· 404 m. aglietta et al. 123 author's personal copy. 2 climate ﬁnance at risk of...

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International EnvironmentalAgreements: Politics, Law andEconomics ISSN 1567-9764Volume 15Number 4 Int Environ Agreements (2015)15:403-420DOI 10.1007/s10784-015-9298-1

Financing transition in an adverse context:climate finance beyond carbon finance

Michel Aglietta, Jean-Charles Hourcade,Carlo Jaeger & Baptiste Perrissin Fabert

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ORIGINAL PAPER

Financing transition in an adverse context: climatefinance beyond carbon finance

Michel Aglietta1 • Jean-Charles Hourcade2,3 • Carlo Jaeger4 •

Baptiste Perrissin Fabert3

Accepted: 15 September 2015 / Published online: 14 October 2015� Springer Science+Business Media Dordrecht 2015

Abstract The Cancun conference decided to establish a Climate Green Fund (CGF) to

help developing countries align their development policies with the long-term UNFCCC

objectives. This paper clarifies the links between the two underlying motives: the first,

technical in nature, is the necessity to redirect the infrastructure instruments in these

countries (energy, transportation, building, material transformation industry) to avoid lock-

in in carbon-intensive pathways in the likely absence of a significant world carbon price in

the coming decade; the second, political in nature, is the interpretation of the CGF as a

practical translation of the notion of the common but differentiated responsibility principle,

since the funds are expected to come from Annex 1 countries. This paper shows why this

latter perspective might generate some distrust given the orders of magnitude of funds to be

levied in Annex 1 countries especially in the context of the financial crisis and major

constraints on public budgets. It then explores the basic principles around which it is

possible to minimize these risks by upgrading climate finance in the broader context of the

evolution of the financial and monetary systems. After exploring how such links could help

make climate policies that contribute to reducing some of the imbalances caused by

economic globalization by reorienting world savings and reducing investment uncertainty,

it sketches how this perspective might be palatable for the OECD, the major emerging

economies and fossil fuel exporters.

& Jean-Charles [email protected]

1 Centre de recherche francais dans le domaine de l’economie internationale (CEPII), 113, rue deGrenelle, 75007 Paris, France

2 CIRED, Centre International de Recherche sur l’Environnement et le Developpement, (CNRS,Agro ParisTech, EHESS, CIRAD), 45bis avenue de la Belle Gabrielle, 94736 Nogent-sur-Marne,France

3 Centre National de la Recherche Scientifique, Delegation Paris Michel-Ange, 3 rue Michel-Ange,75794 Paris Cedex 16, France

4 Global Climate Forum, Neue Promenade 6, 10178 Berlin, Germany

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Int Environ Agreements (2015) 15:403–420DOI 10.1007/s10784-015-9298-1

Author's personal copy

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Keywords Climate finance � Low-carbon transition � Financial crisis � Economic

globalization

AbbreviationsABSs Asset-backed securities

BAU Business-as-usual

CBDR Common but differentiated responsibilities

CC Carbon certificates

CDM Clean development mechanism

CDO Collateralized debt obligation

GCF Global climate fund

GDP Gross domestic product

IMF International monetary fund

IPCC Intergovernmental panel on climate change

LCPs Low-carbon projects

LOLR Lender-of-last-resort

MRV Measuring, reporting, verifying

NAMAs Nationally appropriate mitigation actions

PFMs Public finance mechanisms

SIVs Special investment vehicles

SMEs Small- and medium-sized enterprises

UNFCCC United Nations framework convention on climate change

VCRA Value of climate remediation assets

1 Introduction

The Cancun agreement establishes a Global Climate Fund (GCF) as an operating entity of

the Financial Mechanism of the Convention. Whatever the content of the institutional

arrangements to be finalized later, the scaling up of this Fund is critical for breaking the

distrust circle which pervades the climate negotiations since the Kyoto Protocol (Jacoby

et al. 1998) and for operationalizing the common but differentiated responsibilities

(CBDR) principle of the United Nations framework convention on climate change

(UNFCCC).

This paper first delineates the risks of reinforcing this distrust cycle in the adverse

context of public budget deficits in donor countries. It shows the magnitude of the funding

needed for climate policies, why this goes beyond the promised made in the context of the

GCF and why, because climate finance cannot stay a marginal department of global

finance, its scaling up cannot be disconnected from the reforms of global financial and

monetary systems. It then proposes the basic principle of a monetary instrument to redirect

world savings towards low-carbon investments and lower the risk level of these invest-

ments. It ends by explaining why this instrument paves the way to a palatable deal for all

world regions by making climate policies a fulcrum to reduce imbalances in the current

pattern of economic globalization.

404 M. Aglietta et al.

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2 Climate finance at risk of disappointment and misunderstanding

2.1 Problems of order of magnitude

The credibility of climate negotiations might be undermined by the gap between the USD

100 billion a year by 2020 to which 2020 Annex 1 countries committed to at COP 15

(Copenhagen 2009) and the USD 15 billion per year envisaged by the EU member states in

a first step. If the same share of gross domestic product (GDP; 0.082 %) is envisaged for all

Annex I countries, transfers would amount to USD 31 billion. Although representing only

about one-third of the commitments, they would increase the pre-2008 overseas devel-

opment assistance by about a third; hence the temptation, in a tight financial context, of

greenwashing existing transfers.

