## Chapter 3 — Financial Sector Policies to Unlock Private Climate Finance in Emerging Market and Developing Economies

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### Chapter at a glance: scale, sector, and timeline
- Global gross climate mitigation investment needs to reach about $5 trillion annually by 2030 to achieve net zero greenhouse gas emissions by 2050.
- The International Energy Agency projects climate mitigation investment needs will increase to $2 trillion per year by 2030 in emerging market and developing economies (EMDEs).
- This $2 trillion corresponds to 12 percent of total investment in EMDEs by 2030, up from the current 3 percent.
- About 40 percent of global mitigation investment needs are estimated to be in EMDEs.
- The majority of climate mitigation investments (about 60 to 70 percent) are expected to be in the energy sector.
- All investment needs reported are adjusted for inflation and are expressed in 2020 US dollars.

### The crucial role of private finance in EMDEs
- Current private finance share in EMDEs is about 40 percent; the private share must increase significantly by 2030.
- Estimated 2030 total investment in EMDEs: US$ 17 trillion; estimated 2030 climate investment needs in EMDEs: US$ 2.0 trillion.
- Current (2020) climate investment in EMDEs: US$ 0.4 trillion; current (2020) total investment in EMDEs: US$ 10 trillion.
- Under the Chapter’s Panel 3 scenarios:
  - Point estimate based on a public climate financing share that increases by a factor of 1.5 until 2030 implies private finance will have to cover about 80 percent of climate mitigation investment needs in EMDEs by 2030.
  - Excluding China, the private financing share is about 90 percent in the same scenario.
  - The maximum (minimum) range refers to a scenario where the climate share of public investments stays the same (doubles) as the current level.

### Barriers to deploying private climate finance in EMDEs
- Credit ratings and market access:
  - About 40 percent of emerging market economies and nearly all developing economies do not reach an investment-grade rating or have no rating at all.
  - Only about 60 percent of emerging markets and 8 percent of developing economies have an investment-grade rating.
  - Among developing economies, 58 percent have a rating below investment grade, and 34 percent have no sovereign rating at all.
  - Sovereign ratings often serve as a “rating ceiling” for private entities and limit the investor base; many fiduciaries restrict investments to “investment grade.”
- Country-specific hurdles raising financing costs:
  - High political risks, legal and institutional uncertainty, and implementation risks.
  - Lack of well-structured, investable climate project pipelines.
  - Weak climate-related data: many EMDEs lack high-quality, reliable, and comparable climate-related data, raising greenwashing risks.
- Foreign exchange and market structure constraints:
  - Commercial hedging options are primarily available in larger EMDEs but tend to be expensive, with limited liquidity, and incomplete at the tenor and size needed.
  - Market hedging options are virtually nonexistent in smaller emerging markets and low-income countries.
- Capital allocation behavior of global institutions:
  - Supply of capital to EMDEs is strongly driven by global financial institutions’ allocation decisions, and allocations to EMDEs are significantly below their contribution to global GDP or growth potential.
- Credit rating treatment of climate policies:
  - Current rating agency methodologies do not sufficiently reward middle- and lower-income countries that implement better climate policies; benefits of climate investments for credit ratings and financing costs are limited under current practices.

### Coal dependence, phaseout, and sectoral challenges
- Coal is the single largest source of greenhouse gas emissions globally (about 20 percent).
- EMDEs account for:
  - Three-fourths of the world’s 9,000 coal-fired power plants.
  - About 90 percent of the global capital tied in coal-fired power plants (World Bank 2023).
- Only about 20 percent of current coal-fired generation is covered by agreements among countries to phase out coal or stop developing new power plants (International Energy Agency 2022).
- Power plants are relatively young in EMDEs (about 40 years in the United States compared with less than 15 years in the Asia Pacific region).
- On average, it takes about 43 years to phase out coal after a peak in coal consumption per capita has been reached (IMF 2020).
- Phasing out coal entails net financial losses when plants are retired before expected lifespan, but could yield considerable net economic and social gains—potentially about $85 trillion (Adrian, Bolton, and Kleinnijenhuis 2022).
- Transition taxonomies and alignment tools should integrate measures for a managed phaseout and leverage private finance; currently there are no standardized criteria for repurposing and coal phaseout plans are not eligible in many transition finance frameworks and taxonomies.

### Fossil-fuel investment patterns and lock-in risks
- Capital investment continues to flow into fossil fuels, responsible for 75 percent of global greenhouse gas emissions, increasing carbon lock-in risks.
- Capital expenditures in the coal industry have remained stable; trends driven by strong demand and high coal prices, especially in China and the rest of the Asia Pacific region (International Energy Agency 2023b).
- Oil and gas sector:
  - Capital expenditures in the oil and gas sector rebounded in 2022.
  - Low-carbon component of oil and gas sector capex increased 300 percent between 2020 and 2022 but remains insufficient.
  - Capex forecasts for new oil and gas fields remain high, accounting for roughly 75 percent and 95 percent of energy industry investments by 2030 and 2050, respectively.
  - Nonlisted companies in EMDEs account for about one-third of investment plans in new oil and gas capacity.
- Government climate policy indicators tend to be negatively correlated with capex estimates for oil and gas fields by 2030 in EMDEs.

