Stockholm (NordSIP) – Following months of difficult negotiations, EU leaders eventually agreed to a new €750 billion COVID-19 fiscal stimulus package in the middle of the summer. The main innovation of the “Next Generation EU” plan is that the funds will, for the first time, be borrowed by the EU as a whole, rather than by national governments. Moreover, a substantial fraction of these funds is to be allocated “for technical assistance to ‘smart’ and ‘green’ objectives”.
The plan raises several issues at the intersection of governance and climate management that investors should be mindful of. To disentangle this knot, NordSIP spoke with Alessia Falsarone, Head of Sustainable Investing at Pinebridge Investments, to discuss some of the concerns she highlighted in a note at the time of its announcement.
Watching for Unexpected Effects
“Programs to fight climate change are a centrepiece of the plan, amounting to roughly $500 billion and signalling a strong commitment overall to EU green stimulus as part of the post-Covid recovery roadmap,” Falsarone explained in her article at the time. “This includes expenditures earmarked to promoting energy efficiency and developing renewable energy resources, emission-free vehicles, and sustainable transport, among other measures of environmental protection aimed to place Europe on course to meet its 2050 climate neutrality pledge and to modernize its economy.”
Falsarone identified five key areas of the EU deal’s green agenda that investors should keep an eye on. First, investors should keep an eye out for was the EU’s approach to monitoring the way that the funds will be spent. Other concerns focus on the lack of funds dedicated to a just transition and the distributional effects of the stimulus and the role of public-private partnerships in moving from green financing to green growth. Finally, Falsarone highlights the risk that climate concerns may undermine global supply chains and the global trade effects of the stimulus.
Addressing Moral Hazard
“The methodology to monitor spending on ‘green’ initiatives will be a key governance measure that will either enhance the credibility of this unprecedented policy action or hinder future attempts to make it work,” Falsarone said in her article. “Moral hazard and adverse selection will be an inevitable ingredient. It’s a new recipe,” she explained to NordSIP.
The mechanisms developed by sustainable fixed income securities might offer a useful template to overcome these risks. One of the main benefits of Green bonds is that it specifically ties the use of proceeds to environmental projects. “With respect to green bond issuance and national plans, [in the future] Treasury bills will only be green, social and sustainable. This is an important development for the economy as it shifts towards being inclusive, digital and environmentally sound. Moreover, we are close to seeing the rewriting macroeconomic theory, shifting towards a willingness to pay to bear the risk of economic shortfall due to environmental disasters, natural calamities and social unrest.”
However, there are other mechanisms. “The financial system needs to be increasingly clear about the cost of transitioning to a green economy. If we were to interpret the EU taxonomy verbatim and apply it cross-borders, we would live in an economy where close to 90-95% of assets are ‘to be transitioned’. These assets clearly can’t be stranded at zero value, especially when that value includes social factors. Rather, these assets need to be transitioned gradually and replaced along the way.”
“The concept of a carbon border tax is powerful. So is the rethinking of social contracts based on traditional measures of cost of labour, such as a national wage. Another question is also how to incorporate higher mortality rates and increased health and safety risks due to pollution,” she adds.
Climate Policy and Responses to COVID-19
Another interesting point Falsarone raised in her article was the potential for future climate policy, including a carbon border tax, to create “additional hurdles to responsible sourcing of commodities from emerging markets”. In making this connection, the parallel between COVID-19 and climate change is clear.
“Commodity markets have an interesting nuance. They respond swiftly to localized problems in a globalized fashion,” she says. “One example is the state of natural rubber plantations in South-East Asia and Africa during the early COVID shutdowns of automotive end-markets in the developed world.”
“As crop yields suffered, the lack of economic incentives for smallholders directly affected the competitiveness of exports and resulted in land use switching from mature plantations to higher-margin commodities. In some cases, countries have moved from exporters to net importers of rubber in a very short time. Malaysia is one example of this pattern.”
“The common interests of net exporters and net importers will determine the balance of issues concerning deforestation and competitive market behaviours including payment transparency and socio-economic imbalances in local markets,” Falsarone concludes.
Image courtesy of Pinebridge Investments