Private investment in the ecological transition (Note)

DISCLAIMER: « This publication reflects the personal views of the author and does not express the position of his employer. »

Private investment in the green transition

Contribution by BSI Economics to the National Assembly report

On January 30, 2019, the Evaluation and Control Mission of the National Assembly’s Finance Committee published its information report on public tools encouraging private investment in the ecological transition, co-written by MPs Bénédicte Peyrol and Christophe Bouillon (available here).

BSI Economics contributed to this mission lastspring, and three of its economists were interviewed on June 28, 2018.

Here is a review of the report’s conclusions and recommendations, as well as BSI Economics’ contribution to the deputies’ findings and recommendations.

The ecological transition requires a significant reorientation of private investment

• Given the insufficient investment in the ecological transition to achieve the objectives of the Paris Agreement, both globally[1], in Europe[2], and in France[3], it is as much a question of redirecting existing investment flows (from fossil fuels to energy efficiency and new low-carbon technologies) as it is of increasing the stock of investments.

Filling this green investment gap therefore requires the mobilization of private investment, which, according to the report, must become a key focus of climate ambitions[4], as  » the state cannot achieve such an effort alone. » The report also points out that this additional investment would not be equivalent to a macroeconomic cost, given that the additional financing requirements would be largely offset by: the avoidance of expenditure related to the impacts of climate change, savings on energy consumption, the effects of economic recovery, and the multiplier effect on economic activity.

• To this end, the report highlights a series of proposals aimed at improving the use of the tax tool in particular. Taxation remains the most effective tool for steering investment towards a low-carbon trajectory (« price signal »). However, it should not overlook the decisive role of regulatory measures in directing investment towards processes that are compatible with the objectives of the ecological transition. In this regard, it is interesting to note that the rapporteurs call for new research to be undertaken, given the lack of tools for fine-tuning the balance between regulation and taxation and assessing their effects on behavior or innovation.

The report points out that, although explicit carbon pricing covers 20 to 25% of global greenhouse gas (GHG) emissions, current carbon prices remain 80% below the levels recommended by the Stern-Stiglitz Commission in May 2017. In addition to external carbon pricing by governments, the rapporteurs also highlight the internal carbon pricing adopted by a growing number of companies. The aim of such a measure would be to internalize the economic cost of GHG emissions and enable companies to anticipate the requirements of the energy transition.

In this context, the rapporteurs propose:

1. Restoring the conditions for the acceptability of carbon pricing by placing environmental taxation at the heart of a comprehensive tax reform and making its use more transparent to those involved in ecological transition policies (the report recalls the existence of a « tax revenue » linked to the definition of a carbon price);
2. Analyzing the anti-redistributive effects of the rise in carbon prices and developing transition aid for affected households, in addition to social assistance;
3. Setting a deadline for phasing out tax expenditures that are detrimental to the ecological transition in order to begin their gradual reduction;
4. Taking better account of the challenges of the ecological transition through the energy check, given the still excessive support for carbon-based energy consumption; and
5. The integration of negative externalities into incentive taxation (e.g., the allocation of a portion of the budgetary revenue from tax measures to ecological transition plans for the benefit of the sectors concerned).

Strengthen public funding allocated to ecological transition sectors while improving its consistency

Public spending is a significant lever for private investment, while also allowing the risks associated with the implementation of public policies to be assumed and reassuring private co-financiers. It must also be accompanied by regulations that promote good practices and curb those that are most harmful to the environment (risk conditions, project remuneration) and by adequate technical support.

In this context, the report’s findings and recommendations are twofold:

• First, strengthen public funding.

In this regard, the report highlightsthe knock-on effect of the Investment for the Future Program ( PIA) and its positive results in terms of credit allocation, which has enabled the financing of projects that have enjoyed significant industrial success. It is recommended that the criteria for assessing the environmental impact of projects be harmonized, while avoiding any reduction in direct funding. The provisions of the PIA should also be continued through a fourth program by 2020 in order to avoid any interruption in funding.

The report also highlights the role of public support (i.e., subsidies, tax breaks, fossil fuel taxation) in improving the competitiveness of renewable energies, while pointing to the need to strengthen cost control guarantees and improve the monitoring of public funding over time. In particular, the rapporteurs propose that the multi-year energy program (PPE) be submitted for approval through a specific law.

An important point in the report remains the need for greater consistency in public funding and its impact, through: (i) better integration of international environmental commitments into national budgetary procedures; (ii) the necessary alignment of industrial policy objectives with the ecological transition objectives set out in the PPE and the National Low-Carbon Strategy[6], given the lack of strategic vision in the industrial sector; (iii) paying particular attention to innovative public-private partnership mechanisms, in line with the recommendations of the Canfin-Zaouati report, which proposes, in particular, the creation of « France Transition » to steer a « French-style Juncker Green Plan »; (iv) providing local authorities with regulatory and fiscal levers for ecological transition, and support for projects and their ex-post evaluation ; and (v) guiding private supply through public procurement tools.

