Policy Shift Weekly News: our selection of recent analysis on climate risk and sustainable finance


Every week, Policy Shift will share a selection of recent articles and publications focused on public policy and innovation. This week's theme deals with critiques of the “Wall Street Consensus” and Nordhaus climate change economics, but also proposals and evolutions in the sustainable finance field and in climate change economic policy - notably in light of the Covid-19 crisis.


A paper (in English) about the Wall Street Consensus, a newly-formed macro-financial architecture that builds on the financial sector to achieve the SDGs


By Daniela Gabor, this paper aims to conceptualize the “Wall Street Consensus”, as an emerging policy paradigm that “reframes the post-Washington consensus in the language of the SDGs and identifies global finance as the actor critical to achieving the SDGs”. Daniela Gabor draws on a so-called “critical macro-finance” approach reflecting political processes through which private finance seeks protection from systemic risks and accommodation for new asset classes (Dafermos et al. 2020) – building on a post-Washington consensus acceptance that state intervention is necessary to correct market failures (notably through regulation and global institutions such as multilateral development banks - MDBs). In particular, there is an ever-increasing need for compensation of climate risks, which are progressively becoming part of regulatory frameworks as material credit risks.


The paper therefore argues that the Wall Street Consensus is a new form of politics of “de-risking” by the state, shifting from (i) developmental state de-risked policies for exportations and trade; and from (ii) the manufacturing sector to the local financial system (by restructuring financial systems in emerging economies towards (resilient) securities market-based finance). This Consensus also reflects the structural importance of US-based institutional investors and their asset managers (example of the G20 Infrastructure as an Asset Class initiative); partly given that its architecture confers real infrastructural power to the financial sector – while the author argues that securitization is increasingly promoted as a de-risking instrument potentially accelerating lending to infrastructure projects. Ultimately, ESG ratings are becoming a strategic necessity in the Wall Street Consensus, in order for institutional investors to become credible development partners to MDBs and the de-risking state, while the latter can eventually absorb climate-related risks that would strand infrastructure assets.


The author concludes: “This is not just a technical question of finance. The architecture of securities markets, and their plumbing, changes the structural features of the financial system, and in so doing, the type of development model that can be financed. The old developmental banking model that put finance in the service of well-designed industrial strategies becomes obsolete. This is a political choice”.


A paper (in English) on neoclassical economics of climate change and to what extent they have contributed to a misrepresentation of the economics damage from climate change


By Steve Keen, this paper is a fierce criticism towards William Nordhaus’ research on the estimates of the impact of climate change upon the economy, which have been used to calibrate the “Impact Assessment Models” that have guided the political responses to climate change for decades. His criticism is not just based on the application of a very high discount rate, but first and foremost on the consequences of poor data and hypotheses used to justify the DICE (Dynamic, Integrated Climate and Economics) model.


While economists such as DeCanio (2003) and Weitzman (2011) have largely expressed the significance of climate change on Earth systems and the habitability of the planet, Nordhaus has assumed that most economic activity relies on non-climate variables (i.e. labor skills, access to markets, technology) that swamp climatic considerations in determining economic efficiency. More notably, he has argued that a relatively small part of US GDP is composed of sensitive sectors (agriculture and forestry) whose output depends upon climatic variables while the rest of “indoor activities” will remain largely unaffected – and such conclusions have been asserted by the IPCC in its 2014 report. The paper shows that such literature (i) has assumed that altered temperatures of a specific region on the planet and those of the entire planet would have the same impact on GDP; and (ii) is based on a strong belief in the ability of human societies to adapt (i.e. in neoclassical economics, the economy returns to the equilibrium after an exogenous shock).


The remainder of the paper elaborates on “damage functions'', used by Nordhaus and other economists to connect estimates of the change in global temperature and changes in GDP (i.e. reducing GDP from it would have been in the total absence of climate change to what it will be given different levels of temperature rise) – using a quadratic function (i.e. not including sharp thresholds or “tipping points”, such as the Arctic summer sea-ice loss, the Greenland ice sheet, the melting of permafrost, the decrease in circulation of certain marine currents in the Atlantic, the decline of boreal forest carbon sinks in Canadian and Amazonian countries, etc.). Nordhaus has therefore predicted in 2018 that the impact on GDP of a 4°C increase in temperature is a 3.6% fall.