This is all the more embarrassing as the real ‘funding gap’ at stake to achieve a low-

carbon transition is significantly higher. The World Development Report (The World Bank

2009) assesses this at USD 140–175 billion a year by 2030 which actually corresponds to

USD 264–563 billion upfront financing needs. The former figure assesses the payments due

over the duration of the projects to cover capital and operation costs, including the interest

to be paid to a patient lender; the latter is the cash necessary to cover the cost of the

equipment before they enter into operation. Hence, the funding gap is not one to three but

one to between 5.7 and 9.6.

Moreover, these amounts are only the tip of the ‘financial iceberg’, the incremental

investment costs. Its hidden part is the redirection of investments flows. If the capital cost

of a given quantity of ‘clean’ electricity is say 30 % higher than that of a coal plant, the

real amount of investment to be redirected is 130 %. Moreover, the total incremental costs

for the energy systems result from a combination between higher upfront costs of low-

carbon energy supply and lower energy demand due to changes in energy efficiency and

consumption behaviour which will not be achieved without redirecting investments in

sectors like building and transportation. These sectors represent 41 % of the world gross

capital formation (EUKLEMS 2011). A back of the envelop calculation1 shows USD 516

billion incremental investments costs in 2020 (3 % increase against 2.5 % by the (Inter-

national Energy Agency (IEA) 1989) corresponding to a far higher amount (USD 4100

billion) of redirected investments.

This reassessment of the orders of magnitude at stake does not mean that the challenge

is impossible to meet in turbulent times. It means that, unless the UNFCCC objectives are

de facto abandoned, climate finance must no longer remain a marginal department of

global finance.

2.2 What does scaling up climate finance really mean?

There is no consensus on the measures listed by the High-level Advisory Group on Climate

Change Financing (AGF 2010) established by UN Secretary-General Ban Ki-moon (e.g.

levies on the revenues from auctioned allowances or on international aviation and shipping

1 We assume that in 2020: (a) 25 % of the investments of the households, business and financial inter-mediaries in residential and non-residential infrastructures is redirected towards low-carbon modes with anextra unit cost of 5 %, (b) 10 % of the investment in the transportation sector is redirected towards low-carbon modes (a low percentage because of the low substitutability between rail-based and road-basedtransport) with an extra unit cost of 10 %, (c) 33 % of the electricity and gas capacities investment have anextra unitary upfront investment of 20 %, (d) investment in mining decreases by 10 %, and (e) 20 % of theinvestments in machines have an extra unit cost of 10 %.

Financing transition in an adverse context: climate finance… 405

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emissions, taxes on financial transactions, levies on credit trade and carbon taxes). This

lack of consensus cannot be disconnected from a ‘donor fatigue’ exacerbated by the return

of ‘depression economics’ (Krugman 2009), the shifts in global geopolitics and the fact

that the division line between the rich and the poor coincides less and less with the

traditional North/South division (Chakravarty et al. 2009).

This fatigue is reinforced by doubts about the viability of low-carbon investments. The

cash flows from the Clean Development Mechanism depend on the demand for carbon

offsets, and the limited size of this demand is a current cause for concern. Moreover,

yielded at the end of the projects they fail to reduce the upfront investment risks in the

context of large uncertainty. Public Finance Mechanisms (PFMs) do bring funds during the

incubation phase of the projects but cover only the extra costs and not the bulk of low-

carbon investments (Neuhoff et al. 2010), assuming implicitly that without these costs the

projects would have met positive risk-adjusted returns.

This is due to the ‘additionality principle’ applied since the early nineties to ensure that

environmental aid to developing countries does not crowd out conventional overseas

development assistance. Its consequence is that the ‘carbon-based PFMs’ do not address

the usual risks of any development project: technical and regulatory uncertainty, currency

risks, long payback periods, volatility of market prices and uncertainty about future

demand. Their leverage ratio of public money on private investment (AGF 2010) is lower

than those of traditional PFMs: USD 2–4 for every USD 1 compared with USD 3–15

(Maclean et al. 2008; Ward et al. 2009). Continuing along these lines of reasoning would

make it impossible to redirect the amount of low-carbon investments at stake; no matter

indeed whether these investments are blocked by carbon-specific risks or usual risks. The

challenge is to improve their overall risk-adjusted cost–benefit ratio in order to reach a

‘statistical additionality’ of investments instead of project-based additionality.2

2.3 Turning the approach upside-down

Let us examine the need to expand carbon finance through the lens of climate agnostics

primarily concerned with the stability of financial systems and global economic recovery

after the 2008 crisis. Their concerns are legitimate because the symptoms that led to

unstable financial dynamics are still prevalent:

• The ultra-low interest rate policy of the main Central Banks in developed countries has

exacerbated the search for yield higher than ‘public bonds’ by cash holders (financial

departments of multinational companies, institutional investors like mutual funds or

pension funds). Those holders have moved in and out of capital assets because they are

very sensitive to tiny changes in the communication of Central Banks that might hint to

future changes in interest rates. In the wholesale short-term money market, prior to

2008 these volatile capital flows were channelled through wholesale funding

instruments [asset-backed securities (ABSs) and collateralized debt obligations

(CDOs)] issued by shadow banks [broker–dealers, conduits and special investment

vehicles (SIVs)]. These instruments have disappeared, but the mistrust in the banking

system has motivated continuous build-up of institutional cash pools. The high demand

for safe short-term instruments has provoked an increase in the value of bonds and

driven their interest rate to zero. The shortage of such instruments was aggravated

2 For the discussion of the difference between project additionality and statistical additionality, see(Hourcade et al. 2012).