• Next, improving the government’s sectoral support, particularly for energy-efficient building renovation and clean vehicles. While welcoming the harmonization of support mechanisms for the energy renovation of buildings (particularly around the principle of eco-conditionality), the rapporteurs highlight the limited effectiveness of certain mechanisms that encourage significant changes (i.e., eco-PTZ; the « Habiter mieux » program of the National Housing Agency, etc.). In this regard, their proposals aim to reflect the recommendations of BSI Economics,  » Household investment in the ecological transition » : (i) simplify aid for energy-efficient building renovation in order to enhance its efficiency and increase its scope, while targeting low-income households, tenants, and properties; (ii) prioritize comprehensive renovations for low-income households (thereby reducing windfall effects); (iii) continue to expand the public service for energy efficiency in housing in order to better support households; (iv) develop third-party financing companies; and (v) reinforce the momentum of subsidies for the purchase of clean vehicles (i.e., conversion bonuses, tax incentives for biofuels, etc.).

Strengthen public funding allocated to ecological transition sectors while improving their consistency

Firstly, it should be noted that the report highlights climate change as a systemic risk for the financial sector (see BSI Economics article from May 2018, « Climate change: a systemic challenge for the financial sector » ). In this regard, the authors (i) call in particular for further assessment of the consequences of climate change on the balance of insurance systems and the risks of transmission to other financial actors; (ii) disseminate best practices for reducing banks’ exposure to transition risks related to the activities financed by their loans; and (iii) not overlook the systemic impact of physical risks on banks, in line with the progress made in the insurance sector.

The report then highlights the essential role of financial regulation in the ecological transition, complementing direct financing by the government alongside private investors (households and businesses): green finance « must establish, among the various financial players (individual savers, institutional investors, corporate finance departments, etc.), a transparent approach to the risks and opportunities associated with the ecological transition, and thus promote investments that are aligned with our climate objectives. »

After recalling the pioneering role of French regulations in climate reporting [7], the report stresses that it is now necessary to:

i) Consolidate the structural effects of the provisions of Article 173 of the Energy Transition for Green Growth Act and identify, disseminate, and guarantee the integrity of green assets

To this end, the rapporteurs propose to:

• Promotethe use of appropriate « climate » indicators, in particular by adopting an approach that aligns financial portfolios with a scenario that respects sectoral « carbon budgets » and is compatible with an average temperature increase of less than 2°C.
• Clarify the conditions for sharing the costs of analyzing the climate impact of activities between companies and institutional investors, and consolidate the economic model of the environmental and climate audit sector;

ii) Take action to ensure that credit rating agencies take into account companies’ climate strategies and to disseminate « low-carbon » and « carbon-positive » financial benchmarks;

• Give the Financial Markets Authority the power to regularly and formally monitor the contributions of climate reporting actors, as well as the task of monitoring the quality of information provided by investors on their low-carbon strategies and management of risks related to the effects of climate change;
• Eliminate the distortion in transaction costs between green bonds and other bonds byincreasing reporting requirements with regard to the ecological transition on the content of all bonds issued;
• Establish a process for accrediting external audits certifying the use of green bond financing and providing guarantees that there are no conflicts of interest between consulting and auditing activities.
• Promote the TEEC label criteria to contribute to the definition of a European eco-label.
• Take action to make green finance a tangible reality for investors, particularly individuals.

To this end, the rapporteurs propose:

• In orderto increase the visibility and scope of green investment labels, to establish a single state label with a common basis on « ESG » commitments commitments (SRI label) and specializations (TEEC label), to bring the SRI and TEEC label steering bodies closer together (with a view to merging them), and to finance measures to communicate and distribute these labeled investments, particularly at the local level;
• In order for life insurance to become a lever for green finance, it would be necessary to provide individual investors with accurate and clear information on the use of investments from life insurance funds, and to introduce an obligation to present a range of labeled green financing options for any new unit-linked life insurance policy (see the current PACTE bill).
• Strengthen the contribution of crowdfunding.
• Better identify sustainable loans granted by banks through greater transparency on lending and financial intermediary activities (i.e., overhaul of the Livret A savings account; extension of the obligations of Article 173 to these activities);
• Adapt accounting standards, in particular by creating a climate premium for the discounting of investment or financing projects, which would be adjusted according to the project’s carbon footprint;
• Study the advisability of a prudential penalty(which would be introduced in parallel with a prudential bonus for green assets) in order to increase the cost of carbon-intensive projects.

It should be noted that BSI Economics contributed significantly to the findings and certain recommendations in the chapter of the report on the strategic role of green finance, particularly on the subjects of the classification of green assets and the resulting standards and labels, for which it is explicitly cited in the report (see BSI Economics’ recommendations,  » Classify what is green to better guide investors » ); the risks associated with the introduction of a green prudential bonus; and the greening of insurance capital requirements, aimed at encouraging insurance companies to diversify their portfolios from an environmental perspective (see BSI Economics’ recommendations,  » Financing the ecological transition through institutional investors « ).

DISCLAIMER: « This publication reflects the personal views of the author and does not express the position of his employer. »