The author criticizes the role of the cross-sectional approach (that gathers empirical estimates carried out locally at the sectoral level and aggregates them in order to calibrate the damage function at the global level across all sectors) in determining global GDP impacts. It underlines that Nordhaus has ignored the key role of energy in production (by assuming that nearly 90% of US GDP would not be affected by climate change) and the correlation between global energy production (mainly based on fossil fuels, about 85% of the energy mix in 2020) and global GDP (which, in turn, determines excess CO2 in the atmosphere).


Despite that - assuming constant environmental policies - the central IPCC scenario predicts an increase in temperatures of 2.5°C in 2050 (and up to 5°C in 2100 compared to the pre-industrial period), the macroeconomic estimates all lead to a negative effect at the global level, but of very variable magnitude: some methods indeed estimate an effect of -15% of GDP in 2050 and -30% of GDP in 2100, while others suggest more limited effects (-4% in 2100 and even a zero effect in 2050).


A recent paper from the French Treasury has underlined the likely underestimated effects of climate change on global GDP, for several motives:

  • The lack of known historical precedent about the scope, the speed and magnitude of climate change;

  • The challenges in estimating transition and adaptation costs, reinforced by the difficulty in quantifying the impacts and magnitude of (uncertain) natural disasters;

  • The existence of possible threshold effects that could accentuate the non-linearity of damage functions (i.e. labor productivity, crop yields, or ecosystem services provided by the environment);

  • The uncertainties of climate scenario, with the existence of "tipping points”; and

  • The potential massive nature of indirect effects, far exceeding the direct effects (i.e. typical case of an uncertainty distribution where extreme values cannot be excluded - also called "fat tails”).


A report (in English) on the precautionary approach needed in the face of climate-related financial risks


By Hughes Chenet, Josh Ryan-Collins and Frank van Lerven, this report explores the way to deal with climate-related financial risks (characterized by far-reaching impact, unforeseeable nature and irreversibility), given that they call for action in the short-term to reduce impact in the long-term. In the meantime, many questions remain open around the assumptions that should be used to determine different scenarios and what the outcomes of scenario modelling and stress testing results actually mean for policy interventions. The authors argue that the “Knightian uncertainty” surrounding such risks (i.e. the probabilities of different outcomes are impossible to calculate), that is reinforced by highly interconnected interactions (policy, technological innovation, changing consumer demand, global financial system), calls for a precautionary market-shaping approach to financial policy and supervision.


The authors underline that the focus on the part of regulators and supervisors should therefore be on avoiding tipping points and thresholds, and building system resilience (through macro-prudential policy and monetary policy) – as underlined by Ramirez and Ocampo in this recent paper:


Financial supervisors can and should actively steer market actors in a clear direction — towards a managed transition — to ensure that a scenario that minimizes harm to the financial system and wider economy in the future is the scenario that actually occurs. This requires some self-reflexivity on the part of policy makers. They should recognize the key role of regulation and supervision in determining the nature of emerging climate-related financial risks. They, together with ministries of finance and other relevant parts of government, must view themselves as helping to create their preferred scenario rather than spending years gathering sufficient information attempting to understand and predict a priori what scenario is occurring and then acting accordingly”.


Such conclusion led the Bloomberg columnist Kate Mackenzie in underlying in a recent article entitled “The trouble with climate scenarios is everyone has their own” (dealing with scenario-based decision making by investors and companies): “Scenario analysis has helped introduce financial experts to a level of detail about climate science and decarbonization they might otherwise never have encountered. Those fine details might require less focus now that the general direction of climate change is unmistakably clear and extremely urgent”.


