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2021 | Book

Settling Climate Accounts

Navigating the Road to Net Zero


About this book

As drivers of climate action enter the fourth decade of what has become a multi-stage race, Net Zero has emerged as the dominant organizing principle. Hundreds of corporations and investors worldwide, together responsible for assets in the tens of trillions of dollars, are lining-up for the UN Race to Zero. This latest stage in the race to save civilization from heat, drought, fires, and floods, is defined by steering toward zeroing out greenhouse gas emissions by 2050.

Settling Climate Accounts probes the practice of Net Zero finance. It elucidates both the state of play and a set of directions that help form judgements about whether Net Zero is going to carry climate action far enough. The book delves into technical analyses and activates the reader’s imagination with narrative accounts of climate action past, present, and future.

Settling Climate Accounts is edited and authored by Stanford University faculty and researchers. The first part of the book investigates the rough edges of Net Zero in practice, exploring questions of hedging risk, Scope 3 emissions, greenwashing, and the business of asset management. The second half looks at states, markets, and transitions through the lenses of blended finance, offsets, debt, and securitization. The editors tease out possible solutions and raise further questions about the adequacy and reach of the Net Zero agenda. To effectively navigate the road ahead, the editors call out the need for accountability and ask: who is in charge of making Net Zero add up?

Settling Climate Accounts offers context and foundation to ground the rapidly evolving practice of Net Zero finance. Targeted at seasoned practitioners, newly activated leaders, educators, and students of climate action the world over, this book embraces the complexity of climate action and, in so doing, proposes to animate and drive hope.

Table of Contents

Chapter 1. Introduction—The Rise of Net Zero
.The driving force of this book is an investigation into the data, metrics, and impact of climate action, which is increasingly framed by a new emphasis on achieving “Net Zero” targets. Net Zero describes a state of balance between greenhouse gas emissions produced and removed from the atmosphere, and it has emerged as the organizing principle for climate action. This introduction offers an account of the sequences, direction, meaning, and appeal by three turns in the climate action story: the Turn to Green Finance, the Turn to Risk and the Turn To Net Zero. These turns have redefined the counters of climate action, putting finance at the center. 
Thomas Heller, Alicia Seiger
11. Correction to: Securitization as a Model for an Equitable Transition
Uday Varadarajan

The Dynamics of Net Zero Finance

Chapter 2. A Portfolio Approach to Hedging Climate Risk
This chapter describes methods for investors to integrate climate-related data into their portfolios through risk management techniques rather than by seeking outperformance. We demonstrate this risk management approach using the standard tools of modern portfolio theory and quantitative portfolio construction familiar to many investors. We argue that all investors would be well served by taking at least some steps down this path, whether by marginally modifying their exposures, or wholesale shifts in their portfolio benchmarks. Furthermore, some investors may choose to use more sophisticated long/short strategies to dramatically reduce their carbon exposures across entire investment portfolios.
Marc Roston
Chapter 3. Carbonwashing: ESG Data Greenwashing in a Post-Paris World
Despite the increased attention and capital incentives around corporate sustainability, the development of sustainability reporting standards and monitoring systems has been progressing at a slow pace. As a result, companies have misaligned incentives to deliberately or selectively communicate information not matched with actual environmental impacts or make largely unsubstantiated promises around future ambitions. These incidents are broadly called “greenwashing,” but there is no clear consensus on its definition and taxonomy. We pay particular attention to the threat of greenwashing concerning carbon emission reductions by coining a new term, “carbonwashing.” Since carbon mitigation is the universal goal, the corporate carbon performance data supply chain is relatively more advanced than that of the entire sustainability data landscape. Nonetheless, the threat of carbonwashing persists, even far more severe than general greenwashing due to the financial values attached to corporate carbon performance. This chapter contextualizes sustainable finance-related carbonwashing via an outline of the communication as well as the measurement, reporting, and verification (MRV) of carbon emission mitigation performance.
Soh Young In, Kim Schumacher
Chapter 4. The Road from Scope 3 to Net Zero
Twenty years ago, the Greenhouse Gas Protocol defined emissions Scopes as means to evaluate risks due to impending carbon pricing. Scope 1 counted direct emissions. Scope 2 covered emissions from purchased power. Scope 3 captured upstream and downstream supply chain emissions. In the context of risk management, stakeholders viewed Scope 3 as secondary, and optional. In the turn to Net Zero, Scope 3 has become a key tool for managers and activists. Double counting, internal and external boundary problems, financial engineering offsets, and off-balance sheet exposures confound the usefulness of Scope 3. Using Scope 3 as a tool for capital allocation poses additional challenges as effective use requires carbon pricing imposed by non-government actors, which pushes into uncharted legal territory.
Marc Roston
Chapter 5. Fixing the Plumbing: Asset Management, Clean Energy Technology, and the Valley of Death
This chapter diagnoses the hurdles faced by companies seeking financing to develop and deploy clean energy technology. We trace the historical development of the specialized strategies and firms that displaced banks as financial intermediaries. We then examine the path of a hypothetical innovative clean technology company moving through the financial lifecycle from venture capital to project finance and growth equity to illustrate the various hurdles. Finally, we review several approaches to financial innovation and public action that may speed the path to greater innovation. We conclude, however, that financial innovation typically follows industrial innovation as financial systems adapt existing tools and methods to new technologies and processes.
Richard L. Kauffman, Marc Roston