### Financial institutions’ policies and real economy impact
- Assessment of 30 G-SIBs and nine globally systemic insurers shows limited alignment with net zero:
  - Some banks exclude project finance to new greenfield coal mines and power plants, but most G-SIBs have no policy or weak criteria regarding net-zero-aligned coal phaseout and limitation of financial services to coal expansion.
  - Policies targeting transition financing of the oil and gas industry are even more limited.
  - Banks’ climate disclosures are disconnected from carbon-intensive lending: G-SIB lending to fossil fuel companies has remained stable since the Paris Agreement and increased after the pandemic; sustainable loans to these companies have been minimal.
  - Banks assessed as most ambitious have not seen a greater increase in sustainable loans than less ambitious peers.
- Insurers:
  - Global insurers’ climate policies have shown limited success in aligning underwriting and investment portfolios to net zero targets; European insurers recently adopted more restrictive criteria for coal investment and underwriting, while major Asian and North American insurers have not published such policies.
- Private equity and nonbank finance:
  - Limited disclosures constrain assessment of fossil fuel exposure; available evidence indicates fossil fuel investments in private equity have been increasing.

### Investment funds, EMDE allocations, and climate impact
- Sustainable investment funds have grown considerably faster than conventional funds, especially since 2019.
- Since 2019, sustainable funds have consistently maintained positive net flows and outperformed conventional funds, except for brief instances in 2022 and 2023 (so far).
- Fund categories:
  - ESG funds (largest category by label), Sustainability-themed funds, Climate impact funds, All funds.
  - Climate impact funds remain a very small share of the market despite rapid growth in ESG investing.
- EMDE allocation:
  - Climate impact funds allocate about one quarter of their total assets under management (AUM) to EMDE assets (equities and bonds), a share considerably higher than for other investment funds.
- Carbon risk:
  - The carbon risk score distribution for climate impact funds closely resembles that of conventional funds; the right tail indicates higher transition risks for a sizable share of climate impact funds, suggesting some may not be aligned with intended low-carbon objectives.
- EU SFDR effects:
  - SFDR reclassifications from Article 9 to Article 8 occurred after enactment in February 2023.
  - Initial analysis suggests funds classified as dark green attracted higher inflows compared with Article 6 funds.

### ESG scores versus climate impact scores: measurement and allocation implications
- Corporate ESG scores are designed to capture nonfinancial risks and are not necessarily aligned with climate impact.
- Construction limitations of ESG E pillar scores:
  1. ESG scores combine many data points; only a small subset may relate to creating climate impact.
  2. ESG scores are not necessarily proportional to ESG performance.
  3. ESG scores are industry specific and measure relative performance within an industry.
- Proposed climate impact scores:
  - Use 16 data points out of 64 used for the E score; cover about 10,300 listed firms, of which more than 2,700 are incorporated in emerging markets.
  - Capture current climate performance (for example, carbon intensity) and potential future emission reductions (for example, emission reduction targets).
  - Designed so a significantly higher value maps into significantly better climate impact characteristics, independent of industry.
- Effects on firm ranking and portfolios:
  - Impact-oriented scores yield substantially different firm rankings than E scores.
  - Firms within the worst 5 percent (rank < 400) under the impact score can have a significantly higher rank under the E score.
  - Firm rank correlation between impact scores and E scores = “–0.14”.
  - All reported correlations are statistically significant at the 1 percent level.
  - Implication: Using impact scores instead of E scores would produce significantly different portfolio allocations under negative screening or best-in-class strategies.
- Data providers:
  - Refinitiv and Sustainalytics are among the few that supply underlying ESG data points; underlying data points differ across providers in scope and measurement.

### Firm-level heterogeneity, innovation, and policy trade-offs
- Empirical findings from more than 4,000 large, listed firms:
  - Emission intensities vary dramatically among firms operating in the same industry and country.
  - Emissions per unit of production for the worst 10 percent of emitters are more than six times larger than those of the best 10 percent.
  - Heterogeneity is even larger within EMDEs after controlling for industry fixed effects.
- Drivers of better environmental performance:
  - Firms with fewer green operations use older physical capital stocks, are less knowledge-intensive and innovative, and are less productive.
- Policy simulation (multicountry, multisector, multifirm general equilibrium model):
  - Subsidies targeting innovation or upgraded capital stocks can cut emissions but at significantly larger consumption costs than carbon pricing.
  - For a 25 percent reduction in corporate emissions, the present value of consumption impact is larger for capital subsidy and research and development subsidy relative to a carbon tax.
  - Two economic forces explain higher subsidy costs:
    - Subsidies do not directly incentivize lower energy consumption and can encourage firm expansion.
    - Larger subsidies induce stronger misallocation and higher costs.

### Multilateral, donor risk-sharing, and the RSF’s catalytic role
- The Resilience and Sustainability Trust (RSF) can convene governments, MDBs, and the private sector to foster financing of climate investments, but its total size is small (about $40 billion) relative to global climate investment needs.
- Member countries may choose to use part of the fiscal space created by the RSF to provide risk-sharing and credit enhancement mechanisms for private investors, considering fiscal and debt sustainability.
- In combination with traditional IMF programs, the RSF can help address macroeconomic challenges that mobilize domestic financial resources.
- The IMF can support:
  - Green Public Financial Management and Climate–Public Investment Management Assessment to integrate climate priorities into public financial management.
  - Capacity development for low-income countries to advance climate policies and collect high-quality, reliable, and comparable climate-related data.
- Policymakers should consider whether regulatory barriers disincentivize financial institutions’ use of MDB and donor guarantees.
- The Development Assistance Committee (OECD) is engaging members on official development assistance eligibility for private sector instruments and treatment of credit guarantees (OECD 2022).

