How can we pay for sustainable development?

Finance for sustainable development involves big numbers. If current levels of investment in sustainable development projects are anything to go by, developing countries will have a $2.5 trillion annual gap to plug. Most estimates suggest we need $6 trillion a year in infrastructure investment, much of which needs to be “greened”. More broadly, we need to align all global investments ‒ estimated to be between $20 trillion and $25 trillion ‒ with the goals of sustainable development.

What makes matters worse is that many sustainable development challenges are urgent for individuals, communities and the world as a whole. We can’t wait for the “right” carbon prices, for technology costs to fall, or for citizens to voluntarily change their ways. We need to start making changes now, or the forces of nature will undermine any of our future efforts.

Plugging a multi-trillion dollar gap

Conventionally, the way to finance public goods is to use public finance – such as by subsidising renewables. But because we are talking about trillions, not billions, there is simply not enough public finance to do the job. Even in China, where the state of public finances is comparatively good, at least at the national level, the People’s Bank of China estimates that public finance can only meet about 15% of green financing needs.

So private finance is needed: and lots of it. Global financial and capital markets handle over $300 trillion in financial assets, mainly through bank lending and the value of shares on stock exchanges and bonds. Today, little of these funds are being used to finance sustainable development, and quite a lot is being used to finance environmentally and socially unsustainable economic activities, from dirty coal and inefficient buildings to water and carbon-intensive agriculture. Indeed, much private finance is used for profitable short-term trading, not really touching the real economy, yet dragging much-needed funds away from more productive uses.

At the same time, the owners of the world’s financial assets – citizens – are also in crisis. With low interest rates, these people are unlikely to get the buying power and security they once hoped to see from their savings. The financial system is failing in its traditional role of effectively connecting the owners and users of financial wealth, threatening to impoverish generations of savers and damage the basis on which economic wealth is created – a healthy, inclusive, sustainable real economy.

The financial system we need

So when People’s Bank of China Deputy Governor Yi Gang took to the stage at the IMF/World Bank Annual Meetings in Lima earlier this year, he opened a new chapter in policy debate about the future of financial and capital markets. Announcing a new workstream on green finance under China’s G20 presidency, he was not simply recognizing the importance of sustainability or the climate: he was signalling the need to develop a global financial system fit for the 21st century.

Yi Gang’s comments place him on the right side of history. A quiet revolution is taking place, as growing numbers of central bankers, financial regulators and financial market standard-setters take practical steps to integrate sustainable development considerations into financial market reform and development. These are the core findings of a two-year inquiry from the United Nations, outlined in a report, The Financial System We Need.

Developing countries have led this development. The Indonesian financial services authority has set out a 10-year “sustainable finance roadmap” covering capabilities, information, and fiscal and regulatory measures. Brazil’s central bank has imposed environmental risk regulations on the country’s banking community and Kenya’s central bank has championed the introduction of mobile-based payment services as a means to increase financial inclusion. South Africa has adjusted its pension regulations to ensure that trustees take social and environmental considerations into account. The People’s Bank of China has made a series of regulatory, legal, fiscal and institutional recommendations for greening China’s financial system that will be taken forward as part of the 13th Five Year Plan.

Some developed countries have also joined this leadership group. The Bank of England is a case in point, as is France, with its recent policy measures requiring financial institutions to report on their carbon footprint and climate risks. Almost 30 stock exchanges have signed up to the Sustainable Stock Exchange Initiative, committing to advancing sustainable development reporting in listing requirements. S&P ratings have incorporated climate risks into sovereign credit ratings, and guidelines have emerged to ensure continued robust growth in the issuance of green bonds.

The financial system, like the health or energy systems, has an overarching purpose – to ensure that financial flows support inclusive, sustainable prosperity. While exemplary banks or insurance companies show their leadership through social and environmental responsibility, the real task lies with policy-makers, regulators and standard-setters, who should be shaping the rules of the financial system to ensure it is meeting its broader goals.

The need to finance sustainable development is indisputable – whether this is understood through the lens of national development priorities or the need for international action in addressing global challenges such as climate change. Fortunately, the conditions are right to start better aligning the financial system with these needs.

Author: Simon Zadek is the co-Director of the UNEP Inquiry into Design Options for a Sustainable Financial System. You can follow him on Twitter via @SimonZadek

The Inquiry’s global report, along with many underlying working papers, can be downloaded at www.unepinquiry.org.  An earlier version of this commentary was published on www.chinadialogue.org

Image: Smog shrouds Chile’s capital Santiago, June 22, 2015. REUTERS/Ueslei Marcelino