation. And the government is looking for input from the other sectors to tailor the rules so the investment money can start flowing.
Our experience is that to solve this coordination problem, you have to get around the table together. In the Netherlands we set up the Sustainable Finance Platform. Through this platform, which we chair, the financial sector, supervisory authorities and government ministries work together on sustainability initiatives.
A prime example of good cooperation is the climate commitment that the Dutch financial sector signed in summer 2019. Fifty banks, insurers, pension funds and asset managers pledged their commitment to the government’s climate goals, and signed up to mandatory reporting on the climate impact of their loans and investments, and to have reduction plans in place. The Ministry of Finance and the Ministry of Economic Affairs and Climate are also involved to ensure this commitment is met.
It’s important that someone takes up a convening role. This could be the central bank, the government, the supervisor, or any other party, depending on the national institutional setup. Ultimately, what is most important is getting all parties involved around the table, to learn from each other, build knowledge, and overcome obstacles to sustainable finance.
Because independent though we may be as nations, climate change impacts us all. If we want to preserve what is valuable to us, we will have to change course and work together to get our countries to net zero in time.