### Early country lessons and RSF-facilitated initiatives
- Cross-cutting lessons from IMF engagements (Bangladesh, Barbados, Costa Rica, Jamaica, Rwanda):
  - Scaling climate resource mobilization requires coordinated action across three pillars: climate policy reforms, capacity development, and innovative financing approaches.
  - Using RSF-created fiscal space prudently could help crowd in additional financing; facilities using public resources should have strong governance, project selection, impact reporting, monitoring, and verification.
  - Limited market size and lack of bankable pipelines are larger impediments in smaller economies—regional pooling may be necessary.
- Barbados:
  - Used part of RSF-created fiscal space as equity capital for a new Blue Green Bank to lend for private sector green investments (affordable homes, hurricane-resilient roofs, transport electrification).
  - The Blue Green Bank receives funding from the Green Climate Fund and US Agency for International Development and technical support from partners including CAF and the Inter-American Development Bank.
- Rwanda:
  - Set up Ireme Invest, a green investment facility by the Rwanda Green Fund and the Development Bank of Rwanda.
  - Under the RSF arrangement, development partners committed to scale up climate financing; the initiative is expected to fund a pipeline of projects estimated at €400 million, including €130 million in equity contributions from private investors.
  - The government is prepared to scale up Development Bank equity as the project pipeline expands.

### Selected policy recommendations to unlock private capital (summary)
- Use a broad mix of policies to create an attractive investment environment and unlock private climate finance in EMDEs, recognizing political hurdles to carbon pricing and EMDE-specific challenges.
- Reform fossil fuel subsidies as a first step; fossil fuel subsidies are at a record high and are projected to increase in EMDEs (IMF 2023).
- Strengthen the climate information architecture: improve data, disclosures, taxonomies; leverage International Sustainability Standards Board proposals as a global baseline.
- Implement structural reforms to overcome investment barriers: strengthen macroeconomic fundamentals, deepen financial markets, improve policy predictability, and foster institutional and governance frameworks.
- Support coal phaseout with innovative and tailored financing solutions, including transition taxonomies and blended finance to enable retirement and repurposing of coal-fired power plants.
- Use Just Energy Transition Partnerships and public/donor financing to retire coal plants and mitigate social impacts (reskilling, social safety nets).
- Refocus financial sector policies on climate impact (mitigation and adaptation), not only on identifying activities already “green”; develop transition taxonomies aligned with nationally determined contributions and sectoral decarbonization targets.
- Standardize transition plans, including for financial institutions, to enable comparability and credibility; transition plans for banks can inform microprudential authorities’ forward-looking assessments.
- Ensure disclosures and labels for sustainable investment funds enhance market transparency and integrity; tighten enforcement to avoid lax use of sustainability labels.
- ESG data providers should offer climate impact–oriented scores; regulators should consider oversight sufficiency for ESG ratings and data providers (IOSCO 2021).
- Realign credit rating agencies’ and sovereign ESG methodologies to better reflect climate factors and material sustainability dimensions across EMDEs.
- Expand public–private risk sharing: blended finance, MDB technical assistance, and expanded use of guarantees by MDBs and donors to reduce real and perceived risks and broaden the private investor base.

*Source: CHAPTER 3 — Financial Sector Policies to Unlock Private Climate Finance in Emerging Market and Developing Economies, Global Financial Stability Report, International Monetary Fund | October 2023.*

### Chapter 3 at a Glance

### Chapter 3 at a Glance

### Introduction and context
- The International Energy Agency projects climate mitigation investment needs will increase to $2 trillion per year by 2030 in emerging market and developing economies (EMDEs).
- This $2 trillion corresponds to 12 percent of total investment in EMDEs by 2030, up from the current 3 percent.
- Global gross climate mitigation investment needs to reach about $5 trillion annually by 2030 to achieve net zero greenhouse gas emissions by 2050.
- About 40 percent of global mitigation investment needs are estimated to be in EMDEs.
- The majority of climate mitigation investments (about 60 to 70 percent) are expected to be in the energy sector.
- All projected investment needs reported in this chapter are adjusted for inflation and are expressed in 2020 US dollars.

### The crucial role of private finance
- The private sector needs to cover the majority of climate mitigation investment needs in EMDEs:
  - By 2030, private finance will have to cover about 80 percent of climate mitigation investment needs in EMDEs under a scenario where the share of climate investments in total public investment increases by a factor of 1.5 from current levels.
  - Excluding China, the private financing share is about 90 percent in the same scenario.
- Current private finance share in EMDEs is about 40 percent; the private share must increase significantly by 2030.
- Estimated 2030 total investment in EMDEs: US$ 17 trillion; estimated 2030 climate investment needs in EMDEs: US$ 2.0 trillion.
- Current (2020) climate investment in EMDEs: US$ 0.4 trillion; current (2020) total investment in EMDEs: US$ 10 trillion.
- The required rise in climate investments implies a climb to 12 percent of total investments in EMDEs by 2030 from about 3 percent currently.
- The private sector share scenarios:
  - Panel 3 scenarios: point estimate based on a public climate financing share that increases by a factor of 1.5 until 2030; maximum (minimum) range refers to a scenario where the climate share of public investments stays the same (doubles) as the current level.

