Financing transition in an adverse context: climate finance beyond carbon finance

Transcription

1 Financing transition in an adverse context: climate finance beyond carbon finance Michel Aglietta, Jean-Charles Hourcade, Carlo Jaeger & Baptiste Perrissin Fabert International Environmental Agreements: Politics, Law and Economics ISSN Volume 15 Number 4 Int Environ Agreements (2015) 15: DOI /s

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3 Int Environ Agreements (2015) 15: DOI /s ORIGINAL PAPER Financing transition in an adverse context: climate finance beyond carbon finance Michel Aglietta 1 Jean-Charles Hourcade 2,3 Carlo Jaeger 4 Baptiste Perrissin Fabert 3 Accepted: 15 September 2015 / Published online: 14 October 2015 Springer Science+Business Media Dordrecht 2015 Abstract The Cancun conference decided to establish a Climate Green Fund (CGF) to help developing countries align their development policies with the long-term UNFCCC objectives. This paper clarifies the links between the two underlying motives: the first, technical in nature, is the necessity to redirect the infrastructure instruments in these countries (energy, transportation, building, material transformation industry) to avoid lockin in carbon-intensive pathways in the likely absence of a significant world carbon price in the coming decade; the second, political in nature, is the interpretation of the CGF as a practical translation of the notion of the common but differentiated responsibility principle, since the funds are expected to come from Annex 1 countries. This paper shows why this latter perspective might generate some distrust given the orders of magnitude of funds to be levied in Annex 1 countries especially in the context of the financial crisis and major constraints on public budgets. It then explores the basic principles around which it is possible to minimize these risks by upgrading climate finance in the broader context of the evolution of the financial and monetary systems. After exploring how such links could help make climate policies that contribute to reducing some of the imbalances caused by economic globalization by reorienting world savings and reducing investment uncertainty, it sketches how this perspective might be palatable for the OECD, the major emerging economies and fossil fuel exporters. & Jean-Charles Hourcade hourcade@centre-cired.fr Centre de recherche français dans le domaine de l économie internationale (CEPII), 113, rue de Grenelle, Paris, France CIRED, Centre International de Recherche sur l Environnement et le Développement, (CNRS, Agro ParisTech, EHESS, CIRAD), 45bis avenue de la Belle Gabrielle, Nogent-sur-Marne, France Centre National de la Recherche Scientifique, Délégation Paris Michel-Ange, 3 rue Michel-Ange, Paris Cedex 16, France Global Climate Forum, Neue Promenade 6, Berlin, Germany

4 404 M. Aglietta et al. Keywords Climate finance Low-carbon transition Financial crisis Economic globalization Abbreviations ABSs Asset-backed securities BAU Business-as-usual CBDR Common but differentiated responsibilities CC Carbon certificates CDM Clean development mechanism CDO Collateralized debt obligation GCF Global climate fund GDP Gross domestic product IMF International monetary fund IPCC Intergovernmental panel on climate change LCPs Low-carbon projects LOLR Lender-of-last-resort MRV Measuring, reporting, verifying NAMAs Nationally appropriate mitigation actions PFMs Public finance mechanisms SIVs Special investment vehicles SMEs Small- and medium-sized enterprises UNFCCC United Nations framework convention on climate change VCRA Value of climate remediation assets 1 Introduction The Cancun agreement establishes a Global Climate Fund (GCF) as an operating entity of the Financial Mechanism of the Convention. Whatever the content of the institutional arrangements to be finalized later, the scaling up of this Fund is critical for breaking the distrust circle which pervades the climate negotiations since the Kyoto Protocol (Jacoby et al. 1998) and for operationalizing the common but differentiated responsibilities (CBDR) principle of the United Nations framework convention on climate change (UNFCCC). This paper first delineates the risks of reinforcing this distrust cycle in the adverse context of public budget deficits in donor countries. It shows the magnitude of the funding needed for climate policies, why this goes beyond the promised made in the context of the GCF and why, because climate finance cannot stay a marginal department of global finance, its scaling up cannot be disconnected from the reforms of global financial and monetary systems. It then proposes the basic principle of a monetary instrument to redirect world savings towards low-carbon investments and lower the risk level of these investments. It ends by explaining why this instrument paves the way to a palatable deal for all world regions by making climate policies a fulcrum to reduce imbalances in the current pattern of economic globalization.

