An investment emissions intensity tax would challenge funds to match their net zero declarations with actions.

David

Marie

Nadia

The introduction of an investment emissions intensity tax to penalise investors based on the emissions their portfolios finance could challenge funds to match net zero declarations with actions.&nbsp;
This is supposed to be the golden age of climate disclosure. But despite their catastrophic emissions, business is booming for oil and gas majors: ExxonMobil&rsquo;s share price hit an all-time high this February, BP executive pay doubled, and Shell reported its highest profits in 115 years, all while G20 countries subsidised oil, gas, and coal to the tune of $3.2tn between 2016 and 2020.
And although fund managers are swimming in environmental, social, and governance ratings, only a minority of ESG and climate-themed funds have portfolios aligned with Paris Agreement targets. Some still have significant fossil fuel-related holdings, justifying these with promised transition plans rather than actual emissions and investment plans.&nbsp;
<h2>The current landscape</h2>
Governments have pinned their hopes on the power of disclosure to direct capital toward low-carbon assets. It is not working &mdash; the current incentives to invest in the net zero transition are too weak. When it comes to sustainable investing, sunlight is not the best disinfectant.&nbsp;
That leaves high-carbon industries with booming capital flows, locking in future emissions. Meanwhile, low-carbon businesses struggle to secure the investment they need. It adds up to climate catastrophe.&nbsp;
It is time to consider the case for taxing investment portfolios based on the emissions they finance &mdash; not just on their returns.&nbsp;
<h2>The power of a tax</h2>
An investment emissions intensity tax would penalise investors if their portfolio emissions intensity exceeded thresholds tied to net zero pathways. That would incentivise funds &mdash; and the companies in which they invest &mdash; to set a credible course for net zero emissions. Funds that fail to do so would shoulder a major tax burden. As a result, businesses that fail to reduce their emissions would struggle to secure affordable capital.&nbsp;
Unlike carbon or income taxes, this does not aim to boost revenue. Funds could minimise their tax exposure by aligning their portfolios to net-zero targets. Instead, it is designed to change behaviour. An advance notice period before the investment emissions intensity tax is implemented would allow funds to engage with investees early and adjust their portfolios to avoid liabilities.&nbsp;
The scale of that change could be enormous. We studied its potential impact on OECD-based regulated funds: insurance, pension, and investment funds which hold around 25 percent of global corporate debt and equity securities. The results show that this tax could directly influence substantial investment flows &mdash; these funds represent an asset base of $44tn.&nbsp;
<h2>A backstop for carbon pricing&nbsp;</h2>
An investment emissions intensity tax has a set of distinct advantages, making it a powerful backstop for emissions trading schemes and disclosure and investment taxonomy policies.&nbsp;
First, the tax treats asset classes neutrally, giving funds the flexibility to implement their own net-zero strategies. Low-carbon replacement of embedded fixed assets, an essential part of the net zero transition, can often only be funded with conventional equity or debt. An asset-neutral tax enables that.
Second, it can be implemented across borders. While carbon taxation is constrained by territorial limits, an investment emissions intensity tax accepts the reality that funds invest internationally.&nbsp;
Third, with little need for international coordination, the tax could be implemented within a decade. Speed matters in climate finance policymaking &mdash; just 4 percent of global emissions in 2022 were covered by carbon prices aligned with global warming of 2C.&nbsp;
Fourth, it is powerful enough to include indirect emissions &mdash; those embedded in supply chains, or released when products are used. Even the most influential carbon accounting and disclosure initiatives, including the Greenhouse Gas Protocol and the Task Force on Climate-Related Financial Disclosures, allow Scope 3 reporting to remain voluntary. Including those emissions in this tax will drive companies to focus on energy-efficient processes and product design and minimise greenwashing.&nbsp;
An obvious risk is offshoring &mdash; that regulated funds divest polluting assets to investors who are not covered by the tax. This risk can be reduced by setting tax thresholds by sector. This penalises the most polluting outliers within sectors, instead of creating excessive exposure (and offshoring risk) for the most emissions-intensive industries.&nbsp;
Outliers would be incentivised to reduce their emissions by the promise of keeping hold of their access to capital from regulated funds.&nbsp;
Even with all that optimism, all these schemes, and all those headlines, climate disclosures do not have the power to divert capital away from fossil fuels quickly enough. An investment emissions intensity tax would challenge funds to match their net zero declarations with actions.
This article is also published in <a href="https://www.sustainableviews.com/disclosure-isnt-enough-its-time-to-tax-high-carbon-investment/?xnpe_tifc=4uQuxDnjxk4uxIQuxdbJbjpsafeWaeiWhFWctue" target="_blank" rel="noopener">Sustainable Views</a><span data-slate-node="text" data-slate-fragment="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">. illuminem Voices is a democratic space presenting the thoughts and opinions of leading Sustainability &amp; Energy writers, their opinions do not necessarily represent those of illuminem.

Disclosure isn’t enough: It’s time to tax high-carbon investment

Transparency on climate risks is important, but it will not divert capital away from fossil fuels without big structural changes to the financial system.

