An initiative called sustainable financing has become a full-fledged trend among international financial groups and institutional investors.Sustainable investment and financing hold the key to promoting the shift of industrial and corporate activities toward decarbonization,and to circulate funds to the development of innovative green technologies that are essential for such transition.
Financial authorities and central banks in various countries have begun to take action, in consideration of the risks that climate change pose to the financial system.Some European central banks are embarking on sustainable financing through reviewing their assets.
Great economic and social transformation
Japan and the European Union (EU) have set a goal of net-zero greenhouse gas (GHG) emissions by 2050, and the U.S. Biden administration also aims to achieve zero GHG emissions by 2050. China, the world's biggest GHG producer, also declared net-zero by 2060. Japan, the United States, Europe, and China have entered into an intense international competition for "green recovery" with the view of securing leadership in international order after the COVID-19 pandemic.
The road to decarbonization is bumpy and winding, as it requires radical transformation of the current economic and social systems that rely on fossil fuels. An executive of a major oil company has stated that the 2050 target is not an easy task for the Japanese industry.
Looking at the world's energy sources, fossil fuels including oil, coal, and natural gas accounted for an overwhelming 84% in 2019. They accounted for 80% of the energy sources in Japan, the United States, and China, and 70% even in EU, where the adoption of renewable energy is increasing. Although countries and regions are moving toward a shift to solar, wind, and other renewable energy, that transition alone is not enough to achieve decarbonization.
The steel industry, which requires a high-temperature heat source for blast furnaces, is seeking an alternative heat source for replacing coal, which emits large amounts of GHG. The aviation and shipping industries are still exploring their options under pressure to introduce green fuels. While countries are scrambling to develop innovative green technologies, such as the use of hydrogen and ammonia and the storage of carbon dioxide (CO2), there are still high hurdles to implement such technologies in society at an affordable cost.
President Biden promised a $2-trillion investment in infrastructure mainly for measures against climate change, zero GHG emissions in the electric power sector by 2035, and construction of electric vehicle (EV) charging stations at 500,000 locations in the United States. The EU has established a €750 billion recovery fund for the European Green Deal, a growth strategy to achieve a balance between economic growth and decarbonization.
Japan set up a 2-trillion yen fund, aiming for the development of innovative technologies and their implementation in society in 14 key areas, including renewable and nuclear energy, by 2030. China revealed its policy for supporting innovation in green technologies in its long-term plan regarding the national policy by 2035.
The transition toward decarbonization requires not only industrial reforms but also overall changes in the lifestyles of people. With global environmental problems such as extreme heat, heavy rain, and the biodiversity crisis becoming increasingly serious, planetary boundaries will be inevitably crossed so long as humankind does not review its economic and social activities that include people's lifestyles.
Take the meat industry for example: fossil fuels used to grow feed crops for cows and pigs produce large amounts of GHG, and cows themselves are the source of methane gas, a type of GHG. The emerging movement in Europe and the United States to replace the meat diet with vegetable protein sources such as meat analogues made from soybeans and insects is part of an attempt to transform food systems.
Professor Naoko Ishii from the University of Tokyo emphasized in an online symposium hosted by the Institute for International Monetary Affairs the need to radically transform the entire economic and social system including energy, food, and cities, and to achieve recycling-oriented consumption and production. She pointed out the importance of the concept of protecting the global commons by everyone, involving cooperation between citizens and academia in order to achieve a recycle-oriented system. "The role of finance is extremely large," she said.
On the other hand, there is a growing sense of crisis that the success or failure of decarbonization by 2050 depends completely on this decade up to 2030 among European countries, international companies in the United States and Europe, and domestic and international civil organizations, who want to further accelerate their efforts to combat climate change. This shows how difficult it is to change the economic and social system that relies on fossil fuels.
In fact, the International Energy Agency noted that the world's fossil fuel-derived CO2 emissions (approx. 70% of the total GHG) in 2020 decreased by 5.8% year-on-year, achieving the largest drop after World War II, but also pointed out the risk of a significant increase in 2021 if the reduction effort is not continued. 2020 saw a reduction in CO2 emissions (-14% y-o-y) due to travel restrictions under the COVID-19 pandemic, as less fuel, electricity, and heat were used in the transportation sector. It was stated that emissions could significantly rise as economic and social activities resume in 2021.
Funds for decarbonization technology
One of the initiatives required for sustainable financing in this situation to achieve a sustainable society through decarbonization is to create irreversible flows of funds toward the development of innovative green technologies while maintaining the stability of financial systems. One of the concerns in this regard is that, while advanced initiatives in Europe and the United States are becoming international norms, both funders and recipients in Japan are considered being one lap—or even two laps—behind overall.
President Rintaro Tamaki from Japan Center for International Finance said at a symposium held by the Institute for International Monetary Affairs that Japan's efforts to combat climate change are ranked 50th among the 61 countries surveyed by a foreign research organization, and that we must seriously accept the reality that Japan has a low evaluation overseas. With regard to green recovery, which puts importance on environmental value, he said, "Most Japanese business people think that environmental investments make corporations grow, but this is incorrect. It is no more than the fact that companies must be environmental-friendly to grow." He clarified the gap between the international community and Japan.
Mark Carney, who served as the Governor of the Bank of England, and explained the need for focusing on climate change in the financial sector at an early stage, pointed out in a speech held by Lloyd's of London (a group of experts for risk management) the three risks that climate change would have on the financial sector: 1) physical risk of increasing natural disasters, 2) liability risk of increasing claims for damages caused by climate change, and 3) transition risk where a wide range of assets are re-evaluated during the course of decarbonization.
For example, the asset value of fossil fuels could deteriorate following the transition to a decarbonized society (which is actually the case for coal), and the rise in sea level could submerge offices and factories in coastal areas, making it impossible to recover invested capital from them. Changes in consumer preferences after the introduction of carbon taxes or due to environmental issues could completely change the business environment.
International companies in the United States and Europe such as Apple have announced a policy to remove companies that are not sufficiently committed to decarbonization from their international supply chains. Even if a Japanese company takes sufficient decarbonization measures, such as adopting 100% renewable energy, they will be locked out of these international supply chains if they buy parts from a supplier that is not committed to decarbonization. Prof. Ishii stressed that borders are meaningless because of global value chains.
Since decarbonization involves a major transformation of economic and social systems, Mr. Tamaki warned that some suppliers will drop off, and that financial institutions will suffer serious damages unless they review their assets and take appropriate actions.
（Continue to the 12th edition.）
* This paper was published in the May 13 2021 issue of Kinyu Zaisei Business.After the publication of the issue, the Bank of Japan announced its policy on climate change.
writer：Visiting Fellow of Jiji Research Institute Yoshio Hori
Yoshio Hori joined Jiji Press in 1981 and was assigned to the Economic Department. He covered the Ministry of Finance, Ministry of Economy, Trade and Industry, the Bank of Japan, the business community, and trading companies. He was a correspondent in London from 1993 to 1997, and has been the vice director of the Economic / Industrial Departments, director of the Industrial Department, and full-time chief of the Editorial Department. He now works as a commentator. He has been a visiting fellow of Jiji Research Institute since April 2021.