5 Financing transition in an adverse context: climate finance Climate finance at risk of disappointment and misunderstanding 2.1 Problems of order of magnitude The credibility of climate negotiations might be undermined by the gap between the USD 100 billion a year by 2020 to which 2020 Annex 1 countries committed to at COP 15 (Copenhagen 2009) and the USD 15 billion per year envisaged by the EU member states in a first step. If the same share of gross domestic product (GDP; %) is envisaged for all Annex I countries, transfers would amount to USD 31 billion. Although representing only about one-third of the commitments, they would increase the pre-2008 overseas development assistance by about a third; hence the temptation, in a tight financial context, of greenwashing existing transfers. This is all the more embarrassing as the real funding gap at stake to achieve a lowcarbon transition is significantly higher. The World Development Report (The World Bank 2009) assesses this at USD billion a year by 2030 which actually corresponds to USD billion upfront financing needs. The former figure assesses the payments due over the duration of the projects to cover capital and operation costs, including the interest to be paid to a patient lender; the latter is the cash necessary to cover the cost of the equipment before they enter into operation. Hence, the funding gap is not one to three but one to between 5.7 and 9.6. Moreover, these amounts are only the tip of the financial iceberg, the incremental investment costs. Its hidden part is the redirection of investments flows. If the capital cost of a given quantity of clean electricity is say 30 % higher than that of a coal plant, the real amount of investment to be redirected is 130 %. Moreover, the total incremental costs for the energy systems result from a combination between higher upfront costs of lowcarbon energy supply and lower energy demand due to changes in energy efficiency and consumption behaviour which will not be achieved without redirecting investments in sectors like building and transportation. These sectors represent 41 % of the world gross capital formation (EUKLEMS 2011). A back of the envelop calculation 1 shows USD 516 billion incremental investments costs in 2020 (3 % increase against 2.5 % by the (International Energy Agency (IEA) 1989) corresponding to a far higher amount (USD 4100 billion) of redirected investments. This reassessment of the orders of magnitude at stake does not mean that the challenge is impossible to meet in turbulent times. It means that, unless the UNFCCC objectives are de facto abandoned, climate finance must no longer remain a marginal department of global finance. 2.2 What does scaling up climate finance really mean? There is no consensus on the measures listed by the High-level Advisory Group on Climate Change Financing (AGF 2010) established by UN Secretary-General Ban Ki-moon (e.g. levies on the revenues from auctioned allowances or on international aviation and shipping 1 We assume that in 2020: (a) 25 % of the investments of the households, business and financial intermediaries in residential and non-residential infrastructures is redirected towards low-carbon modes with an extra unit cost of 5 %, (b) 10 % of the investment in the transportation sector is redirected towards lowcarbon modes (a low percentage because of the low substitutability between rail-based and road-based transport) with an extra unit cost of 10 %, (c) 33 % of the electricity and gas capacities investment have an extra unitary upfront investment of 20 %, (d) investment in mining decreases by 10 %, and (e) 20 % of the investments in machines have an extra unit cost of 10 %.

6 406 M. Aglietta et al. emissions, taxes on financial transactions, levies on credit trade and carbon taxes). This lack of consensus cannot be disconnected from a donor fatigue exacerbated by the return of depression economics (Krugman 2009), the shifts in global geopolitics and the fact that the division line between the rich and the poor coincides less and less with the traditional North/South division (Chakravarty et al. 2009). This fatigue is reinforced by doubts about the viability of low-carbon investments. The cash flows from the Clean Development Mechanism depend on the demand for carbon offsets, and the limited size of this demand is a current cause for concern. Moreover, yielded at the end of the projects they fail to reduce the upfront investment risks in the context of large uncertainty. Public Finance Mechanisms (PFMs) do bring funds during the incubation phase of the projects but cover only the extra costs and not the bulk of lowcarbon investments (Neuhoff et al. 2010), assuming implicitly that without these costs the projects would have met positive risk-adjusted returns. This is due to the additionality principle applied since the early nineties to ensure that environmental aid to developing countries does not crowd out conventional overseas development assistance. Its consequence is that the carbon-based PFMs do not address the usual risks of any development project: technical and regulatory uncertainty, currency risks, long payback periods, volatility of market prices and uncertainty about future demand. Their leverage ratio of public money on private investment (AGF 2010) is lower than those of traditional PFMs: USD 2 4 for every USD 1 compared with USD 3 15 (Maclean et al. 2008; Ward et al. 2009). Continuing along these lines of reasoning would make it impossible to redirect the amount of low-carbon investments at stake; no matter indeed whether these investments are blocked by carbon-specific risks or usual risks. The challenge is to improve their overall risk-adjusted cost benefit ratio in order to reach a statistical additionality of investments instead of project-based additionality Turning the approach upside-down Let us examine the need to expand carbon finance through the lens of climate agnostics primarily concerned with the stability of financial systems and global economic recovery after the 2008 crisis. Their concerns are legitimate because the symptoms that led to unstable financial dynamics are still prevalent: The ultra-low interest rate policy of the main Central Banks in developed countries has exacerbated the search for yield higher than public bonds by cash holders (financial departments of multinational companies, institutional investors like mutual funds or pension funds). Those holders have moved in and out of capital assets because they are very sensitive to tiny changes in the communication of Central Banks that might hint to future changes in interest rates. In the wholesale short-term money market, prior to 2008 these volatile capital flows were channelled through wholesale funding instruments [asset-backed securities (ABSs) and collateralized debt obligations (CDOs)] issued by shadow banks [broker dealers, conduits and special investment vehicles (SIVs)]. These instruments have disappeared, but the mistrust in the banking system has motivated continuous build-up of institutional cash pools. The high demand for safe short-term instruments has provoked an increase in the value of bonds and driven their interest rate to zero. The shortage of such instruments was aggravated 2 For the discussion of the difference between project additionality and statistical additionality, see (Hourcade et al. 2012).

