Two years after the Paris Agreement of 2015, the global multilateral development banks (MDBs) committed to align their financial flows with the historical objectives of the climate pact.
Now, four years later, it is clear that as a group, the MDBs are still a long way from realizing their commitment across all of their portfolios. While the MDBs have focused on aligning direct investments with the Paris targets, this effort is not ambitious enough, nor completed. They have paid less attention to whether their indirect investments support climate goals. And policy-based lending – a favored instrument in times of crisis – also remains a blind spot.
By updating previous research on the MDBs Paris Alignment Promise, we found that significant progress will be needed for these banks to meet their commitments by 2023-2024. Individual banks are making progress, but their efforts are not shared within the group. Effective leadership of MDBs within an ambitious joint framework is essential to deliver on their climate commitments.
With COP26 underway, here are the main areas they need to address to show they are at the forefront of efforts to align with the Paris Agreement.
- Fossil fuel exclusion policies need to be extended and standardized across all institutions. Standard practices on excluding fossil fuels can reinforce the market signal that the future of fossil fuels is limited. Since 2018, the European Investment Bank and the Inter-American Development Bank have formalized new criteria to exclude the financing of coal, oil and gas projects. Conversely, the African Development Bank, the Asian Infrastructure Investment Bank, the Asian Development Bank and the World Bank Group have kept high emission projects in their project pipeline because they do not have formal criteria for excluding fossil fuels. A positive sign, the African Development Bank and the Asian Development Bank are expected to officially exclude coal from their updated energy policies and the latter is at the forefront of plans for an energy transition mechanism to launch public partnerships. -private to buy and retire from coal-fired power plants.
- MDBs need to standardize the way they count and price emissions. MDBs still do not have a unified approach to greenhouse gas (GHG) accounting and application of Scope 3 emissions. As of 2018, the European Bank for Reconstruction and Development and the the World Bank have broadened their carbon emission thresholds to account for emissions in more investments. While the African Development Bank has started piloting GHG accounting at the project level, it has not set any emissions targets; no other bank has updated its GHG accounting policy since 2018. All MDBs should follow the EBRD, EIB and IDB in public reporting of portfolio-wide emissions. By setting a shadow price for carbon for their operations, many MDBs have closely aligned themselves with the recommendation of the High Level Commission on Carbon Prices (HLCCP), while others do not systematically apply shadow pricing of carbon. carbon in all projects. The European Investment Bank recently decided not to use a lower limit value for the carbon price, increasing the overall cost of carbon for all projects and making it less likely that the bank will finance emissions-intensive projects.
- With developed countries’ commitment to jointly mobilize $ 100 billion in annual climate finance, it is likely that they will run out of around $ 20 billion, MDBs will need reforms to help close this gap. Almost all banks have made notable progress in accelerating climate finance targets since 2018, particularly for the post-2020 period. Nonetheless, climate finance from MDBs to developing countries defined by the UNFCCC has fallen by almost 5%. % in 2020 compared to 2019. With many banks claiming that with recent Climate finance targets pushing the limits of what they can deliver, radical change is needed to meet the demand for transformational investments needed to achieve emissions to zero by mid-century and to pave the way for financing adaptation and resilience.
Not all instruments are aligned with Paris
MDBs also need to take a more holistic approach to the Paris alignment, including how they assess climate risks before deciding on operations. While they have made progress in terms of direct investment, other instruments remain to be discovered. For example, at the International Finance Corporation of the World Bank Group, many investments are channeled to indirect investments through financial intermediaries. And policy-based funding, in the MDBs that use it, has represented the bulk of support for countries to weather the COVID-19 crisis.
- Support capacity building for Paris alignment among financial intermediaries and counterparties. Many MDBs, particularly at their private sector windows, transfer large proportions of their total investments through local financial institutions. This allows them to indirectly finance clients or smaller projects and help strengthen domestic financial markets. Typically, however, MDBs are not always sure which subprojects will benefit from their funding when an investment is agreed with a financial intermediary (FI). This requires the FI’s client, in turn, to be aligned with Paris, for the BMD to claim that the funding channeled through the FI is aligned with Paris. We propose a gradual, risk-based approach to align indirect investments that recognizes that FIs have different levels of capacity to implement alignment, and encourages MDBs to support them in this regard. In addition, the approach should include a climate risk disclosure process for all projects in banks’ portfolios. The MDBs will present their common methodology for aligning indirect financing at COP26. The EIB will also present guidelines for the alignment of counterparties, going beyond FIs to include companies. Other MDBs are expected to follow suit by embracing this broader view of due diligence for the Paris Alignment.
- Make policy-based finance a tool for climate action. Policy-based financing works by closing the deficit of a budget deficit in exchange for recipient governments completing agreed-upon political and institutional reforms, or “policy actions”. These reforms can have negative impacts on a country’s ability to meet its climate goals. For example, the WBG has been shown to encourage new investments in fossil fuels in certain projects, through legislation supported by policy-based operations. At the same time, policies and regulations that align government activities with climate goals and increase market incentives for green technologies and practices are essential for putting economies on low-emission and climate-resilient pathways. Policy-based financing can provide an additional incentive for such reforms, as illustrated by the IDB’s support for Costa Rica’s decarbonization plan. For the Paris alignment, banks that provide policy-based finance will need to ensure that policy actions do not undermine climate goals and, to the extent possible, identify opportunities to enable climate-friendly reforms.
Climate leadership at a difficult time
Development banks are at the crossroads of the public and private sectors and the developed and developing worlds. With their ability to provide concessional finance (especially in riskier long-term investments) as well as their technical and political expertise, MDBs should be at the forefront, not lagging behind, in the transition to low risk. carbon emission and resilient to climate change.
Against the backdrop of these transformational investment needs, however, arises the more immediate challenge posed by rising debt related to COVID. Aligning all policy frameworks, strategies and financial flows with the Paris Agreement is already a big challenge; the pandemic has made this even more difficult. MDBs are the main creditors of developing countries. (For example, the WBG and other multilateral creditors account for 41% of all African debt service). After the pandemic generated fiscal imbalances due to high spending and low income, financial resources declined. Developing countries may have no choice but to put climate action on the chopping block – something the MDBs (and the IMF) need to make sure that doesn’t happen. MDBs can prevent this possibility by becoming proactive participants in debt relief initiatives that will protect climate action.
MDBs, however, are not entirely their own masters. Shareholder governments vote on their policies. These parties should provide advice on how to move the Paris alignment from the abstract level of policies and strategies to the operations and details of MDBs. Ultimately, the mandate to meet these challenges must come from the shareholders.
Recent developments suggest that shareholder governments may be up to the task. Although progress has been uneven across MDBs, the G20 countries themselves have taken the initiative to move beyond fossil finance in recent months. The G7 agreed to end international support for coal power earlier this year. The United States has issued voting guidelines to further limit MDB investments in fossil fuels. China has pledged to stop building new coal-fired power plants abroad. The Powering Past Coal Alliance – a coalition of governments, businesses and organizations committed to phasing out coal-fired electricity generation – includes 15 developing countries among its 41 national member governments.
Progress on the Paris alignment of all financial flows must materialize quickly given the urgency to step up support for enhanced climate action and the deadlines that the MDBs have set for themselves. Their work is not yet finished.
This article originally appeared on WRI Insights.