Regulatory debate over the link between climate and finance is intensifying this year, especially now that the Federal Reserve has joined the Global Network for Greening the Financial System.

Unfortunately, much of the international regulatory work to date has focused on identifying which industries are good (green, less risky) or bad (high carbon emitters, more risky). In some cases, this dualistic approach has suggested that funding for a “bad” company should be stopped altogether. This could prevent companies from receiving the funds needed to accelerate the transition to more climate-friendly business models and support their capital investments in greener infrastructure and technologies.

The dualistic approach to labeling is also present within sectors.

For example, some are very quick to suggest that not all fossil fuel-based energy sources should be called “green”, but in reality, energy sources should be viewed on a spectrum along a pathway. multi-year transition. For example, natural gas is a much greener form of energy than coal. Pair this understanding with the likelihood that many countries will not be able to meet their electricity needs or provide energy sources to consumers using wind or solar power in the foreseeable future, and the conclusion is clear. For a while, financing the development of natural gas or even oil for many countries will be needed.

Just look at India – the third largest energy consumer in the world – which derives 45% of its energy from coal, according to a report by the US Energy Information Administration 2019. Replacing some of this coal consumption with natural gas should be encouraged and not be seen as a lack of progress.

Paris agreement also calls for limiting global warming at 1.5 degrees Celsius. Achieving this would require around $ 100-150 trillion in climate-aligned finance over the next three decades, or 3 to 5,000 billion dollars per year, according to a study by the Global Financial Markets Association.

While sustainable financing has almost doubled in recent years, it falls far short of the scale needed to transition the economy to a low-carbon model.

Private financing represented the majority of sustainable financing at 56% in 2019, with public funding representing the remaining 44%, according to the Climate Policy Initiative. Within private finance, the majority of sustainable direct investments have been made by companies, but commercial financial institutions are playing an increasing role through green bond underwriting, direct lending and refinancing. Between 2015 and 2018, commercial financial institutions increased their sustainable financing by 51%, according to the report.

The scale of transition funding is monumental and will take time to develop. Volume is increasing in all sustainable asset classes, but funding for the transition has been limited in some cases through private initiatives, such as the Climate Bond Standard and the Green Bond Standard, which provide products with a green label or seal of approval.

Overly strict labeling criteria or ‘product use’ requirements that determine when an asset can be considered ‘green’ – such as requiring 100% of the proceeds to be used for ‘green’ projects or excluding funding if some is used for working capital – may limit funding for transition-related activities.

Any regulatory or other legislative action aimed at moving to a low-carbon economy should not hinder the scaling up of sustainable finance, but rather encourage it.

Government policy will need to address the lack of clarity on carbon pricing, as well as provide incentives to finance innovative solutions that may not be profitable in the short term, or projects that would otherwise be too risky for commercial lenders. Policies should also address data gaps through consistent disclosure of the business climate and the establishment of agreed-upon metrics, especially in the context of what constitutes transition activities.

The start of the transition should not be motivated by prudential regulations that could call into question the soundness of climate-related finance by reducing capital requirements for investments considered green. Regulation should also not hamper the financing of the transition for certain companies or certain sectors with regulatory “sanctions”, which will only widen the financing gap.

If policy is to be effective in creating a large-scale transition to a greener economy, then it must focus less on the risks and more on recognizing the challenges and opportunities of such a change.