7 Financing transition in an adverse context: climate finance 407 because foreign Central Banks buy them for reserve keeping. Ultimately, there is a higher mass of liquidity than sovereign bonds that can be issued backed on public assets. The way governments and Central Banks have dealt with the problems of excessive risk-taking did not succeed in combating the too-big-to-fail syndrome and hedging against the risk of losing control (King 2011) remains an unachieved business. Therefore, existing cash pools are largely outside banks because of widespread distrust. They have been estimated by the IMF (Pozsar 2011) at USD 3400 billion in 2010 against USD 3800 bn in 2007 and USD 100 bn in 1990). 3 Firms operate in a business environment which prioritizes, since the eighties, shareholder value against the maximization of the long-term growth of the firm typical of a managerial business regime (Roe 1994). This is a main cause of the obsession for liquidity. The profusion of cash in large companies fuelled bursts in dividend distribution and share buyback to boost equity prices. It contributes to exacerbating inequalities of income distribution. Investment rates have thus declined with lack of effective demand. Flagging credit demand by small- and medium-sized enterprises (SMEs) is met with bank reluctance to lend. Investors face a kind of Buridan s donkey dilemma, 4 where the donkey which died of hunger and thirst because it hesitated too long between eating oats or drinking water: they do not know which long-term investments to invest in. Viewed through this lens, the financing problem posed by the low-carbon transition does not come from a lack of funds. It comes from the inability of the present system of financial intermediation to fund productive investments. Higher and more stable growth would be possible by reducing excess liquidity via heavy taxes which is highly unlikely; matching treasury bill issuance and the volume of cash pools which is not recommended in times of consolidation of public debts; and expansion of the umbrella of the lender-of-last-resort (LOLR) to non-banks is also not a palatable solution. The only viable solution is creating intermediaries able to bridge long-term assets and short-term cash balances, the preferred support of saving, so that they will be invested productively, without incurring the risks of excess leverage, maturity mismatch and interconnectedness (non-liquid long-term assets financed by short-term, unsecured liabilities of money market funds) that have fostered the systemic crisis. The question though is whether climate finance can provide the opportunity to create such links. If it can lower the investment risks of low-carbon projects and redirect savings towards productive activities, it will reduce the magnitude of the cash pools and fuel the world growth engine by shortening the trickling down of savings to productive investments. This is a timely suggestion as the globalization pattern is changing and new patterns of shifting wealth accumulation are taking place. Export-led growth and reserve accumulation in emerging economies was fuelled by excess credit growth in many OECD 3 They are held by (1) global non-financial corporations and institutional investors outside the banking system; (2) mutual funds and hedge funds (managed liquidity and cash collateral associated with securities lending); (3) the overlay of derivatives linked to derivatives-based investment; and (4) wealthy individuals and endowments. 4 This legend is a caricature of Jean Buridan, a theologian at the Sorbonne in the fourteenth century, who argued that wise conduct is to postpone decisions until the necessary information becomes available. The legend recounts the sad story of a donkey who dies because it hesitates for too long between oats and the pail of water placed at equal distance from him.

8 408 M. Aglietta et al. countries. There are attempts to replace this pattern by more inward-focused growth, fuelled by the widening middle class in emerging economies, pressures for higher wages and services and a huge investment demand driven by urbanization and environmental concerns. This mutation also concerns international financial intermediation. European banks have retrenched on their home borders since the Euro zone crisis and no longer borrow dollars via their US subsidiaries to relend worldwide. Faced with this vacuum Asian development banks and sovereign wealth funds are stepping up their ventures. A financial model is emerging, based on long-term bilateral financial contracts at agreed upon prices backed by government guarantees and on Bond issuance substituting national currencies to the dollar which is the de facto reserve currency 3 A carbon-based financial device backed by monetary refinancing In this context, options to finance the low-carbon transition despite limited carbon markets are many. However, given limited public budgets and constrained banking systems, investors have to internalize the social value of avoided carbon emissions into the economy by means of a carbon-based monetary instrument. For climate agnostic policy-makers who implemented unconventional monetary policies after 2008, this value is of interest only if it is used in a system helping the banks to develop their credit activities towards productive investments. The basic trick consists 5 of injecting Central Bank liquidities into the economy, provided that they are used to fund low-carbon investments. Governments would need to provide a public guarantee on a new carbon asset, which allows the Central Bank to provide new credit lines refundable with effective CO 2 emissions abatement. This targeted credit facility makes it possible to expand credit to low-carbon projects (LCPs) as it offsets LCPs financial risk perceived by the banks and investors relatively to business-as-usual (BAU) projects and would make these projects more attractive. How to transform this general perspective into an operational system is out of the scope of this paper. However, any such system will hardly avoid following the principles presented in Fig. 1. Step 1: A political compromise on the social value of carbon remediation activities The valuation of climate change damage, theoretically necessary to calculate the social cost of carbon (f) along an optimized trajectory, is highly controversial (Tol 2008; Dumas et al. 2010), if not impossible at the world level. 6 It depends on many parameters among which pure time preference, assumptions about the costs of carbon-free techniques and beliefs about climate change damage. However, the objective of preventing a temperature increase [2 above pre-industrial levels is equivalent to acknowledging risks to go significantly beyond these 2 C are worth avoiding with and without transitory overshoot. 5 Many types of systems can be designed along the same lines. The system presented here are archetypes and aspirational. For instance, we can imagine a system that does not imply the intervention of the Central Bank as suggested by Rozenberg et al. (2013). This system might be politically easier to implement but might not deliver the same general benefits in terms of reducing some of the failures of economic globalization as explained above. 6 Some countries have nevertheless adopted social values of carbon: the UK (DECC 2014), the USA and France (Quinet et al. 2009) (USD 42, USD 60 and USD 130 in 2030, respectively).

