IMF Warns Against Climate Transition Financial Risks

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    Stockholm (NordSIP) – On the eve of the 26th United Nations Climate Change Conference of the Parties (COP26) due to take place between 31 October and 12 November 2021 in Glasgow, the IMF included a chapter in its latest global financial stability report on the role of investment funds in fostering the transition to a green economy. The report warns that a sudden shift in funds flowing to transition investments could disrupt financial markets and spillover into the real economy. The report also warns that without proper data, disclosures, regulations and supervision, greenwashing is a risk to investors.

    Still Small

    According to IEA and IMF estimates, achieving net-zero carbon emissions by 2050 will require additional global investments in the range of 0.6% to 1% of annual global GDP over the next two decades, equivalent to a cumulative US$12 trillion to US$20 trillion. The report argues that sustainable investment funds are an important driver of the global transition to a low-greenhouse-gas (“green”) economy over the next three decades, necessary to limit global warming to well below  2°C by 2100, as per the 2015 Paris Agreement.

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    Although sustainable investment funds’ total assets under management are small, they doubled over the past four years to reach US$3.6 trillion in 2020. However, climate-oriented funds only account for a relatively small fraction (US$130 billion) of that total.


    Financial Challenges and Opportunities

    Considering other dynamics, the report also notes that climate-related news has not had a meaningful impact on investment fund returns and flows in the past, but large and sudden transition risk shocks could be disruptive in the future.

    Precisely because so few funds are aligned, the IMF warns that ”a large and sudden transition shock could trigger outflows from funds that have large transition-sensitive exposures—a development that could lead to fire sales, thus causing a further fall in asset values and macro-financial spillovers. Structural vulnerabilities in the investment fund sector (such as liquidity mismatches between funds’ asset holdings and redemption features, credit exposure, and use of financial leverage) could amplify the impact. If large and abrupt, the drops in asset prices could then spill over to other parts of the financial sector and to the real economy through tighter financial conditions.”


    Investors & Policy-Makers – Wants &Needs

    According to survey of 26 portfolio managers and representatives from 11 asset management firms and one asset owner, with over US$16 trillion in combined assets under management, based in Asia, Europe, and the USA, the lack of adequate data is a key obstacle to implementing sustainable investment strategies.

    Policymakers should pursue a three-pronged policy course to ensure that the sustainable fund sector can become an effective driver of the transition. First, they strengthen the global climate information architecture for both firms and investment funds. This means ensuring the quality of data and disclosures, and creating sustainable finance classifications including climate taxonomies. Second, they should establish a regulatory oversight to prevent greenwashing.

    After those elements are in place, tools to channel savings toward transition-enhancing funds (such as financial incentives for investments in climate-oriented funds) could be considered to complement other critical climate-change-mitigation measures, such as a carbon tax.

    Finally, policymakers should implement a climate policy consistent with an orderly transition and conduct scenario analysis and stress testing of the investment fund sector, to mitigate potential financial stability risks stemming from the transition.

    Filipe Albuquerque
    Filipe Albuquerque
    Filipe is an economist with 8 years of experience in macroeconomic and financial analysis for the Economist Intelligence Unit, the UN World Institute for Development Economic Research, the Stockholm School of Economics and the School of Oriental and African Studies. Filipe holds a MSc in European Political Economy from the LSE and a MSc in Economics from the University of London, where he currently is a PhD candidate.
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