Roadmap for Inclusive Green Finance Implementation – Building Blocks to Implement IGF Initiatives and Policies

Dirk A. Zetzsche is Professor and ADA Chair in Financial Law at the University of Luxembourg and Director of the Center for Business & Corporate Law at Heinrich Heine University in Duesseldorf; Ross Buckley is ARC Laureate Fellow and KPMG Law – KWM Professor of Disruptive Innovation, UNSW Sydney; and Douglas W. Arner is Kerry Holdings Professor of Law at the University of Hong Kong. This post is based on their new report presented at the COP27. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Does Enlightened Shareholder Value Add Value? (discussed on the Forum here) both by Lucian A. Bebchuk and Roberto Tallarita; Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock (discussed on the Forum here) by Leo E. Strine, Jr.; Stakeholder Capitalism in the Time of Covid (discussed on the Forum here) by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita; and Corporate Purpose and Corporate Competition (discussed on the Forum here) by Mark J. Roe.

Our “Roadmap for Inclusive Green Finance Implementation presents a series of recommendations for financial regulators to promote inclusive sustainable growth by financial regulation. The report was drafted with the Working Group on Inclusive Green Finance of the Alliance for Financial Inclusion (AFI), a policy alliance of central banks and financial regulators from nearly 80 developing economies, and launched on November 16, 2022, at COP27 in Sharm-el-Sheikh, Egypt. The IGF Roadmap presents six “building blocks” to assist regulators to further sustainable finance and will guide sustainability-oriented financial regulation in the AFI member countries in the years to come.

I. On Inclusive Green Finance

We focus on IGF in the context of individuals and micro, small and medium enterprises (MSMEs), two groups to which financial inclusion offers the broadest benefits. So conceptualized, IGF is a coherent ‘holistic’ policy supporting both financial inclusion (as a social and economic goal) and environmental goals. IGF involves more than just access to financial services, regulators must focus on how those services will be used and how they will benefit individuals and MSMEs, as well as society and the environment at large.

We argue that Inclusive Green Finance (IGF) can help mitigate, and build resilience to, the negative impacts of climate change and biodiversity loss. We identify IGF as a subset of sustainable finance and identify policy tools to further advance it, summarize the related challenges, and provide recommendations for IGF policy implementation.

II. Guidance for Central Banks and Financial Regulators

Based on research, international approaches and AFI members’ experiences, our roadmap provides guidance on what central banks and financial regulators can do, on both a small and large scale, to further financial inclusion and enhance climate change resilience in AFI member countries, and includes insights of relevance in “developed” economies.

An IGF policy is necessary for two reasons. First, markets are poor at assessing uncertain, long-term risks due to the lack of reliable data regarding the future trajectory of climate change. Second, the benefits of IGF are primarily societal and long-term, although the long-term consequences of failure will certainly also impact individuals. IGF objectives are ‘public goods’: individual entities do not directly reap the full benefits from investments in financial inclusion and environmental protection. In the absence of such public policy action, private actors will thus tend to under-invest in financial inclusion and environmental protection.

Much can be learned from the early approaches to sustainable finance regulation worldwide. While the U.S. approach focuses on sustainability risks, the European Union is working on a fully-fledged revamp of financial regulation based on ‘double materiality’, an approach that factors in both sustainability risks and the impact of financial activities on sustainability factors. It is too early to assess whether these ambitious reforms will lead to fundamental changes in economic activity. The EU’s approach has focused, to date, on large companies where cost concerns are less important. By contrast, costs in emerging and developing economies deserve particular attention since most will end up being paid by poorer members of society, with clear exclusionary risks.

III. Towards Double Materiality

Some AFI member institutions have pursued IGF by issuing Sustainable Banking Principles and ESG-related Sustainable Frameworks. These principles generally comprise risk management requirements, sustainability reporting, and governance requirements. While sustainability risks fall within the logic of traditional financial risk management, the same is not true for the impact of financial activity of institutions on sustainability. Beyond reporting, regulators must actively ensure that these externalities are prioritized within the financial institution under supervision. This is particularly the case where an institution’s short-term interest in profiting from unsustainable businesses collide with the public interest in protecting the environment long-term.

Each country has specific climate-related challenges and financial objectives. Accordingly, the preferable pathway will depend on the country’s national priorities, size of its banking sector, availability and readiness of credit financing schemes, significance of its capital markets, level of development of its digital retail payment system, and market size of its digital financial services.

IV. The Need for Aggregate Sectoral Approaches

The international discussion is ongoing, specifically for individuals and MSMEs, as to the level of granularity that is feasible in data collection and risk management. The answer to this question will be country-specific and depend on the level of datafication of the public administration and MSMEs.

We argue in our report that aggregate sectoral approaches, mimicking Basel standards for capital requirements relating to small banking clients, paired with officially endorsed datasets to mitigate the data gap as to MSMEs, may well be in order for measuring sustainability risk and estimate the MSMEs’ impact on sustainability factors in all economies.

The full report may be downloaded here.

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