9 Financing transition in an adverse context: climate finance 409 Fig. 1 The key elements of a climate-friendly financial architecture, Source: own diagram The social value of the carbon externality is thus the cost of meeting a given climate target. Uncertainty about these costs is still large, but orders of magnitude lower than on climate change damage. The last report by the intergovernmental panel on climate change (IPCC) provides corridors of such costs. This corridor provided a good guidance but what matters ultimately is the willingness of governments to act to mitigate climate change and this willingness in turn includes the cobenefits of climate mitigation (air pollution, benefits of the recycling of the revenues of carbon pricing, energy security). 7 This is why what matters is the social value of climate remediation (VCRA) which incorporates both the value of reducing the carbon externality and the co-benefits of this reduction. Should this value be specific to each country or common at the world level is an open question. However, a political agreement on a world VCRA should be easier than on a carbon price. First, it serves as a notional value for low-carbon investments and does not 7 For a 2 C target, the corridor is between USD 60 and 130 in 2030 and between USD 200 and 375 in 2050.

10 410 M. Aglietta et al. impose an immediate extra cost on firms and consumers. Second, each government will value its VCRA in relation to its own perception of the domestic co-benefits of climate mitigation. Hence, countries might agree to the same VCRA for various reasons, and since this VCRA could be revised every 5 years, a process can be triggered which will allow for further correction as new information becomes available. More important is to hedge against the vagaries of market exchange rates. The SVC value would be nominally similar to the USD 35 per ounce of gold under the Bretton Woods regime. However, since the exchange rates are relative values, the VCRA in national currencies will thus differ from one country to another and will be subject to variations. These variations can be large enough to generate time inconsistencies in investment projects funded in different countries. This is why the world SVC should be the weighted average, in purchasing power parity (PPP), of national prices. The internal rate of return of investment projects would then all be implicitly computed in the PPP price system (reviewed every five years) which would minimize the inefficiencies caused by the volatility of exchange rates. Step 2: A carbon-based money issuance Together with this political agreement on a VCRA, volunteer governments could announce that they support a new class of eligible assets recognized by their Central Bank: carbon assets. Their unitary value is the SVC and their quantity is an overall volume of emission reduction corresponding to governments commitments (see Hourcade et al. 2015). The Central Banks then can announce that they will (a) allow commercial and development banks to draw on new credit lines provided that they use the liquidities to fund lowcarbon projects, (b) accept as repayment carbon certificates (CC) testifying effective carbon emission reduction and valued at the SVC and (c) transform them into carbon assets. Carbon-based liquidities can then be gradually injected into the economy as the banking system funds low-carbon projects drawing on the credit lines opened by the Central Bank. Carbon assets will be incorporated into the Central Bank s balance sheet when the bank returns the carbon certificates, i.e. the monetary value of the emissions reduction yielded by the project (see Appendix for a description of the credit line? CC? carbon assets circuit through the balance sheets of the Central Bank, commercial banks and the entrepreneurs). In this way, the money issued is automatically backed by real wealth in the form of low-carbon equipment and infrastructure in addition to the future benefits of emission reductions. Step 3: A supervisory body to select the projects and monitor effective CO 2 emission reduction The new credit facility is meant to help both projects that can pay for themselves but suffer from a credibility gap inhibiting their adoption and projects that need specific support because of the additional costs and uncertainties. The credibility and the accuracy of the MRV process is then critical including the guarantee that the funded projects are aligned with the development objectives of the recipient country and yield effective CO 2 emission reduction. An Independent International Supervisory Body, similar to the Clean Development Mechanism (CDM) Executive Board, is thus needed which would first determine eligible mitigation projects and policies (on technology, sector, time horizon) in relation to their consistency with the Nationally Appropriate Mitigation Actions (NAMAs) presented by