A column (in English) on the need for global standards in green investments and independent scientific review


By Kim Schumacher, the column argues that in view of the development of the sustainable finance market and related “greenwashing” and “competence washing” risks, global standards for ESG investment factors as well as independent scientific review are utterly needed. This is all the more important that high-level financial-sector stakeholders have developed industry guidelines for green financial products (including ESG-aligned bonds, funds and indexes) while rating agencies, independent verifiers, auditors and data aggregators have been creating their own proprietary ways to measure, evaluate and report on the impacts of ESG investments (Kotsantonis and Serafeim, 2019). Such methodologies remain often inconsistent and lack transparency, while not providing much expertise in areas such as greenhouse-gas emissions, biodiversity, hydrology, atmospheric science or marine biology.

On the link between Covid-19, climate change and sustainable finance


  • A perspective article by Ben Caldecott on “transition finance” and how to embed it in the post Covid-19 recovery. He argues that transition finance is poorly defined today and covers a wide range of “sustainable finance” methods (i.e. use of proceeds financing for polluting companies to fund cleaner activities; financing that incentivizes better sustainability performance”). In this context, Ben Caldecott proposes a wider definition that allows for a wider view of the role of financing products and services in contributing to counterparties aligned with sustainability objectives over time (engagement and active ownership, sustainability-linked loans and bonds, debt-to-climate swaps, smart contracts, new forms of public-private partnerships…). Such wider view will be all the more helpful in the post Covid-19 context that has created unprecedented challenges and opportunities;

  • An article by Ulrich Volz on sustainable investing in times of Covid-19, given the stretched public finances impeding countries to finance a recovery and undertake critically needed investments in climate adaptation and mitigation. Ulrich Volz reminds the need for an alignment of financial flows with a low-carbon pathway, the consideration of climate-related financial risks and the important support to vulnerable countries with, for instance, countercyclical lending aligned with ESG objectives. He underlines: “If we don’t act now and make a concerted effort to significantly strengthen investment to mitigate and adapt to climate change, many more countries will find themselves in permanent crisis mode. The few countries fortunate enough to be spared will not be able to shield themselves from problems elsewhere. Just as the COVID-19 virus has spread across borders, the impacts of climate change will be felt across the world, not least through an increase in migration in the context of disasters and climate change”.

  • The French “Haut Conseil pour le Climatannual report, entitled “Getting back on track, recovering the transition”, in which this high-level council underlines that (i) crisis recovery plans must factor in climate considerations in order to accelerate the unavoidable changes to the economy required in light of climate change, by anticipating market developments; (ii) the implementation of the French national low-carbon strategy is hampered by a lack of firm direction and of a cross-cutting vision, which must be swiftly addressed; (iii) the agriculture sector does not currently display the structural changes needed to be in line with the low-carbon trajectory ; and (iv) the just transition is an issue requiring exemplary State accountability;

  • An article published in Nature by Forster et al. (2020), which shows that the direct effect of the pandemic-driven response on climate change mitigation will be negligible, with a cooling of around 0.01 ± 0.005 °C by 2030, compared to a baseline scenario that follows current national policies. In contrast, with an economic recovery tilted towards green stimulus and reductions in fossil fuel investments, it would be possible to avoid future warming of 0.3 °C by 2050.

And as a bonus this week, two links to ongoing public consultations at European level


1. Consultation for the establishment of a green bond standard (open until October 2nd, 2020) on this page.


While green bonds play an increasingly important role in financing assets needed for the low-carbon transition, there is no uniform green bond standard within the EU. This consultation builds upon the European Green Deal Investment Plan, which seeks to mobilize at least €1 trillion in sustainable investments over the next decade. As part of the Green Deal and its investment plan, the European Commission has reaffirmed its commitment to establish an EU green bond standard.


2. Consultation on sustainable corporate governance (open until October 8th, 2020) on this page.


This initiative aims to improve the EU regulatory framework on company law and corporate governance. It would enable companies to focus on long-term sustainable value creation rather than short-term benefits. It aims to better align the interests of companies, their shareholders, managers, stakeholders and society. It would help companies to better manage sustainability-related matters in their own operations and value chains as regards social and human rights, climate change, environment, etc.

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