### Barriers to deploying private climate finance in EMDEs
- Credit ratings and market access:
  - About 40 percent of emerging market economies and nearly all developing economies do not reach an investment-grade rating or have no rating at all.
  - Only about 60 percent of emerging markets and 8 percent of developing economies have an investment-grade rating.
  - Among developing economies, 58 percent have a rating below investment grade, and 34 percent have no sovereign rating at all.
  - Sovereign rating often serves as a “rating ceiling” for private entities and limits investor base; many fiduciaries restrict investments to “investment grade.”
- High financing costs and other country-specific hurdles:
  - High political risks, legal and institutional uncertainty, and implementation risks increase financing costs.
  - Lack of well-structured, investable climate project pipelines is an obstacle to private capital deployment.
  - Many EMDEs lack high-quality, reliable, and comparable climate-related data, complicating risk and opportunity assessment for investors and raising greenwashing risks.
- Credit rating treatment of climate policies:
  - Current credit rating agency methodologies do not sufficiently reward middle- and lower-income countries that implement better climate policies; benefits of climate investments for credit ratings and financing costs are limited under current practices.
- Capital allocation behavior of global institutions:
  - Supply of capital to EMDEs is strongly driven by capital allocation decisions of global financial institutions, and allocations to EMDEs are significantly below their contribution to global GDP or growth potential.

### Coal phaseout and sectoral challenges
- Phasing out coal is necessary to reach climate goals, but many EMDEs highly depend on coal.
- Phasing out coal-fired power plants will require substantial private investments and public support.
- Transition taxonomies and alignment tools should integrate measures for a managed phaseout of coal-fired power plants, given the need to leverage private finance.

### Policy recommendations and instruments to unlock private capital
- A broad mix of policies is needed to create an attractive environment for private capital in EMDEs.
- Carbon pricing:
  - Carbon pricing can be highly effective in shifting capital flows toward low-carbon investments but should be complemented with additional policies given political hurdles in EMDEs.
- Structural policies to lower cost of capital and mobilize finance:
  - Strengthen macroeconomic fundamentals.
  - Deepen financial markets.
  - Improve policy predictability.
  - Foster institutional and governance frameworks.
  - Strong climate policies and commitments can signal to investors.
- Coal phaseout policies:
  - Appropriate policies and innovative financing structures for the coal phaseout need to be tailored to country circumstances.
- Strengthening the climate information architecture:
  - Improve data, disclosures, and alignment approaches (including taxonomies).
  - High-quality, reliable, and comparable data are prerequisites for assessing and pricing risks and opportunities.
- Transition taxonomies and fund disclosures:
  - Transition taxonomies in EMDEs could align incentives and mobilize private financing, including in carbon-intensive sectors.
  - Disclosures and labels for sustainable investment funds should enhance market transparency, integrity, and alignment with climate objectives.
  - Climate impact scores should be constructed to better align climate outcomes with investor expectations on climate impacts.
- Public–private risk sharing and MDBs:
  - Expanded use of guarantees by multilateral development banks and donors could reduce real and perceived risks in EMDEs.
  - Blended finance structures could improve the risk–reward profile of investment opportunities and broaden the range of private sector investors.
  - Enhanced use of MDBs’ and donors’ guarantees can help achieve derisking and broaden the investor base if designed well and used appropriately.
  - In low-income countries, larger international public support is essential given steep challenges in attracting private climate finance.
- Role of the IMF:
  - The IMF Resilience and Sustainability Facility (RSF) can help create an enabling investment environment and attract private capital by supporting reforms, capacity development, and longer-term financing.
  - The IMF can help strengthen public financial and climate investment management, support development of investable project pipelines, and provide capacity development for collection of high-quality, reliable, and comparable climate-related data.
- Financial sector policy orientation:
  - Financial sector policies should refocus on fostering climate impact (such as greenhouse gas emissions reduction) rather than only identifying activities already “green.”
  - Transition taxonomies and alignment tools can help identify activities that could substantially reduce emissions over time.

*Authors: Torsten Ehlers (co-lead), Charlotte Gardes-Landolfini (co-lead), Ekaterina Gratcheva, Shivani Singh, Hamid Tabarraei, and Yanzhe Xiao, under the guidance of Prasad Ananthakrishnan and Fabio Natalucci. Markus Brunnermeier was an expert advisor.*

### CHAPTER 3 FINANCIAL SECTOR POLICIES TO UNLOCk PRIvATE CLIMATE FINANCE IN EMERGING MARkET ANd dEvELOPING ECONOMIES

### CHAPTER 3 FINANCIAL SECTOR POLICIES TO UNLOCk PRIvATE CLIMATE FINANCE IN EMERGING MARkET ANd dEvELOPING ECONOMIES

### Barriers to Private Climate Finance in EMDEs
- Investors avoid EMDEs because perceived risk–return profiles are not in line with institutional investors’ risk bearing capacity.
- Key investor concerns include:
  - Difficulties in navigating EMDEs’ perceived complexities.
  - Reputational risk from inadequate governance, poor institutional capacity, and an uncertain policy environment.
  - Increasingly stringent ESG regulations in advanced economies raising compliance risks and costs for EMDE investments.
- Scale of specialized firms that actively seek EMDE investments remains limited despite their ability to exploit informational asymmetries.
- Constraints cited by investors for deploying capital in EMDEs:
  - Lack of well-structured, investable project pipelines meeting private investors’ risk–return requirements.
  - Bankable projects in lower-income countries are primarily driven by MDBs and their balance sheet deployment, with limited private sector participation.
  - Project implementation challenges: slow disbursements, regulatory changes, long timelines, small project size, high due diligence costs, and lack of diversification.
- Low domestic capital market development:
  - Lower- and lower-middle-income countries do not have established or mature capital markets.
  - Low financial and capital market development limits domestic resource mobilization and deters international investors.
  - Even in EMDEs with more developed capital markets, operating environments can include withholding taxes, local regulatory restrictions, and potential currency repatriation restrictions.
- Foreign exchange risk management issues:
  - Management of foreign exchange risk is challenging, so investors prefer climate investments with limited or no foreign exchange risk exposure.
  - Commercial hedging options exist primarily in larger EMDEs but tend to be expensive, with limited liquidity, and incomplete, especially at the tenor and size needed for large-scale, long-term projects.
  - Market hedging options are virtually nonexistent in smaller emerging markets and low-income countries.