11 Financing transition in an adverse context: climate finance 411 the countries to the UNFCCC. Second, since the objective is to trigger GHG abatements which would not have been realized, otherwise, it will fix the allocation rules of carbon certificates per type of projects in participating countries in relation to their expected emission reductions. Those rules are necessary to avoid the transaction costs of projectbased assessments and to secure a statistical additionality of the wave of projects triggered by the system even though some of them individually could have been realized without its support (Hourcade et al. 2012). The last responsibility of this Supervisory Body should be to monitor the conformity of a project at the time of its launching and to confirm ex-post its level of completion. It has then to cancel part of the carbon certificates if it judges that the project did not fulfil the exante performance criteria. Step 4: An incentive to mobilize entrepreneurs and banks Accepting as repayment certified emission reduction instead of cash entails cancelling out the entrepreneur s debt at the height of the value of the certified emission reductions. This is the primary level to strengthen the solvency of low-carbon projects, to lower their risk level and to enhance their attractiveness for the entrepreneurs and project contracting authorities. One important point is that a VCRA growing with time would counterbalance the effect of the discount rate and enhance the social value of long-lived infrastructures. For commercial banks in the process of deleveraging, this new credit facility will encourage them to expand their lending activity, instead of accumulating liquid reserves. An additional regulatory incentive for the banks might be that a high share of LCPs in their loan book would make their balance sheet less risky, since this share of their assets would benefit from a public guarantee. One could even imagine that they keep part of the carbon assets. Banks would then be rewarded with a reduction in the cost of their prudential capital constraint. They could be indeed allowed to apply a zero risk coefficient in the same fashion as for sovereign bonds to the fraction of the loan that comes from Central Bank liquidities backed by the value of emission reduction. Step 5: Redirecting saving towards long-term climate-friendly investments In addition to redirecting bank credit to support a low-carbon transition, the success of the system will depend on its capacity to redirect private saving towards LCP&P. To do so, banks or specialized climate investment funds could use the carbon-based monetary facility to back highly rated climate-friendly financial products attractive for households and institutional investors, such as AAA climate bonds with a return on investment slightly above the usual safe deposit rate in order to attract long-term savings. Welltailored paid-in capital makes it possible to issue a multiple of this capital in highly rated climate bonds. The proceeds of those bonds would then fund loans to a pool of LCPs (with possibly a mean rating of BBB ). The paid-in capital acts as a buffer against loss given default of the pool of LCPs and thus sustains the good rating of the climate bonds. Sovereign wealth funds, public private and corporate pension funds, insurance companies, endowments and investment management companies could be interested in AAA-rated climate coloured bonds (like the green bonds of the World Bank) instead of speculative financial products for both ethical and regulatory purposes. As described in Fig. 2, the trick is to fill up the paid-in capital with carbon certificates. One major tool for mobilizing savings kept by institutional investors and households would be to use a share of the carbon assets to capitalize the GCF independently from the only goodwill of the tax payers of the developed countries. The potential leverage effect of this multilateral tool is high. As suggested by De Gouvello and Zelenko (2010), the GCF

12 412 M. Aglietta et al. Fig. 2 Climate finance as a means to redirect long-term saving towards low-carbon investments, Source: own diagram could issue Green Bonds worldwide. If the Fund could accumulate USD 100 billion by 2030 and if it invested this in well-diversified projects, so that one can assume that the probability density function is Gaussian, meaning that it would have a 99.9 % probability that its capital base could absorb its losses. Hence, it could issue USD 1 trillion in bonds to back up credit facilities to developing countries, and this credit would have real wealth as collateral. 4 Climate finance: contributing to sustainable globalization One legitimate reflex is to suspect that this system will generate inflationary risk and nurture speculation. The first risk only exists in case of generalized failure of the LCPs or embezzlement of the funds since liquidities will be gradually injected in the economy as real wealth produced by the projects. But the existence of a Supervisory Body to certify the projects provides a good safeguard against this risk. As to the second, it is controlled by the fact that the total volume of carbon-based liquidities is limited by a given amount of emission reduction and by the fixed value of the SVC. More difficult to address is the legitimate fear of climate diplomats to venture into uncharted domains. It can be overcome only if this perspective gets support from climate agnostic policy-makers because they are convinced that it might contribute to a stable monetary order in these times of knife-edged equilibrium between monetary laxity fuelling speculative bubbles and monetary rigour fuelling sluggish growth. 4.1 Economic rationale of an international recognition of carbon assets Figure 3 visualizes one major problem of the growth regime triggered as soon as deregulation has started: the Great Moderation 8 of business cycles and financial cycles of far larger magnitude and far longer times span than in the past (Schularick and Taylor 2009). Financial cycles are measured by the gap relative to trend of an index combining credit growth and asset prices (a mix of equity, bonds, real estate price indices). 8 The great Moderation was first discussed by Stock and Watson (2002), see also Summers (2005).