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because foreign Central Banks buy them for reserve keeping. Ultimately, there is a

higher mass of liquidity than sovereign bonds that can be issued backed on public

assets.

• The way governments and Central Banks have dealt with the problems of excessive

risk-taking did not succeed in combating the too-big-to-fail syndrome and hedging

against the risk of losing control (King 2011) remains an unachieved business.

Therefore, existing cash pools are largely outside banks because of widespread distrust.

They have been estimated by the IMF (Pozsar 2011) at USD 3400 billion in 2010

against USD 3800 bn in 2007 and USD 100 bn in 1990).3

• Firms operate in a business environment which prioritizes, since the eighties,

shareholder value against the maximization of the long-term growth of the firm

typical of a ‘managerial business regime’ (Roe 1994). This is a main cause of the

obsession for liquidity. The profusion of cash in large companies fuelled bursts in

dividend distribution and share buyback to boost equity prices. It contributes to

exacerbating inequalities of income distribution. Investment rates have thus declined

with lack of effective demand. Flagging credit demand by small- and medium-sized

enterprises (SMEs) is met with bank reluctance to lend. Investors face a kind of

Buridan’s donkey dilemma,4 where the donkey which died of hunger and thirst because

it hesitated too long between eating oats or drinking water: they do not know which

long-term investments to invest in.

Viewed through this lens, the financing problem posed by the low-carbon transition does

not come from a lack of funds. It comes from the inability of the present system of financial

intermediation to fund productive investments. Higher and more stable growth would be

possible by reducing excess liquidity via heavy taxes which is highly unlikely; matching

treasury bill issuance and the volume of cash pools which is not recommended in times of

consolidation of public debts; and expansion of the umbrella of the lender-of-last-resort

(LOLR) to non-banks is also not a palatable solution. The only viable solution is creating

intermediaries able to bridge long-term assets and short-term cash balances, the preferred

support of saving, so that they will be invested productively, without incurring the risks of

excess leverage, maturity mismatch and interconnectedness (non-liquid long-term assets

financed by short-term, unsecured liabilities of money market funds) that have fostered the

systemic crisis.

The question though is whether climate finance can provide the opportunity to create

such links. If it can lower the investment risks of low-carbon projects and redirect savings

towards productive activities, it will reduce the magnitude of the cash pools and fuel the

world growth engine by shortening the trickling down of savings to productive

investments.

This is a timely suggestion as the globalization pattern is changing and new patterns of

‘shifting wealth’ accumulation are taking place. Export-led growth and reserve accumu-

lation in emerging economies was fuelled by excess credit growth in many OECD

3 They are held by (1) global non-financial corporations and institutional investors outside the bankingsystem; (2) mutual funds and hedge funds (managed liquidity and cash collateral associated with securitieslending); (3) the overlay of derivatives linked to derivatives-based investment; and (4) wealthy individualsand endowments.4 This legend is a caricature of Jean Buridan, a theologian at the Sorbonne in the fourteenth century, whoargued that wise conduct is to postpone decisions until the necessary information becomes available. Thelegend recounts the sad story of a donkey who dies because it hesitates for too long between oats and the pailof water placed at equal distance from him.


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countries. There are attempts to replace this pattern by more inward-focused growth,

fuelled by the widening middle class in emerging economies, pressures for higher wages

and services and a huge investment demand driven by urbanization and environmental

concerns.

This mutation also concerns international financial intermediation. European banks

have retrenched on their home borders since the Euro zone crisis and no longer borrow

dollars via their US subsidiaries to relend worldwide. Faced with this vacuum Asian

development banks and sovereign wealth funds are stepping up their ventures. A financial

model is emerging, based on long-term bilateral financial contracts at agreed upon prices

backed by government guarantees and on Bond issuance substituting national currencies to

the dollar which is the de facto reserve currency

3 A carbon-based financial device backed by monetary refinancing

In this context, options to finance the low-carbon transition despite limited carbon markets

are many. However, given limited public budgets and constrained banking systems,

investors have to internalize the social value of avoided carbon emissions into the economy

by means of a carbon-based monetary instrument. For climate agnostic policy-makers who

implemented ‘unconventional monetary policies’ after 2008, this value is of interest only if

it is used in a system helping the banks to develop their credit activities towards productive

investments.

The basic trick consists5 of injecting Central Bank liquidities into the economy, pro-

vided that they are used to fund low-carbon investments. Governments would need to

provide a public guarantee on a new carbon asset, which allows the Central Bank to

provide new credit lines refundable with effective CO2 emissions abatement. This targeted

credit facility makes it possible to expand credit to low-carbon projects (LCPs) as it offsets

LCPs’ financial risk perceived by the banks and investors relatively to business-as-usual

(BAU) projects and would make these projects more attractive.

