A mechanism for green recovery: carbon Eurobonds

Date: 2015
La finance climat, au-delà de l'enjeu climatique
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A pro-climate financial architecture

The challenge of the next Conference of the Parties of the Convention on Climate Change (COP 21) is to enable the international community to escape from the circle of distrust that has built up around the climate issue, and to deliver the 'paradigm shift' that was called for at Cancun (COP 16) for 'building a low-carbon society that [...] ensures continued high growth and [...] an equitable access to sustainable development'. In UN parlance, this means abandoning the framing of the negotiations that has dominated since Berlin (1995), through Kyoto (1997) and until Copenhagen (2009).

Even if another Kyoto adaptation was possible, see R. Guesnerie and H. Tulkens (2009), J.C. Hourcade, (2000) and J.C. Hourcade, L. Tubiana, H Le Treut (2010).

This framework was focused on the issue of the sharing of the global emissions budget and has made us lose sight of the benefits of cooperation and the spirit of Rio (1992), which included climate policies in the perspective of sustainable development.

Rio picked up from the Stockholm compromise (1972): to obtain the full participation of Southern countries in environmental policies, these policies must not be an obstacle to their development.

However, there is a risk that the circle of distrust could be re-established. In Copenhagen (2009), expectations were raised for financial transfers via the Green Climate Fund ($100 billion per year). These expectations could be disappointed in a context of financial crisis, strained public budgets and 'fiscal fatigue', especially when some of the recipient countries have new middle classes and are therefore seen as competitors.

This text discusses the notion that success is only possible by considering climate finance as a financial system reform tool, rather than a marginal department of global finance. Also, a low-carbon transition should be considered as a lever for transformation away from the type of economic globalization that led to the 2008 crisis.

Why do we need 'climate finance'?

It is only very recently that the economic literature on climate has tackled the financial issue. The Kyoto economy was characterized by a per-country allocation of the overall emission budget, efficiency was ensured by a single carbon price through a global carbon market, and equity was provided by a generous allocation of emission rights for low-income countries.

This article does not address the obstacle of the allocation of emission rights. Emerging countries are in a phase of development where the use of heavy industries is needed. They will be heavily penalized by any significant carbon prices and developed countries will be reluctant to give more than 1% of their current GDPs in compensation, given that they never met the objective of a 0.7% allocation of GDP for assistance during the post-war boom.

Instead this article focuses on another obstacle: the fact that carbon price provides an incomplete signal, which is drowned out by the noise from other signals (volatility of fossil fuel prices, property prices, evolving regulation of the electricity sector, etc.). In addition, carbon prices improve the profitability of low-carbon investments if all goes well, but they do not respond to the fact that technologies are often capital intensive and that, when investment costs are exceeded, the ventures can be perceived as overly risky, which threatens their capital value and makes additional loans very expensive.

It is this deadlock that climate finance has to remove by reducing the risks of low-carbon investments based on the social value of avoided emissions. It needs to do so urgently because emerging countries are rapidly building infrastructure that will determine much of the century's greenhouse gas emissions. The challenge is to reorient the development choice for countries that are under the dual pressure of providing their middle classes with a decent standard of living, and the risk of confining three billion people to a poverty trap. This window of opportunity is rapidly closing.

Can climate finance exist in an unfavourable context?

Seizing this window of opportunity seems impossible given the state of public budgets and the fragility of the banking system. However, we can look at the situation from the other way around: as the major decarbonization of economies requires a redirection of investment into 40% of the gross fixed capital formation (energy, construction, transportation, material processing and food production), it is therefore in accord with the latest IMF report that calls for a revival of infrastructure investments, a call that reflects a genuine concern for a sustainable recovery of the world economy.

The additional investment costs for a low-carbon transition are moderate, less than 1% of GDP by 2035. There is therefore no savings deficit blockage, but as is the case for other productive investments, there is a blockage due to a financial intermediation that prefers liquid assets to long-term investments. Combined with a business management system that is very sensitive to the immediate value of a company, and given the risks associated with productive investment, this behaviour pushes savings towards speculative investments, particularly property.