13 Financing transition in an adverse context: climate finance 413 Fig. 3 Business and financial cycles in the USA ( ), Source: own diagram This misalignment, over decadal periods, of asset prices and very long run benchmarks has pervasive efficiency costs. Together with the volatility of exchange rates, it swamps the signals on which investors should base their decisions. It is propelled by private credit dynamic and its magnitude is caused by the self-fulfilling beliefs of market participants that prices will go on moving the way they have gone just before. Financial intermediaries are governed by the same self-fulfilling expectations as their borrowers; they lend money to finance speculative positions on asset prices and take the assets as collaterals of their loans. More credit has thus led to higher asset prices, higher value of collateral and lower perceived risk premiums on loans. The asset prices thus cannot be vectors of adjustment in the macro-economy. Their volatility exacerbates real disequilibria, as shown by the cumulative global imbalances in the balance of payments and in the balance sheets of financial institutions, which receded only in the financial crisis. Price reversals arise only through crises that are endogenous as booms gone bust, while unknown tipping points shift the mood of market participants from euphoria to panic (Adrian et al. 2013). If the macro-prudential policies are not strong enough to mitigate the impact of the reversal in asset prices, finance is not self-stabilizing and a monetary policy only focused on low inflation is not conducive either to macro-stability. Real imbalances are even magnified by the Great Moderation in inflation, because the huge gyrations in asset prices are real price changes (Aglietta 2014). One response is a renewed version of the Chicago Plan, but it is politically demanding since it implies that banks are treated as public utilities. To be safe in any circumstances, banks would be required to buy Treasury securities for a large share of their deposits and lend only to highly rated borrowers. The bulk of the credit would then be channelled through from securitized lending and corporate bonds. Narrowing the scope of bank

14 414 M. Aglietta et al. activities, this plan widens the role of financial intermediaries on the wholesale money market with shadow banks playing the role of liquidity suppliers. It thus moves fragilities from one compartment of the financial system to the next. Another response is to anchor money on a basket of commodities as in Keyne s Bancor proposal at Bretton Woods. The obstacles to such a Bancor remain, but carbon-based assets have the advantage of incentivizing financial intermediation to do its job of financing the real economy instead of pursuing capital gains magnified by higher and higher leverage. They are not a substitute for stricter financial regulation and will not suffice in preventing financial crises which arose even in the gold standard era. However, they can contribute to the search for a more stable financial context and this is the reason why, although the issuance of carbon assets should result from the voluntary initiative of countries, their international recognition matters. Carbon assets would then de facto acquire the status of world reserves, and this opens a wider perspective to lower one source of tensions in the economic globalization process, i.e. the distortions in exchange rates due to the war-chest of official reserves accumulated in the emerging world after the 1980s/1990s financial crises in Latin America and Asia. Those reserves invested mainly in US Treasury securities and were built to protect exportled growth strategies against exchange-rate appreciation and as self-insurance against currency crises. Carbon-based reserve assets could allow these economies to increase and diversify their foreign exchange reserves in a way conducive to cooperation against a global externality. This concern was underlined by Zhu Xiaochuan, the governor of the People s Bank of China when he called for a SDR reserve-based system in Jaeger et al. (2013) show how this proposal could contribute to sustainable development. If countries with non-convertible currencies have access to internationally recognized carbon-based assets, they would be less inclined to run balance-of-payment surpluses, since they would get their reserves in proportion to the emission reductions they finance domestically Clearing up a foggy business environment and getting the world out of the doldrums The virtuous cycle cannot be fully understood without coming back to the paradox of the current coexistence of a vast pool of savings and of over-indebtedness and its impact on real economies. Since the financial crisis the world economy has languished. The stimulating plans after 2009 succeeded in supporting 3 % growth rate in the USA in 2010, after 2 years of recession. But this rate was only 1.8 % in 2011 and 2.5 % in 2013, fostering a debate on secular stagnation. The real GDP growth of EU-27 declined to 0.6 % per year from 2007 to 2012 and an almost zero growth in The large emerging countries (Brazil, India and even China) suffered a lacklustre performance in 2013, expected to be prolonged further according to the l World Economic Outlook (April 2014). One key underlying mechanism is the deleveraging of the private sector. Planning horizons of firms and households have not adjusted to the length of the downward phase of the financial cycle, and the economic landscape has become fragmented in developed countries. Households are still digesting the impact of the property bust in many countries. 9 This would also spread the gains from seigniorage (i.e. the profit made by governments by issuing currency) and reduce the perverse effect that forces the USA to pump out more USD assets for global reserves.