How to transform this general perspective into an operational system is out of the scope

of this paper. However, any such system will hardly avoid following the principles pre-

sented in Fig. 1.

Step 1: A political compromise on the social value of carbon remediation activities

The valuation of climate change damage, theoretically necessary to calculate the social

cost of carbon (f) along an optimized trajectory, is highly controversial (Tol 2008; Dumas

et al. 2010), if not impossible at the world level.6 It depends on many parameters among

which pure time preference, assumptions about the costs of carbon-free techniques and

beliefs about climate change damage. However, the objective of preventing a temperature

increase[2� above pre-industrial levels is equivalent to acknowledging risks to go sig-

nificantly beyond these 2 �C are worth avoiding with and without transitory overshoot.

5 Many types of systems can be designed along the same lines. The system presented here are archetypesand aspirational. For instance, we can imagine a system that does not imply the intervention of the CentralBank as suggested by Rozenberg et al. (2013). This system might be politically easier to implement butmight not deliver the same general benefits in terms of reducing some of the failures of economic glob-alization as explained above.6 Some countries have nevertheless adopted social values of carbon: the UK (DECC 2014), the USA andFrance (Quinet et al. 2009) (USD 42, USD 60 and USD 130 in 2030, respectively).


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The social value of the carbon externality is thus the cost of meeting a given climate

target. Uncertainty about these costs is still large, but orders of magnitude lower than on

climate change damage. The last report by the intergovernmental panel on climate change

(IPCC) provides corridors of such costs.

This corridor provided a good guidance but what matters ultimately is the willingness of

governments to act to mitigate climate change and this willingness in turn includes the co-

benefits of climate mitigation (air pollution, benefits of the recycling of the revenues of

carbon pricing, energy security).7 This is why what matters is the social value of climate

remediation (VCRA) which incorporates both the value of reducing the carbon externality

and the co-benefits of this reduction.

Should this value be specific to each country or common at the world level is an open

question. However, a political agreement on a world VCRA should be easier than on a

carbon price. First, it serves as a notional value for low-carbon investments and does not

Fig. 1 The key elements of a climate-friendly financial architecture, Source: own diagram

7 For a 2 �C target, the corridor is between USD 60 and 130 in 2030 and between USD 200 and 375 in 2050.


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impose an immediate extra cost on firms and consumers. Second, each government will

value its VCRA in relation to its own perception of the domestic co-benefits of climate

mitigation. Hence, countries might agree to the same VCRA for various reasons, and since

this VCRA could be revised every 5 years, a process can be triggered which will allow for

further correction as new information becomes available.

More important is to hedge against the vagaries of market exchange rates. The SVC

value would be nominally similar to the USD 35 per ounce of gold under the Bretton

Woods regime. However, since the exchange rates are relative values, the VCRA in

national currencies will thus differ from one country to another and will be subject to

variations. These variations can be large enough to generate time inconsistencies in

investment projects funded in different countries. This is why the world SVC should be the

weighted average, in purchasing power parity (PPP), of national prices. The internal rate of

return of investment projects would then all be implicitly computed in the PPP price

system (reviewed every five years) which would minimize the inefficiencies caused by the

volatility of exchange rates.

Step 2: A carbon-based money issuance

Together with this political agreement on a VCRA, volunteer governments could

announce that they support a new class of ‘eligible assets’ recognized by their Central

Bank: carbon assets. Their unitary value is the SVC and their quantity is an overall volume

of emission reduction corresponding to governments’ commitments (see Hourcade et al.

2015).

The Central Banks then can announce that they will (a) allow commercial and devel-

opment banks to draw on new credit lines provided that they use the liquidities to fund low-

carbon projects, (b) accept as repayment ‘carbon certificates’ (CC) testifying effective

carbon emission reduction and valued at the SVC and (c) transform them into carbon

assets.

Carbon-based liquidities can then be gradually injected into the economy as the banking

system funds low-carbon projects drawing on the credit lines opened by the Central Bank.

Carbon assets will be incorporated into the Central Bank’s balance sheet when the bank

returns the carbon certificates, i.e. the monetary value of the emissions reduction yielded

by the project (see ‘‘Appendix’’ for a description of the credit line ? CC ? carbon assets

circuit through the balance sheets of the Central Bank, commercial banks and the entre-

preneurs). In this way, the money issued is automatically backed by ‘real wealth’ in the

form of low-carbon equipment and infrastructure in addition to the future benefits of

emission reductions.

Step 3: A supervisory body to select the projects and monitor effective CO2

emission reduction

The new credit facility is meant to help both projects that can pay for themselves but

suffer from a credibility gap inhibiting their adoption and projects that need specific

support because of the additional costs and uncertainties. The credibility and the accuracy

of the MRV process is then critical including the guarantee that the funded projects are

aligned with the development objectives of the recipient country and yield effective CO2

emission reduction.