Paul H. Dembinski (2014) on savings and sterile finance.

If the low-carbon transition could break this vicious cycle and accelerate the transformation of abundant savings into productive investment, then it would have a positive net effect on short and medium-term growth. This is especially true because this transition is 75% based on the better use of existing techniques and local labour, and concerns activities that are subject to little international competition. Although this requires a favourable business context.

The international debate around economic and monetary policies is well known: fiscal austerity versus the issue of currency. But easier access to credit may well revive the pattern of growth that led to an impasse: debt-financed consumption, competition through wages, property speculation, deindustrialization of many regions, agricultural modernization in tandem with the weakening of rural areas, technological choices with little regard for natural capital, costly imports of oil and fragile energy security. Even the idea of 'project bonds', i.e. bonds dedicated to the financing of infrastructure projects, can lead to a triggering of a lobbying game around random major projects that lack overall coherence. It is here that the climate-agnostic can see the value in financial intermediation based on carbon assets.

Towards the creation of carbon assets

For a more complete development see: J.C. Hourcade, B. Perrissin Fabert and J. Rozenberg (2012). A comprehensive study is available at www.centre-cired.fr

Suppose that governments could agree on a social cost of non-emitted carbon (SCC) and a volume of emission reduction accessible by projects avoiding greenhouse gas emissions. A new asset could then be defined: the Climate Remediation Asset (CRA). Central banks could then open lines of credit in amounts equal to SCC and the volume of CRA; they could accept repayment in the form of carbon certificates (CC) validated by an authority similar to that of the clean development mechanism. Banks could grant loans to low-carbon investments that are partly refundable in CC and not in cash, which are therefore less risky, and their profitability would be increased by lower interest payments. Specialized investment funds could then issue bonds that are attractive to institutional and individual investors.

At the end of the process, central banks would transform CCs into CRAs, which would be counted as assets alongside gold and currencies. There would be no blind injection of liquid funds; the increase of carbon reserves would be correlated with a properly controlled production of wealth, and private savings would be deflected from speculative products by climate-dedicated financial products with a strong guarantee.

Such a system does not affect existing capital, as opposed to a carbon price, but guides the choices made towards the building of future capital. Thus, after a learning phase, the SCC level can be raised much faster than that of a carbon price, with lower transaction costs. Another advantage is the avoidance of discussions on the imposition of penalties on countries that do not respect legally binding commitments; such a country would simply be deprived of access to funding available within the system. Finally, even if only for the sake of the good management of public accounts, states will have an interest in the launch of climate policies, including through carbon taxes, to enhance the attractiveness of low-carbon investment.


It is possible to think that there is a danger of cluttering the climate convention process with sensitive monetary issues that will unfold in other forums of global economic governance. However, it would in fact be within the role of the Climate Convention to provide issues for climate-agnostic actors to seize upon, and the support of these actors is necessary. There now exists an opportunity to be grasped, that emerging countries seem fully aware of, as demonstrated by the Brazil submission in Lima.

This submission calls for the recognition of: 'the social value of mitigation activities [...] in line with the notion of environmental services [...] and to create a consistent, coherent and long-term system of results-based payment through attribution of a financial value to verified mitigation.'

Distrust between countries would be re-established in the case where a minimal agreement was reached, accompanied by the staging of various initiatives that could only poorly mask the fragmentation of action, what J. Jacoby calls a 'favela approach'. We must be bold enough to very rapidly attract the interest of actors that are external to the climate issue and absorbed in other emergencies. Otherwise, it will take ten years to rebuild a negotiation process and we will drift further towards the terra incognita of a 3°C or 4°C warmer world.

A pro-climate financial architecture

The establishment of a new 'carbon' asset that gives a value to non-emitted CO2 would encourage all stakeholders to invest in cleaner technologies and behaviour, while generating the necessary funding for this transformation.
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