15 Financing transition in an adverse context: climate finance 415 Small- and medium-sized enterprises struggle to get credit, while big corporations are awash with cash that they do not know how to use productively. As a consequence, investment has decreased more than overall growth (-14 % in the EU from 2008 to 2012). A carbon-based financial architecture, instead of crowding out productive investment, could thus help overcoming the Buridan s donkey dilemma by indicating where to invest in this subdued business climate. This will be of interest for the pension funds for example which currently tend to avoid getting involved in investments that look safe while masking ventured assets. A natural question is: Why not rely on price signals given by the carbon trading systems? The answer is that, for investments on long-lived infrastructures, these signals are swamped by regulatory uncertainty about the long-run carbon prices, the currency exchange rates and the strategies of OPEC countries (Waisman et al. 2013). A carbonbased financial instrument could overcome a part of these uncertainties through transmitting upfront the social value of avoided carbon emissions. To understand why this transformation of the financial system might trigger a green growth regime, let us recall, with Schumpeter, that financial crises pinpoint transitions in growth regimes: the upward momentum preceding crises piles up distortions in market structures and income distribution, while the downward phase is the search for adapting to an incipient innovation wave. Industrial revolutions are the source of long-term growth cycles. They reshape capital accumulation over the long run and transform consumption patterns and social institutions. However, a new wave can take off only when its promises have captured what Keynes called the animal spirits of finance. The capacity of a low-carbon transition to be a frontier of innovation supporting a new growth regime is real because the concerned sectors (energy, transportation, buildings) represent a dominant share of investments and because they are critical for social inclusiveness and for an inward-oriented growth. Over the past decades, emerging economies grounded their economic catching up on export-led strategies sometimes at the cost of outdated domestic infrastructure and sensitivity to variations of exchange rates as a result of US monetary policy. 10 Since 60 % or more of carbon savings investment (The World Bank 2009) would take place in developing countries, a carbon-based finance would reorient domestically a fraction of the savings that currently flow into the world financial system. A more endogenous, inward-oriented growth pattern might become less risky for political and economic reasons, thanks to the expansion of domestic investment opportunities. 4.3 Reconciling well-perceived nation s interest in an adverse context This perspective will never reach the diplomatic agenda, unless it is perceived by highlevel policy-makers as responding to the specific problems of each region. Let us start with the emerging countries. All of them have the same interest in receiving support to redirect their infrastructural policies towards low-carbon and less energy-intensive choices (Shukla and Dhar 2011). This is a matter of energy security, of inclusive regional and urban development and of less exposure to currency turmoil and variation in domestic asset prices as a result of sudden changes in the direction of cash flows. This is exacerbated in the Chinese case due to the inverted population pyramid in China after 2030 and the fall of the Chinese saving rate. China might be trapped, within this time horizon, in 10 This point is made very clearly by Rajan (2010), former Chief Economist of the IMF and the current governor of the Reserve Bank of India.

16 416 M. Aglietta et al. an energy-intensive pathway which might make it vulnerable to energy shocks. All these countries could gain from reforms, including carbon pricing, urbanization policies and reducing energy and carbon intensity in industry. They will greatly benefit from an international system helping to reorient their domestic savings and foreign capital flows. The Eurozone could be interested in complementing its fiscal compact by a green growth compact to make a better use of its quantitative easing monetary policy and to reinforce a unity undermined by imbalances among partner countries. A carbon-based money emission would help it to find the narrow pathway between monetary laxity and excessive rigour and trigger an inclusive economic dynamic by creating jobs through the productive structure (Aglietta and Hourcade 2012). Such a policy has the additional merit of reducing energy intensity, abating carbon emissions, stimulating regional demand and diminishing the dependency of Europe towards primary commodity producers. Europe could thus match its own interest with recovering a leadership in climate negotiations (Jaeger et al. 1997). Policy lines might change in the USA where multiple climate catastrophes, including Sandy that hurt New York City badly, have revealed the decay of public infrastructure and the lack of public services in adverse conditions. Yet, vested interests in the USA bet on cheap energy due to massive investment in fracking shale gas. The core issue is whether shale gas will be used as manna from heaven to maintain their historical development pattern, or as a tool to facilitate the switch towards low energy-intensive patterns. The upgrading of climate finance sketched in this paper might incite them to follow the second option given its economic and geopolitical side dividends. As to the large group of the least developed countries, dominantly present in Africa and so far bypassed by the CDM, they will benefit from the system because of the large gap between their normative aspirational trajectory and their real emissions, and because they can target their NAMAs as being eligible for financing in this system in such a way that they primarily support priorities such as the access of the population to basic energy services and electricity. Doing so, these countries would be enabled to better control what Rajan (2010) calls the flighty foreign financing which has been one obstacle to their development. One cannot disregard the palatability of the suggested perspective for the oil and gas exporters which are the other key players of a long-term energy transition under climate constraints. Depending on the design of the post-2015 climate regime (including the absence of an effective regime), they might perceive climate policy as a threat because of their adverse impact on the prices of fossil fuels or as a way of escaping the resource curse by using longlasting rents to switch towards viable industry, agriculture, transport and energy systems. 5 Conclusion This paper delineates a carbon-based monetary instrument, which is tantamount to the Central Bank buying a service of carbon emission reduction at a price justified by the politically agreed VCRA, and eventually society s willingness to pay for a better climate. Carbon-based liquidities can be therefore considered as equity in the commonwealth. The equity pays dividends in the form of actual wealth created by productive short-term lowcarbon investments and averted emissions, and a stronger long-term resilience of the economy to environmental shocks. This instrument can produce tangible benefits over the short term through lowering the investment risks on low-carbon projects and policies and redirecting part of the savings which is currently floating in speculative investments towards infrastructure. This