Transparency on climate risks is important, but it will not divert capital away from fossil fuels without big structural changes to the financial system.
Mark Carney&rsquo;s eye-popping promise last week that up to $130tn of private capital would be committed to net zero has been widely questioned. But his other big finance announcement at the UN climate summit &ndash; such as new requirements for the biggest UK firms to make and disclose transition plans &ndash; received less scrutiny. It came days after the UK government <a href="https://www.gov.uk/government/news/uk-to-enshrine-mandatory-climate-disclosures-for-largest-companies-in-law">announced</a> that climate financial disclosures would become mandatory.&nbsp;
It&rsquo;s the latest in a stream of regulators and central banks &ndash; from China to the US &ndash; introducing similar regimes as governments pin their hopes on the power of disclosure to direct capital towards low-carbon assets.
The idea behind it is simple: more transparency on climate risks and the fear of stranded assets should push investors away from dirty assets and increase appetite for green investment. But in practice, transparency relies on a pair of untested assumptions that raise serious questions about its ability to shift capital.
<h1>Fundamentals dictate investor behaviour</h1>
The first is that transparency on climate risk will be enough to motivate investors to move away from carbon intensive assets to reduce risk &ndash; in other words, the idea that sunlight is the best disinfectant.
But the world&rsquo;s most valuable commodity, oil, highlights the holes in that idea. The US and Europe&rsquo;s decline in fossil fuel sector valuations relative to the broader market began well before financial regulators started to consider climate-related risk disclosure in 2015. It wasn&rsquo;t climate risk reporting that moved investors - it was OPEC&rsquo;s decisions that made oil a weaker investment.
Equity returns from fossil fuels are less attractive now than they have been in the past, following years of decline. That simple reality plays a weightier role in investor decisions: it&rsquo;s no wonder that a <a href="https://academic.oup.com/rfs/article/33/3/1067/5735302">survey</a> of institutional investors found they ranked climate risks far lower than other investment risks.&nbsp;
The second assumption worth unpicking is that more transparency will lead to investors &lsquo;switching&rsquo; from dirty to clean assets. It sounds sensible, but in reality, there is no single &lsquo;energy investment system&rsquo; where capital easily moves from one technology towards the other.
Instead, these are two diverse asset classes that markets treat differently. On one hand, fossil fuels represent a highly consolidated industry, dominated by multinationals and large state actors. On the other, the renewable industry remains a young and fragmented sector missing its &ldquo;majors&rdquo;. Despite its rapid growth, it&rsquo;s still characterised by many small participants, often operating in only one market.
That results in lower revenues and market capitalisation, limiting renewables&rsquo; ability to attract investment. For the last few decades, fossil fuel assets have attracted large, stable investments from institutional and investment funds. In contrast, renewable energy assets often still fail to meet investors&rsquo; liquidity criteria because of their small size and daily traded volume.
That means these assets aren&rsquo;t easily switched, no matter how much climate risk is disclosed, because they have their own unique characteristics and risk factors. No investor will sell a fossil asset and replace it directly with a renewable one.
<h1>Policy cannot shirk responsibility</h1>
Understanding what transparency can&rsquo;t do tells us what else regulators should be considering instead. Structural changes to the financial system, like innovation in low-carbon financing, are more likely to increase climate finance flows.&nbsp;
First, the financial ecosystem needs to expand to bring low-carbon investing into the mainstream, making it more attractive to investors. This means scaling up existing green financing channels like green bonds and ETFs, and further securitisation of alternative energy assets that appeal to broader financial market participants. Climate and energy policies need to play their part by incorporating financing considerations &ndash; like investor preferences, risk appetites and capital base &ndash; into policy design to create a stronger ecosystem for green assets.
Second, green policies need to be better integrated into monetary, fiscal and macro-prudential policy. Introducing climate considerations into monetary policy would directly impact central banks&rsquo; asset purchases &ndash; especially relevant considering that most central banks&rsquo; corporate asset purchases remain biased towards high-carbon industries.&nbsp;
Third, international climate policy should prioritise capital flows in developing countries. This is a critical challenge facing international climate cooperation given the difficulties that these countries have in accessing capital at favourable terms. International action needs to create financing channels to attract diverse private capital, reduce costs and create sustainable international financial structures.
Mark Carney isn&rsquo;t alone in expecting disclosures to move investors away from carbon-intensive assets. But the idea that they can effectively shift capital has serious flaws, and this means they can only be one plank of a strategy to finance the transition to net zero. If central banks and regulators continue to line up behind transparency initiatives, they&rsquo;re at risk of giving the finance sector a permission slip to skip more effective action.
This article was co-authored by Nadia Ameli, Sumit Kothari and Michael Grubb.
This article is also published on <a href="https://www.esg-specialist.com/why-climate-disclosures-alone-will-not-move-markets/?xnpe_tifc=bf4ubfH84IbjbdoJ4FolbMpsafeWaeiWhFWDRfpdRfYcVkedad8Wnkhltu4vaMX84.L.xdh_OFB_bDE.OIE.&amp;utm_source=bloomreach&amp;utm_campaign=Sustainable%20Views%20beta%20newsletter%2018%20Nov%202021&amp;utm_medium=email">ESG Specialist</a>. Energy Voices is a democratic space presenting the thoughts and opinions of leading Energy &amp; Sustainability writers, their opinions do not necessarily represent those of illuminem.

Nadia Ameli

Nadia Ameli

Disclosure isn’t enough: It’s time to tax high-carbon investment

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