### Potential Limits to the Speed of the Energy Transition in EMDEs
- Renewable energy specific hurdles:
  - High upfront fixed capital costs (for example, solar panels and electricity grids with energy storage capacity) while marginal costs are typically lower.
  - Significant policy risks in EMDEs that companies struggle to price and manage compared to conventional market risks.
  - Implementation challenges: prerequisite infrastructures, intermittency of renewables and storage capacity, supply chain issues, permits across jurisdictions, and integration into electricity distribution networks.
- Financial attractiveness:
  - Due to policy uncertainty and EMDE risk premia, renewable energy in EMDEs is financially less attractive than in advanced economies.
  - In some major emerging markets, high borrowing costs more than double the cost of renewable electricity production.
- Investment imbalances and commodity pressures:
  - Investment in renewable energy in EMDEs (except for China) still lags behind investments in fossil fuel.
  - A target ratio of about 4:1 for renewable over fossil fuel investment is estimated as required globally throughout this decade (Bloomberg NEF 2022).
  - Total fossil fuel subsidies surged to a record high in 2022 and are expected to increase further in EMDEs (IMF 2023).
  - Advanced-economy actions could slow EMDE transitions by increasing demand for critical metals and minerals, pushing up prices (example: lithium price projections shown in Figure 3.2, panel 2).

### Coal Dependence and Phaseout Challenges
- Coal is the single largest source of greenhouse gas emissions globally (about 20 percent).
- EMDEs account for:
  - Three-fourths of the world’s 9,000 coal-fired power plants.
  - About 90 percent of the global capital tied in coal-fired power plants (World Bank 2023).
- Only about 20 percent of current coal-fired generation is covered by agreements among countries to phase out coal or stop developing new power plants (International Energy Agency 2022).
- Coal plant age and phaseout timing:
  - Power plants are relatively young in EMDEs (about 40 years in the United States compared with less than 15 years in the Asia Pacific region).
  - On average, it takes about 43 years to phase out coal after a peak in coal consumption per capita has been reached (IMF 2020).
- Economic and social costs and benefits:
  - Net financial value of coal-fired power plants is lost when retired before expected lifespan because capital expenditures cannot be recovered.
  - Phasing out coal could yield considerable net economic and social gains—potentially about $85 trillion (Adrian, Bolton, and Kleinnijenhuis 2022).
- Policy and financing needs:
  - Measures must be tailored to country characteristics with innovative and tailored financing solutions.
  - Appropriate sequencing for retirement, regulatory reforms, and consideration of development and social priorities are necessary.
  - Examples of experience: Just Energy Transition Partnerships (Indonesia, Senegal, South Africa, Vietnam).
  - Mobilizing global investors and using financial structures (blended finance, securitization) to repurpose or retire coal-fired plants is challenging; there are no standardized criteria for repurposing, and coal phaseout plans are not eligible in transition finance frameworks and taxonomies.

### Fossil Fuel Investment Trends and Energy Sector Capital Allocation
- Capital investment patterns:
  - Capital investment in the energy sector continues to flow into fossil fuels, which are responsible for 75 percent of global greenhouse gas emissions, increasing carbon lock-in risks while delaying diversification.
  - Capital expenditures in the coal industry have remained stable despite policy support for clean energy.
  - Trend driven by strong demand and high coal prices, especially in China and the rest of the Asia Pacific region (International Energy Agency 2023b).
- Oil and gas sector:
  - Capital expenditures in the oil and gas sector rebounded in 2022.
  - Low-carbon component of oil and gas sector capex (for example, investments to diversify energy operations, such as in solar cells, onshore and offshore wind, and carbon capture and storage) increased 300 percent between 2020 and 2022 but remain insufficient.
  - Capital expenditure forecasts for new oil and gas fields remain high, accounting for roughly 75 percent and 95 percent of energy industry investments by 2030 and 2050, respectively.
  - Nonlisted companies in EMDEs account for about one-third of investment plans in new oil and gas capacity.
  - Nonlisted companies are typically subject to less outside pressure to decarbonize; national oil companies have started to diversify and decarbonize because of growing pressure and dependence on international capital.
- Government climate policies:
  - Indicators of current climate policies, emission-reduction targets, and nationally determined contributions tend to be negatively correlated with capital expenditure estimates for oil and gas fields by 2030 in EMDEs.