17 Financing transition in an adverse context: climate finance 417 redirection can foster what has been repeatedly referred to as a Green Marshall Plan (Schelling 1997). Whatever the metaphor, this redirection could contribute to the recovery from the financial crisis without reproducing the drawbacks of past development patterns. It could also contribute in turn to calming down some of the current and future tensions in economic globalization by a more inward-oriented industrial strategy in the key emerging economies, lesser risks of currency wars and less potential conflicts about resources. An additional note has to be made in this conclusion about the link between this mechanism and the common but differentiated responsibility principle. Pragmatically, this would be done through the rules adopted for carbon assets issuance and through the share of carbon assets contributing to the Green Climate Fund. Perhaps as importantly, if another share of these carbon assets is accepted as an additional member state contribution to the International Monetary Fund (IMF) accounts, OECD countries would then support the consequences of their past responsibilities not only in climate change but also in triggering the financial crisis of an unprecedented magnitude since One counter-argument might be that such reforms exceed the competences of the Climate Convention and are a diplomatic non-starter. But, ignoring the importance of climate finance to break the mistrust cycle that blocks the climate negotiations and the adverse economic context that impairs large-scale North South transfers is also a diplomatic non-starter. A fully fledged system is not needed in the short term. What is needed is to launch a virtuous confidence cycle. To do so, it will suffice that a group of countries takes the initiative of creating carbon-based assets under the UNFCCC and demonstrates to climate agnostic policy-makers the possibility to use it for deeper evolutions of the financial system and the economic globalization process. This will ground the commerce of promises which fuels modern economies on something with recognized value: the avoided climate change damages and the development benefits of low-carbon infrastructure. Appendix: The banking canal of the monetary device Tables 1, 2, 3 and 4 offer a numerical example of the balance sheet consequences for the Central Bank and a commercial bank of a 1000 loan to a low-carbon entrepreneur expected to realize 10 units of CO 2 emission reduction. The VCRA is set at 10, which values the expected emission reduction at 100. Table 1 Balance sheets at the opening date of the low-carbon loan Central Bank Commercial banks Entrepreneur Asset Liability Asset Liability Asset Liability 1000R LC Loan CO 2?900r l?900r d?900r l?100?100?100?100?100?0.08 (900r l ) 10 CO Reduction of CO 2 Drawing rights During the payback period of the loan, the entrepreneur gradually reimburses the loan with monetary revenues of the project as suggested by Table 3. As the project realizes emission reductions, the entrepreneur receives carbon certificates

18 418 M. Aglietta et al. Table 2 Balance sheets at mid-maturity of the low-carbon loan Central Bank Commercial banks Entrepreneur Asset Liability Asset Liability Asset Liability 1000R LC Loan CO 2?450r l?450r d -450r l?450r l?100?100?100?100?5 CC?100?0.08 (450r l ) 10 CO Reduction of CO 2 Drawing rights At the end of loan maturity, Table 4 indicates that the entrepreneur has paid back the entire 900 debt with the monetary revenues of the project and has gotten 10 CC for the emission reduction her project has achieved. Capital constraint for the commercial bank gets null and only the second credit line remains unchanged in the balance sheets Table 3 Balance sheets at the end of the payback period of the low-carbon loan before the asset swap Central Bank Commercial banks Entrepreneur Asset Liability Asset Liability Asset Liability 1000R LC Loan CO 2?0?0-900r l?0?100?100?100?100?10 CC?100?0 10 CO Reduction of CO 2 Drawing rights The last step of this process is an asset swap performed by the Central Bank who accepts the 10 CC as repayment of its 100 financial claims. This results in cancelling out the second credit line corresponding to the carbon debt of the low-carbon project. Total amount of carbon-based liquidities that the Central Bank can issue is reduced by 100 Table 4 Balance sheets after the carbon asset swap Central Bank Commercial banks Entrepreneur Asset Liability Asset Liability Asset Liability 10 CC? R LC?0?0-900r l?0?0 Reduction of CO 2 Drawing rights Table 2 indicates that the loan to the entrepreneur is divided into two credit lines. On the first line, the commercial bank borrows 900 deposits at rate r d and lends 900 at rate r l. The second line refers to the 100 liquidities equivalent to the value of expected emission reduction lent by the Central Bank to the commercial bank that can be paid back with