An Independent International Supervisory Body, similar to the Clean Development

Mechanism (CDM) Executive Board, is thus needed which would first determine eligible

mitigation projects and policies (on technology, sector, time horizon) in relation to their

consistency with the Nationally Appropriate Mitigation Actions (NAMAs) presented by


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the countries to the UNFCCC. Second, since the objective is to trigger GHG abatements

which would not have been realized, otherwise, it will fix the allocation rules of carbon

certificates per type of projects in participating countries in relation to their expected

emission reductions. Those rules are necessary to avoid the transaction costs of project-

based assessments and to secure a statistical additionality of the wave of projects triggered

by the system even though some of them individually could have been realized without its

support (Hourcade et al. 2012).

The last responsibility of this Supervisory Body should be to monitor the conformity of

a project at the time of its launching and to confirm ex-post its level of completion. It has

then to cancel part of the carbon certificates if it judges that the project did not fulfil the ex-

ante performance criteria.

Step 4: An incentive to mobilize entrepreneurs and banks

Accepting as repayment certified emission reduction instead of cash entails cancelling

out the entrepreneur’s debt at the height of the value of the certified emission reductions.

This is the primary level to strengthen the solvency of low-carbon projects, to lower their

risk level and to enhance their attractiveness for the entrepreneurs and project contracting

authorities. One important point is that a VCRA growing with time would counterbalance

the effect of the discount rate and enhance the social value of long-lived infrastructures.

For commercial banks in the process of deleveraging, this new credit facility will

encourage them to expand their lending activity, instead of accumulating liquid reserves.

An additional regulatory incentive for the banks might be that a high share of LCPs in their

loan book would make their balance sheet less risky, since this share of their assets would

benefit from a public guarantee. One could even imagine that they keep part of the carbon

assets. Banks would then be rewarded with a reduction in the cost of their prudential

capital constraint. They could be indeed allowed to apply a zero risk coefficient—in the

same fashion as for sovereign bonds—to the fraction of the loan that comes from Central

Bank liquidities backed by the value of emission reduction.

Step 5: Redirecting saving towards long-term climate-friendly investments

In addition to redirecting bank credit to support a low-carbon transition, the success of

the system will depend on its capacity to redirect private saving towards LCP&P. To do so,

banks or specialized climate investment funds could use the carbon-based monetary

facility to back highly rated climate-friendly financial products attractive for households

and institutional investors, such as ‘AAA’ climate bonds with a return on investment

slightly above the usual safe deposit rate in order to attract long-term savings. Well-

tailored paid-in capital makes it possible to issue a multiple of this capital in highly rated

climate bonds. The proceeds of those bonds would then fund loans to a pool of LCPs (with

possibly a mean rating of ‘BBB’). The paid-in capital acts as a buffer against loss given

default of the pool of LCPs and thus sustains the good rating of the climate bonds.

Sovereign wealth funds, public private and corporate pension funds, insurance companies,

endowments and investment management companies could be interested in AAA-rated

‘climate coloured’ bonds (like the green bonds of the World Bank) instead of speculative

financial products for both ethical and regulatory purposes. As described in Fig. 2, the trick

is to fill up the paid-in capital with carbon certificates.

One major tool for mobilizing savings kept by institutional investors and households

would be to use a share of the carbon assets to capitalize the GCF independently from the

only goodwill of the tax payers of the developed countries. The potential leverage effect of

this multilateral tool is high. As suggested by De Gouvello and Zelenko (2010), the GCF


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could issue Green Bonds worldwide. If the Fund could accumulate USD 100 billion by

2030 and if it invested this in well-diversified projects, so that one can assume that the

probability density function is Gaussian, meaning that it would have a 99.9 % probability

that its capital base could absorb its losses. Hence, it could issue USD 1 trillion in bonds to

back up credit facilities to developing countries, and this credit would have real wealth as

collateral.

4 Climate finance: contributing to sustainable globalization

One legitimate reflex is to suspect that this system will generate inflationary risk and

nurture speculation. The first risk only exists in case of generalized failure of the LCPs or

embezzlement of the funds since liquidities will be gradually injected in the economy as

‘real wealth’ produced by the projects. But the existence of a Supervisory Body to certify

the projects provides a good safeguard against this risk. As to the second, it is controlled by

the fact that the total volume of carbon-based liquidities is limited by a given amount of

emission reduction and by the fixed value of the SVC.

More difficult to address is the legitimate fear of climate diplomats to venture into

uncharted domains. It can be overcome only if this perspective gets support from climate

agnostic policy-makers because they are convinced that it might contribute to a

stable monetary order in these times of knife-edged equilibrium between monetary laxity

fuelling speculative bubbles and monetary rigour fuelling sluggish growth.

4.1 Economic rationale of an international recognition of carbon assets

Figure 3 visualizes one major problem of the growth regime triggered as soon as dereg-

ulation has started: the ‘Great Moderation’8 of business cycles and financial cycles of far

larger magnitude and far longer times span than in the past (Schularick and Taylor 2009).

Financial cycles are measured by the gap relative to trend of an index combining credit

growth and asset prices (a mix of equity, bonds, real estate price indices).