### Lack of Climate Impact of Financial Institutions’ Commitments and Policies
- Assessment of 30 global systemically important banks (G-SIBs) shows need for more ambitious alignment with net zero targets.
  - Some banks exclude project finance to new greenfield coal mines and power plants in their lending and investment policies.
  - Most G-SIBs have no policy or weak criteria regarding provision of financial services for coal expansion or net-zero-aligned coal phaseout (“Net-zero-aligned coal phaseout policy” and “Limitation of financial services to coal expansion”).
  - Policies targeted at transition financing of the oil and gas industry are even more limited (“Net-zero-aligned oil and gas policy”).
- Insurers:
  - Global insurers’ climate policies have shown limited success in aligning underwriting and investment portfolios to net zero targets.
  - Major Asian and North American insurance companies have not published such policies; European insurers have recently adopted more restrictive criteria for coal investment and underwriting.
- Banks’ disclosures vs lending behavior:
  - Banks’ climate disclosures are disconnected from carbon-intensive lending that is not offset by greater low-carbon lending activity.
  - G-SIB lending to fossil fuel companies has remained stable since the Paris Agreement and increased after the pandemic.
  - The share of sustainable loans to these same companies has been minimal.
  - G-SIBs assessed as most ambitious based on sectoral policies have not seen a greater increase in sustainable loans than less ambitious peers.
  - Research indicates banks with stricter climate policies are associated with higher likelihood of retirement or repurposing of coal-fired plants owned by dependent companies (Green and Vallee 2023).
- Private equity and nonbank finance:
  - Limited disclosures constrain assessment of fossil fuel exposure in private equity; their fossil fuel investments have been increasing (Giachino and Mehta-Neugebauer 2021).

### Investment Funds and Climate Impact
- Growth trends:
  - Sustainable investment funds have grown considerably faster than conventional funds, especially since 2019.
  - Since 2019, sustainable funds have consistently maintained positive net flows and outperformed conventional funds, except for brief instances in 2022 and 2023 (so far).
- Fund categories:
  - Funds that incorporate ESG characteristics into their investment strategies are the largest category.
  - “Sustainability-themed” funds incorporate one or more sustainability themes into their investment approach.
  - Climate impact investment funds, dedicated to addressing climate change and supporting the shift toward a low-carbon economy, remain small.
- EMDE allocation:
  - Climate impact funds allocate a larger portion of their portfolios to EMDE assets (equities and bonds).

*Source: CHAPTER 3 FINANCIAL SECTOR POLICIES TO UNLOCk PRIvATE CLIMATE FINANCE IN EMERGING MARkET ANd dEvELOPING ECONOMIES (IMF, October 2023).*

### 1. Assessment of 30 G-SIBs’ Sectoral Policies

### 1. Assessment of 30 G-SIBs’ Sectoral Policies

### Bank and Insurer Sectoral Policy Assessments
- Assessment covers 30 G-SIBs (global systemically important banks) and nine globally systemic insurers.
- Bank policy dimensions assessed (number of banks with each policy):
  - Limitation of financial services to coal expansion
  - Exclusion of project finance to coal mines, plants, and infrastructure
  - Net-zero-aligned coal phaseout policy
  - Net-zero-aligned oil and gas policy
- Insurer policy dimensions assessed (number of insurers with each policy):
  - Limitation of underwriting services to coal expansion
  - Restrictions on underwriting coal companies
  - Net-zero aligned coal phaseout policy
  - Targeting at a minimum oil and gas upstream development
- Note: The description of the assessment methodology is detailed in Online Annex 3.4.

### Syndicated Loan Origination to Fossil Fuel Companies
- Syndicated loan originations to fossil fuel companies by the 30 G-SIBs are reported in billions of US dollars.
- Syndicated loan data were used because they capture a significant part of the energy sector credit (Weyzig and others 2014).
- Fossil fuel companies are classified based on Standard Industrial Classification.
- Sustainable loans include both green loans and ESG linked loans.
- If one loan contains multiple lead banks, loan value is equally allocated to each lead bank.
- Finding: Syndicated loan originations reflect banks’ sectoral policies, including for banks with more ambitious policies.

### Key source and methodological notes
- Sources: Dealogic and IMF staff assessment and calculations.
- ESG = environmental, social, and governance; G-SIBs = global systemically important banks.

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### Sustainable Investment Funds, Fund Allocations, and Climate Impact

### Growth and composition of sustainable funds
- Sustainable investment fund labels tracked: ESG funds, Sustainable themed funds, Climate impact funds, All funds.
- Finding: Climate impact funds remain a very small share of the market despite rapid growth in ESG investing.
- Climate impact funds allocate a relatively high share of assets to EMDEs (emerging market and developing economies), about one quarter of their total assets under management (AUM), a share considerably higher than for other investment funds.

### Fund allocations to EMDEs and fund carbon risk
- Climate impact funds tend to have high allocations to emerging market equities and bonds.
- The carbon risk score distribution for climate impact funds closely resembles that of conventional funds; the right tail indicates even higher transition risks for a sizable share of climate impact funds.
- This exposure suggests some climate impact funds may not be aligned with their intended purpose of directing investments toward low-carbon finance.

### EU SFDR effects
- The EU Sustainable Finance Disclosure Regulation (SFDR) classification system divides funds into Article 6, Article 8, and Article 9 categories.
- The SFDR enacted in February 2023 applied to all funds operating in Europe and brought a wave of reclassifications from Article 9 (“dark green”) to Article 8 (“light green”).
- Initial analysis suggests funds classified as dark green attracted higher inflows compared with Article 6 funds, indicating disclosure requirements can enhance transparency and channel capital toward verified sustainable investments.

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### ESG Scores versus Climate Impact Scores

### Limitations of corporate ESG and E pillar scores
- Corporate ESG scores are designed to capture nonfinancial risks and are not necessarily aligned with climate impact.
- Three construction features reducing ESG scores’ ability to reflect climate impact:
  1. ESG scores combine a multitude of data points; only a relatively small subset may relate to creating ESG impact.
  2. ESG scores are not necessarily proportional to ESG performance.
  3. Corporate ESG scores are industry specific; they measure relative performance within an industry rather than absolute climate impact.