Beyond Net Zero: States, Markets, and Transition

Chapter 6. Blended Finance for State-Led Decarbonization
Blended finance has gained traction in recent years as a promising solution to bridge the funding gap in transitioning to a decarbonized economy. Yet, there exists little guidance and knowledge on the “how” of this approach, especially in specific country contexts. This chapter examines the Republic of Korea as a case study and the government’s efforts to trigger the introduction and institutionalization of green finance for decarbonizing its economy. Focusing on the design of incentives and institutions by the public sector to manage risks and catalyze private capital, we highlight necessary conditions for the successful application of blended finance. First, consensus building between public and private investors can facilitate harmonizing and internalizing the concept and practice of green finance. Second, designating a dedicated coordinating agency for green finance activities can reduce fragmentation and promote the efficient allocation of capital in the economy. Third, instituting stringent reporting standards and monitoring and evaluation frameworks can ensure climate finance is allocated to impactful projects and sectors. Lastly, climate-related sectors, such as energy, should be structurally conducive to private investment and activities. A state-led approach may be rapid in execution, but it should also be accompanied by these four measures to direct private finance towards green investments and to scale its impact.
Esther Choi, Soh Young In
Chapter 7. A Natural Approach to Net Zero
A widely accepted view among leading sustainability standard setters and guidance providers holds that to achieve Net Zero, companies must first prioritize reducing the greenhouse gases (GHG) in their value chains before compensating for any unabated emissions that remain through the use of carbon credit offsets. This chapter argues that this view, the received Net Zero logic, suffers from conceptual failings that threaten to divert private sector resources from one of the most underfunded but critically important areas for climate action, namely Nature Based Solutions (NBS). The chapter provides examples of how the received Net Zero logic has disincentivized the purchase of carbon linked to the protection of natural ecosystems. In response, the chapter argues that recent innovations in the carbon markets linked to NBS credits, particularly the use of a jurisdictional rather than a project-based approach, offer an improved way to incorporate carbon credits into a credible corporate Net Zero strategy. In addition, the chapter explores how structuring NBS credits through the lens of “contributions” to supply-country emissions reductions efforts, rather than “offsets,” may offer a way to avoid double-counting and misleading claims. These innovations help ensure greater “demand side” and “supply side” integrity as well as improve the accuracy and integrity of the global accounting framework for Net Zero. The paper concludes by calling for increased investment into NBS credits to bring greater scale, integrity, and impact to the voluntary carbon market.
Lorenzo Bernasconi
Chapter 8. A Note on Transition Bonds and Finance
Transition finance will play a critical role in reaching agreed global climate targets. This chapter moves from an overview of the landscape of existing purpose-built bonds, including green bonds, to a detailed discussion of the goals, issues, and guiding principles for a recently created transition finance tool, transition bonds. Analyzing the rationale, goals, and challenges of a transition bond framework, it derives lessons from experience with green bonds and related climate finance instruments that have proliferated in number and scale of funds raised in the past decade. It notes that while competing initiatives to define new transition metrics and pathways are predicated on developing markets around voluntarily-accepted quality standards for transition bonds, persistent concerns with reconciling high-level transition standards with firm-specific flexibility and incentives for carbonwashing still need to be addressed. In conclusion, the chapter argues that states, as market regulators, and the ultimate bearers of sovereign risk in economies exposed to increasing transition impacts will have primary responsibility for orderly transition.
Gireesh Shrimali, Thomas Heller
Chapter 9. Securitization as a Model for an Equitable Transition
While action on climate change appears to be increasingly affordable in the long run, the costs and risks of the transition to a low-carbon economy—most of which are likely to fall on those least able to bear them—are emerging as a critical barrier to rapid action. This chapter will introduce and analyze emerging green financing mechanisms that can help mitigate these inequitable burdens using a portion of future benefits from a low-carbon economy. We focus on the example of the transition challenges associated with near term risks and costs borne by energy customers, workers, and communities in the context of a rapid phaseout from coal by regulated US utilities. We introduce and discuss a specific financial tool—ratepayer-backed bond securitization—that has emerged over the last seven years as a key financial mechanism for facilitating a just and equitable transition of regulated US utilities. We discuss experience with the tool across several US states, with a view towards identifying some of the practical challenges to wider implementation. Finally, we turn to a discussion of the lessons learned and explore ways in which the experience with securitization could be generalized and scaled across geographies and sectors as a template for how financial innovation can help enable a more equitable transition to a low-carbon economy.
Uday Varadarajan
Chapter 10. Conclusion: Accounting for Climate
The chapters of this volume offer empirical studies of Net Zero in practice. Taken together, they expose a series of unsettled accounts: problematic and persistent features of Net Zero implementation that bring into question both its accountability and credibility in the triple senses of accounting for climate. These open accounts defy and resist consensual or authoritative settlement and increase incentives to game the regime, potentially redirecting its outcomes away from the narrative that justified Net Zero’s ascendance. The roster of open accounts can be associated categorically with: (1) increasing levels of noise in the information Net Zero accounting sends out to its users; (2) contested rules over Net Zero’s boundaries for coverage; (3) unclear enforceability of future-centric commitments that create incentives to defer compliance and transfer responsibilities (i.e. timing); and, (4) undefined management obligations that both over-simplify risk and, through decentralized accounts, fail to add up to a coordinated climate policy.
Thomas Heller, Alicia Seiger
Settling Climate Accounts
Thomas Heller
Alicia Seiger
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