Fig. 2 Climate finance as a means to redirect long-term saving towards low-carbon investments, Source:own diagram

8 The ‘great Moderation’ was first discussed by Stock and Watson (2002), see also Summers (2005).


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This misalignment, over decadal periods, of asset prices and very long run benchmarks

has pervasive efficiency costs. Together with the volatility of exchange rates, it swamps the

signals on which investors should base their decisions. It is propelled by private credit

dynamic and its magnitude is caused by the self-fulfilling beliefs of market participants that

prices will go on moving the way they have gone just before. Financial intermediaries are

governed by the same self-fulfilling expectations as their borrowers; they lend money to

finance speculative positions on asset prices and take the assets as collaterals of their loans.

More credit has thus led to higher asset prices, higher value of collateral and lower

perceived risk premiums on loans.

The asset prices thus cannot be vectors of adjustment in the macro-economy. Their

volatility exacerbates real disequilibria, as shown by the cumulative global imbalances in

the balance of payments and in the balance sheets of financial institutions, which receded

only in the financial crisis. Price reversals arise only through crises that are endogenous as

‘booms gone bust’, while unknown tipping points shift the mood of market participants

from euphoria to panic (Adrian et al. 2013).

If the macro-prudential policies are not strong enough to mitigate the impact of the

reversal in asset prices, finance is not self-stabilizing and a monetary policy only focused

on low inflation is not conducive either to macro-stability. Real imbalances are even

magnified by the Great Moderation in inflation, because the huge gyrations in asset prices

are real price changes (Aglietta 2014).

One response is a renewed version of the Chicago Plan, but it is politically demanding

since it implies that banks are treated as public utilities. To be safe in any circumstances,

banks would be required to buy Treasury securities for a large share of their deposits and

lend only to highly rated borrowers. The bulk of the credit would then be channelled

through from securitized lending and corporate bonds. Narrowing the scope of bank

Fig. 3 Business and financial cycles in the USA (1980–2011), Source: own diagram


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activities, this plan widens the role of financial intermediaries on the wholesale money

market with shadow banks playing the role of liquidity suppliers. It thus moves fragilities

from one compartment of the financial system to the next.

Another response is to anchor money on a basket of commodities as in Keyne’s Bancor

proposal at Bretton Woods. The obstacles to such a Bancor remain, but carbon-based assets

have the advantage of incentivizing financial intermediation to do its job of financing the

real economy instead of pursuing capital gains magnified by higher and higher leverage.

They are not a substitute for stricter financial regulation and will not suffice in preventing

financial crises which arose even in the gold standard era. However, they can contribute to

the search for a more stable financial context and this is the reason why, although the

issuance of carbon assets should result from the voluntary initiative of countries, their

international recognition matters.

Carbon assets would then de facto acquire the status of world reserves, and this opens a

wider perspective to lower one source of tensions in the economic globalization process,

i.e. the distortions in exchange rates due to the ‘war-chest’ of official reserves accumulated

in the emerging world after the 1980s/1990s financial crises in Latin America and Asia.

Those reserves invested mainly in US Treasury securities and were built to protect export-

led growth strategies against exchange-rate appreciation and as self-insurance against

currency crises. Carbon-based reserve assets could allow these economies to increase and

diversify their foreign exchange reserves in a way conducive to cooperation against a

global externality. This concern was underlined by Zhu Xiaochuan, the governor of the

People’s Bank of China when he called for a SDR reserve-based system in 2010. Jaeger

et al. (2013) show how this proposal could contribute to sustainable development.

If countries with non-convertible currencies have access to internationally recognized

carbon-based assets, they would be less inclined to run balance-of-payment surpluses,

since they would get their reserves in proportion to the emission reductions they finance

domestically.9

4.2 Clearing up a foggy business environment and getting the worldout of the doldrums

The virtuous cycle cannot be fully understood without coming back to the paradox of the

current coexistence of a vast pool of savings and of over-indebtedness and its impact on

real economies.

Since the financial crisis the world economy has languished. The stimulating plans after

2009 succeeded in supporting 3 % growth rate in the USA in 2010, after 2 years of

recession. But this rate was only 1.8 % in 2011 and 2.5 % in 2013, fostering a debate on

‘secular stagnation’. The real GDP growth of EU-27 declined to 0.6 % per year from 2007

to 2012 and an almost zero growth in 2013. The large emerging countries (Brazil, India and

even China) suffered a lacklustre performance in 2013, expected to be prolonged further

according to the l World Economic Outlook (April 2014).

One key underlying mechanism is the deleveraging of the private sector. Planning

horizons of firms and households have not adjusted to the length of the downward phase of

the financial cycle, and the economic landscape has become fragmented in developed

countries. Households are still digesting the impact of the property bust in many countries.

9 This would also spread the gains from seigniorage (i.e. the profit made by governments by issuingcurrency) and reduce the perverse effect that forces the USA to pump out more USD assets for globalreserves.


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Small- and medium-sized enterprises struggle to get credit, while big corporations are

awash with cash that they do not know how to use productively. As a consequence,

investment has decreased more than overall growth (-14 % in the EU from 2008 to 2012).

A carbon-based financial architecture, instead of crowding out productive investment,

could thus help overcoming the Buridan’s donkey dilemma by indicating where to invest in

this subdued business climate. This will be of interest for the pension funds for example

which currently tend to avoid getting involved in investments that look safe while masking

ventured assets.