### Construction and coverage of newly proposed impact scores
- New climate impact scores can be constructed using data ESG providers already collect (details in Online Annex 3.6).
- Coverage: The scores cover about 10,300 listed firms, of which more than 2,700 are incorporated in emerging markets.
- Design principles:
  - Scores consider only data points that directly reflect climate impact (16 data points out of 64 used for the E score).
  - Scores capture current climate performance (for example, carbon intensity) and information about potential future emission reductions (for example, emission reduction targets).
  - Impact scores are calculated so that a significantly higher value maps into significantly better climate impact characteristics, independent of the industry.

### Effects on firm ranking and portfolio construction
- Impact-oriented scores yield a substantially different ranking of firms than E scores.
  - Firms within the worst 5 percent (rank < 400) under the impact score can have a significantly higher rank under the E score.
  - Firm rank correlation between impact scores and E scores = “–0.14”.
- All reported correlations are statistically significant at the 1 percent level.
- Implication: Using impact scores instead of E scores would produce significantly different portfolio allocations under negative screening or best-in-class strategies.

### Data provider notes
- Refinitiv is one of the few data providers that supplies the underlying data points of their ESG scores, as is Sustainalytics.
- The underlying data points differ across data providers in both scope and measurement.

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### Policy Recommendations (Selected, from Chapter text)
- Use a broad mix of policies to create an attractive investment environment and unlock private climate finance in EMDEs, recognizing political hurdles of carbon pricing and EMDE-specific challenges.
- Reform fossil fuel subsidies as a first step; fossil fuel subsidies are at a record high and are projected to increase in EMDEs (IMF 2023).
- Strengthen the climate information architecture (data, disclosures, taxonomies) to provide high-quality, reliable, and internationally comparable data; leverage International Sustainability Standards Board proposals as a global baseline.
- Implement structural reforms to overcome investment barriers in EMDEs, boost domestic resource mobilization, and attract private capital: strengthen macroeconomic fundamentals, deepen financial markets, improve policy predictability, and foster institutional and governance frameworks.
- Support coal phaseout in EMDEs with innovative and tailored financing solutions, including transition taxonomies and blended finance to enable retirement and repurposing of coal-fired power plants.
- Use Just Energy Transition Partnerships, supported by public and donor financing, to retire existing coal-fired plants and minimize negative economic effects; include policies to support workers and communities (reskilling, social safety nets).
- Refocus financial sector policies on climate impact, covering both mitigation and adaptation, and tailor to EMDE challenges.
- Develop transition taxonomies aligned with nationally determined contributions and sectoral decarbonization targets; connect transition taxonomies to sectoral transition plans and investable project pipelines.
- Standardize transition plans, including for financial institutions, to enable comparability and credibility; transition plans for banks can inform microprudential authorities’ forward-looking assessments.
- Ensure disclosures and labels for sustainable investment funds enhance market transparency and integrity; set clear rules and tighten enforcement to avoid lax use of sustainability labels.
- ESG data providers should offer climate impact–oriented scores; regulators should consider oversight sufficiency for ESG ratings and data providers (IOSCO 2021).
- Realign credit rating agencies’ and sovereign ESG methodologies to better reflect climate factors and material sustainability dimensions across EMDEs.
- Expand public–private risk sharing to foster private climate investments in EMDEs: blended finance, technical assistance by MDBs, and expanded use of guarantees by MDBs and donors to reduce real and perceived risks and broaden the private investor base.

*Source: GLOBAL FINANCIAL STABILITY REPORT, International Monetary Fund | October 2023 (Chapter 3).*

### CHAPTER 3 FINANCIAL SECTOR POLICIES TO UNLOCk PRIvATE CLIMATE FINANCE IN EMERGING MARkET ANd dEvELOPING ECONOMIES

### CHAPTER 3 FINANCIAL SECTOR POLICIES TO UNLOCk PRIvATE CLIMATE FINANCE IN EMERGING MARkET ANd dEvELOPING ECONOMIES

### Multilateral and Donor Risk-Sharing, and the Resilience and Sustainability Trust (RSF)
- The Resilience and Sustainability Trust (RSF) can act as a catalyst by convening governments, MDBs, and the private sector to foster financing of climate investments.
- The total size of the Resilience and Sustainability Trust is small (about $40 billion) relative to global climate investment needs.
- Member countries may choose to use part of the fiscal space created by the RSF to provide risk-sharing and credit enhancement mechanisms for private investors, taking into account fiscal and debt sustainability considerations.
- In combination with traditional IMF programs, the RSF can help address macroeconomic challenges that mobilize domestic financial resources.
- The IMF Green Public Financial Management framework and the IMF Climate–Public Investment Management Assessment provide entry points to integrate climate priorities into public financial management and improve public investment institutions and processes for low-carbon and climate-resilient infrastructure.
- The IMF can provide capacity development, particularly in low-income countries, to advance climate policies and the collection of high-quality, reliable, and comparable climate-related data.
- Policymakers should consider whether regulatory barriers disincentivize use of MDB and donor guarantees by financial institutions such as banks and insurance companies.
- The Development Assistance Committee of the Organisation for Economic Co-operation and Development is actively engaging members to reach a consensus on official development assistance eligibility of members’ private sector instruments, treatment of loans to the private sector, and treatment of credit guarantees (OECD 2022).

