Rethinking the Role of Finance in the Net-Zero Transition

The Institute of International Finance (IIF) has published a thought-provoking staff paper that challenges the prevailing narrative around the financial sector's role in the net-zero transition. The report offers a nuanced perspective, highlighting the need for a balanced approach that aligns policy measures, regulatory frameworks, and international financial architecture to enable the real economy to drive the transition.

Unlocking the Power of Transition Finance

Aligning Policy and Finance for a Just Transition

The IIF report emphasizes the essential role of policy measures in creating the conditions for a pro-growth, net-zero transition. It acknowledges the enormous costs associated with decarbonization and recognizes that the financial sector can only support this transition when the underlying economics make sense. This reality, the report argues, is often overlooked in the expectations placed on the financial industry.The report highlights the need to reassess the prevailing "finance-centric theory of change" for the net-zero transition. It cautions that regulatory and supervisory approaches based on this theory can actually impede the financial sector's ability to contribute effectively. The report identifies three key concerns: the differences in approaches to transition finance, the conflation of financial sector activities to support the transition with climate-related financial risk, and the overreliance on metrics based on financed emissions as risk indicators.

Strengthening the Real Economy's Role

The IIF proposes a shift in emphasis, calling for a greater focus on scaling up transition activity and demand for transition finance across the real economy. This shift recognizes that the financial sector must follow the lead of the real economy, rather than attempting to drive the transition itself.The report outlines three key priorities for moving forward:1. Strengthening real economy policy frameworks and developing national-level transition strategies2. Ensuring that financial sector policy remains risk-based and is not used as a substitute for broader net-zero policy measures3. Enhancing the international financial architecture in support of transition finance in emerging and developing economies

Bridging the Divide: Bipartisan Collaboration for Climate Solutions

The article acknowledges the differences in approaches between liberals and conservatives when it comes to addressing climate change. While liberals tend to see the financial sector as leading the energy transition, conservatives often place more emphasis on technology and innovation in the real economy, including a broader range of solutions beyond renewable energy.The author argues that neither side has all the right answers, and that it is essential for those with different theories of change to work together to create stable, bipartisan solutions. This collaboration is necessary to establish the appropriate regulatory environment that the IIF report calls for.

Navigating the Complexities of Climate Finance

The article examines several organizations that exemplify the "finance-centric theory of change," including the Glasgow Financial Alliance for Net Zero (GFANZ) and Climate Action 100+. While these groups have made significant strides in mobilizing the financial sector, the author expresses skepticism about the effectiveness of their approach, particularly in light of the IIF's findings.The article also explores the role of environmental NGOs, such as the Sierra Club and 350.org, which have taken a more confrontational approach, focusing on exclusion and divestment from fossil fuel companies. The author suggests that these strategies may be misaligned with the IIF's call for a more balanced, policy-driven approach to the net-zero transition.

Toward a Balanced and Bipartisan Approach

The article concludes by emphasizing the need for a more balanced and bipartisan approach to addressing climate change. The author suggests that a global price on carbon could be a more effective solution than the current focus on targets and disclosures, although acknowledges the challenges in achieving such a policy.The key, the author argues, is for all stakeholders to approach the net-zero transition with an open and collaborative mindset, guided by the insights and recommendations of the IIF report. By working together to create the appropriate regulatory environment and enabling the real economy to drive the transition, the financial sector can play a supportive and constructive role in addressing the global challenge of climate change.