A natural question is: Why not rely on price signals given by the carbon trading

systems? The answer is that, for investments on long-lived infrastructures, these signals are

swamped by regulatory uncertainty about the long-run carbon prices, the currency

exchange rates and the strategies of OPEC countries (Waisman et al. 2013). A carbon-

based financial instrument could overcome a part of these uncertainties through trans-

mitting upfront the social value of avoided carbon emissions.

To understand why this transformation of the financial system might trigger a green

growth regime, let us recall, with Schumpeter, that financial crises pinpoint transitions in

growth regimes: the upward momentum preceding crises piles up distortions in market

structures and income distribution, while the downward phase is the search for adapting to

an incipient innovation wave. Industrial revolutions are the source of long-term growth

cycles. They reshape capital accumulation over the long run and transform consumption

patterns and social institutions. However, a new wave can take off only when its promises

have captured what Keynes called the ‘animal spirits’ of finance.

The capacity of a low-carbon transition to be a frontier of innovation supporting a new

growth regime is real because the concerned sectors (energy, transportation, buildings)

represent a dominant share of investments and because they are critical for social inclu-

siveness and for an inward-oriented growth. Over the past decades, emerging economies

grounded their economic catching up on export-led strategies sometimes at the cost of

outdated domestic infrastructure and sensitivity to variations of exchange rates as a result

of US monetary policy.10 Since 60 % or more of carbon savings investment (The World

Bank 2009) would take place in developing countries, a carbon-based finance would

reorient domestically a fraction of the savings that currently flow into the world financial

system. A more ‘endogenous’, inward-oriented growth pattern might become less risky for

political and economic reasons, thanks to the expansion of domestic investment

opportunities.

4.3 Reconciling well-perceived nation’s interest in an adverse context

This perspective will never reach the diplomatic agenda, unless it is perceived by high-

level policy-makers as responding to the specific problems of each region.

Let us start with the emerging countries. All of them have the same interest in receiving

support to redirect their infrastructural policies towards low-carbon and less energy-in-

tensive choices (Shukla and Dhar 2011). This is a matter of energy security, of inclusive

regional and urban development and of less exposure to currency turmoil and variation in

domestic asset prices as a result of sudden changes in the direction of cash flows. This is

exacerbated in the Chinese case due to the inverted population pyramid in China after 2030

and the fall of the Chinese saving rate. China might be trapped, within this time horizon, in

10 This point is made very clearly by Rajan (2010), former Chief Economist of the IMF and the currentgovernor of the Reserve Bank of India.


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an energy-intensive pathway which might make it vulnerable to energy shocks. All these

countries could gain from reforms, including carbon pricing, urbanization policies and

reducing energy and carbon intensity in industry. They will greatly benefit from an

international system helping to reorient their domestic savings and foreign capital flows.

The Eurozone could be interested in complementing its ‘fiscal compact’ by a ‘green

growth’ compact to make a better use of its quantitative easing monetary policy and to

reinforce a unity undermined by imbalances among partner countries. A carbon-basedmoney

emission would help it to find the narrow pathway between monetary laxity and excessive

rigour and trigger an inclusive economic dynamic by creating jobs through the productive

structure (Aglietta and Hourcade 2012). Such a policy has the additional merit of reducing

energy intensity, abating carbon emissions, stimulating regional demand and diminishing the

dependency of Europe towards primary commodity producers. Europe could thus match its

own interest with recovering a leadership in climate negotiations (Jaeger et al. 1997).

Policy lines might change in the USA where multiple climate catastrophes, including

Sandy that hurt New York City badly, have revealed the decay of public infrastructure and

the lack of public services in adverse conditions. Yet, vested interests in the USA bet on

cheap energy due to massive investment in fracking shale gas. The core issue is whether

shale gas will be used as ‘manna from heaven’ to maintain their historical development

pattern, or as a tool to facilitate the switch towards low energy-intensive patterns. The

upgrading of climate finance sketched in this paper might incite them to follow the second

option given its economic and geopolitical side dividends.

As to the large group of the least developed countries, dominantly present in Africa and

so far bypassed by the CDM, they will benefit from the system because of the large gap

between their normative aspirational trajectory and their real emissions, and because they

can target their NAMAs as being eligible for financing in this system in such a way that they

primarily support priorities such as the access of the population to basic energy services and

electricity. Doing so, these countries would be enabled to better control what Rajan (2010)

calls the ‘flighty foreign financing’ which has been one obstacle to their development.

One cannot disregard the palatability of the suggested perspective for the oil and gas

exporters which are the other key players of a long-term energy transition under climate

constraints. Depending on the design of the post-2015 climate regime (including the absence

of an effective regime), theymight perceive climate policy as a threat because of their adverse

impact on the prices of fossil fuels or as a way of escaping the resource curse by using long-

lasting rents to switch towards viable industry, agriculture, transport and energy systems.

5 Conclusion

This paper delineates a carbon-based monetary instrument, which is tantamount to the

Central Bank buying a service of carbon emission reduction at a price justified by the

politically agreed VCRA, and eventually society’s willingness to pay for a better climate.

Carbon-based liquidities can be therefore considered as ‘equity in the commonwealth’. The

equity pays dividends in the form of ‘actual wealth’ created by productive short-term low-

carbon investments and averted emissions, and a stronger long-term resilience of the

economy to environmental shocks.