### Credit Rating Agencies, Sovereign ESG Scores, and Capital Allocation
- Credit rating agencies have long assessed issuers’ capacity and willingness to meet financial obligations; they crucially influence capital flows in EMDEs.
- Investors seek broader sustainability information beyond traditional financial and economic factors, fueling the now $7.7 billion environmental, social, and governance (ESG) industry, expected to quadruple by 2030.
- Challenges to integrating long-horizon climate and sustainability factors into sovereign credit assessments:
  - A disconnect exists between the financial industry’s investment horizon and the horizon over which many ESG factors are expected to be material for creditworthiness.
  - Understanding of materiality of ESG and sustainability factors and their effects on sovereign creditworthiness is evolving, with notable limitations around modeling and comprehensive data.
- EMDE-specific issues identified:
  - Credit rating agencies’ assessments of EMDEs can fall short of reflecting countries’ preparedness for low-carbon transitions or exposure to stranded asset risks due to dependence on the hydrocarbon sector.
  - Lower-middle-income and low-income countries are generally not rewarded for good E policies, unlike high- and upper-middle-income countries (see Figure 3.1.1).
  - EMDEs dependent on fossil fuels and exposed to stranded asset risks are not necessarily penalized.
- Sovereign ESG methodologies are nascent and evolving:
  - Sovereign ESG score providers increased the weight of the E pillar from an average of 23 percent in 2020 to 35 percent in 2023.
  - Climate factors are still not reflected by the majority of sovereign ESG scores.
  - There is little agreement among sovereign ESG score providers on what constitutes good sovereign performance on environmental issues and which E factors are material across countries with different income levels and regions.

### Firm-Level Emission Intensities, Innovation, and Policy Trade-Offs
- Empirical findings from a global sample of more than 4,000 large, listed firms:
  - Emission intensities—emissions scaled by revenues—vary dramatically among firms operating in the same industry and country.
  - Emissions per unit of production for the worst 10 percent of emitters are more than six times larger than those of the best 10 percent.
  - This heterogeneity holds for both EMDEs and advanced economies and is even larger within EMDEs after controlling for industry fixed effects.
- Drivers of better environmental performance:
  - Firms with fewer green operations use older physical capital stocks, are less knowledge-intensive and innovative, and are less productive.
- Policy simulation insights (multicountry, multisector, multifirm general equilibrium model calibrated to match empirical moments):
  - Subsidies targeting innovation or upgraded capital stocks can cut emissions but at significantly larger costs than carbon pricing.
  - For a 25 percent reduction in corporate emissions, the present value of consumption impact is larger for:
    - Capital subsidy
    - Research and development subsidy
    - Relative to a carbon tax (carbon tax implies lower consumption cost for same 25 percent reduction).
  - Two economic forces explain higher costs of subsidy-based emission cuts:
    - Subsidies are weaker levers than carbon pricing because they do not directly incentivize lower energy consumption and can encourage firm expansion as productivity rises, requiring large subsidies to achieve significant cuts.
    - Subsidies can misallocate resources; larger subsidies induce stronger misallocation and higher costs.

### Early Lessons from RSF Engagements and Country Examples (Barbados and Rwanda)
- Cross-cutting lessons from early IMF engagements in Bangladesh, Barbados, Costa Rica, Jamaica, and Rwanda:
  - EMDE climate financing needs are substantial; coordinated efforts among governments, international financial institutions, and development partners are essential to leverage expertise and mobilize additional climate finance.
  - Scaling climate resource mobilization requires coordinated action across three pillars: climate policy reforms, capacity development, and innovative financing approaches.
  - Using part of the fiscal space created by RSF arrangements in a prudent manner could help crowd in additional financing for climate investments.
  - Facilities using public resources should have appropriate governance structures; project selection, impact reporting, monitoring, and verification should meet highest international standards.
  - Climate solutions must be customized to each country’s climate needs and economic characteristics; adaptation versus mitigation investments likely require different policy and financing approaches.
  - Limited market size and lack of a robust pipeline of bankable projects are larger impediments in smaller economies, potentially necessitating regional pooling of projects.
- Barbados example:
  - The government used part of RSF-created fiscal space as equity capital for a new Blue Green Bank to provide lending for private sector green investments in affordable homes, hurricane-resilient roofs, and transport electrification.
  - The Blue Green Bank receives funding from the Green Climate Fund and US Agency for International Development and technical support from partners including CAF and the Inter-American Development Bank.
  - Low-cost, long-term financing and grants from development partners will support government investments in water, sanitation, and flood and coastal protection projects; partners will also support PPP capacity to attract private investment in resilient infrastructure.
- Rwanda example:
  - Rwanda set up Ireme Invest, a green investment facility by the Rwanda Green Fund and the Development Bank of Rwanda.
  - Under the RSF arrangement, development partners such as Agence Française de Développement and the European Investment Bank committed to scale up climate financing with budget support, technical assistance, and long-term low-cost loans.
  - The initiative is expected to fund a pipeline of projects estimated at €400 million, including €130 million in equity contributions from private investors.
  - The government is prepared to scale up the equity of the Development Bank as the project pipeline expands.

*Source: CHAPTER 3 FINANCIAL SECTOR POLICIES TO UNLOCk PRIvATE CLIMATE FINANCE IN EMERGING MARkET ANd dEvELOPING ECONOMIES, Global Financial Stability Report, October 2023.*

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2023/october/english/ch3.pdf_