This instrument can produce tangible benefits over the short term through lowering the

investment risks on low-carbon projects and policies and redirecting part of the savings

which is currently floating in speculative investments towards infrastructure. This


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redirection can foster what has been repeatedly referred to as a Green Marshall Plan

(Schelling 1997). Whatever the metaphor, this redirection could contribute to the recovery

from the financial crisis without reproducing the drawbacks of past development patterns.

It could also contribute in turn to calming down some of the current and future tensions in

economic globalization by a more inward-oriented industrial strategy in the key emerging

economies, lesser risks of currency wars and less potential conflicts about resources.

An additional note has to be made in this conclusion about the link between this

mechanism and the common but differentiated responsibility principle. Pragmatically, this

would be done through the rules adopted for ‘carbon assets issuance’ and through the share

of carbon assets contributing to the Green Climate Fund. Perhaps as importantly, if another

share of these carbon assets is accepted as an additional member state contribution to the

International Monetary Fund (IMF) accounts, OECD countries would then support the

consequences of their past responsibilities not only in climate change but also in triggering

the financial crisis of an unprecedented magnitude since 1945.

One counter-argument might be that such reforms exceed the competences of the Climate

Convention and are a diplomatic non-starter. But, ignoring the importance of climate finance

to break the mistrust cycle that blocks the climate negotiations and the adverse economic

context that impairs large-scaleNorth–South transfers is also a diplomatic non-starter. A fully

fledged system is not needed in the short term. What is needed is to launch a virtuous

confidence cycle. To do so, it will suffice that a group of countries takes the initiative of

creating carbon-based assets under the UNFCCC and demonstrates to climate agnostic

policy-makers the possibility to use it for deeper evolutions of the financial system and the

economic globalization process. This will ground the ‘commerce of promises’ which fuels

modern economies on somethingwith recognized value: the avoided climate change damages

and the development benefits of low-carbon infrastructure.

Appendix: The banking canal of the monetary device

Tables 1, 2, 3 and 4 offer a numerical example of the balance sheet consequences for the

Central Bank and a commercial bank of a 1000 loan to a low-carbon entrepreneur expected

to realize 10 units of CO2 emission reduction. The VCRA is set at 10, which values the

expected emission reduction at 100.

Table 1 Balance sheets at the opening date of the low-carbon loan

Central Bank Commercial banks Entrepreneur

Asset Liability Asset Liability Asset Liability

1000RLC

Loan CO2 ?900rl ?900rd ?900rl

?100 ?100 ?100 ?100 ?100

?0.08 (900rl)

10 CO2 100

Reduction of CO2 Drawing rights

During the payback period of the loan, the entrepreneur gradually reimburses the loan with monetaryrevenues of the project as suggested by Table 3. As the project realizes emission reductions, the entre-preneur receives carbon certificates


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Table 2 indicates that the loan to the entrepreneur is divided into two credit lines. On

the first line, the commercial bank borrows 900 deposits at rate rd and lends 900 at rate rl.

The second line refers to the 100 liquidities equivalent to the value of expected emission

reduction lent by the Central Bank to the commercial bank that can be paid back with

Table 2 Balance sheets at mid-maturity of the low-carbon loan



1000RLC

Loan CO2 ?450rl ?450rd -450rl ?450rl

?100 ?100 ?100 ?100 ?5 CC ?100

?0.08 (450rl)

10 CO2 100


At the end of loan maturity, Table 4 indicates that the entrepreneur has paid back the entire 900 debt withthe monetary revenues of the project and has gotten 10 CC for the emission reduction her project hasachieved. Capital constraint for the commercial bank gets null and only the second credit line remainsunchanged in the balance sheets

Table 3 Balance sheets at the end of the payback period of the low-carbon loan before the asset swap



1000RLC

Loan CO2 ?0 ?0 -900rl ?0

?100 ?100 ?100 ?100 ?10 CC ?100

?0

10 CO2 100


The last step of this process is an asset swap performed by the Central Bank who accepts the 10 CC asrepayment of its 100 financial claims. This results in cancelling out the second credit line corresponding tothe ‘carbon debt’ of the low-carbon project. Total amount of carbon-based liquidities that the Central Bankcan issue is reduced by 100

Table 4 Balance sheets after the carbon asset swap



10 CC ?100 1000RLC

?0 ?0 -900rl ?0

?0



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certified emission reduction. Prudential rule about minimum capital requirement only

applies to the first credit line (900rl), as a zero coefficient risk is applied to the line coming

from the carbon-based liquidities. Then net worth increase in the bank should only be

?0.08*900rl instead of 0.08*1000rl as in the BAU case, that is the funding of a con-

ventional project.

The Central Bank owns a new 100 claim on the commercial bank. Thanks to the 1000

loan, the entrepreneur launches a project with expected returns RLC which makes the total

expected revenues amounting to 1000RLC. Two lines appear in the liability side of the

entrepreneur’s balance sheet corresponding to two types of debt: 900 will be paid back

with the monetary revenues of the projects and at the interest rate rl, and 100 paid back

with effective emission reduction.11

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