This chapter first recalls the range of real-economy public policies that may drive alignment or misalignment of finance with the Paris Agreement. It then focusses on financial sector policies, taking stock of existing typologies and best‑available evidence on the degree of integration of climate‑related considerations as well as on the expected or observed effects in relation to financial and climate policy goals. Additionally, the chapter briefly summarises available evidence on a selection of climate‑related actions taken by investors and financial institutions.
OECD Review on Aligning Finance with Climate Goals
Assessing Progress to Net Zero and Preventing Greenwashing
Green Finance and Investment
Abstract
Real‑economy policies remain crucial levers to influence the attractiveness of investments in activities contributing to or undermining climate goals. Governments have relied more on climate‑related economic policies, but other types of climate‑related policies, such as regulatory, government investment and consumption, voluntary approaches, and information, have increased more in recent years. At the same time, existing policies continue to provide incentives for emissions‑intensive economic activities and investments, both domestically and internationally, such as fossil fuel subsidies and investment treaties.
Financial sector policies have financial and price stability, and market integrity and efficiency, as primary objectives but can also influence climate outcomes. Such influence can result from existing core financial sector policies or, depending on mandates of relevant authorities, from financial sector policies integrating climate considerations. By 2023, 81 countries worldwide and the EU had adopted financial sector policies integrating climate considerations, up from 18 countries in 2015 when the Paris Agreement was adopted. Over 450 such policies have been adopted since 2000.
Climate‑related financial sector policies have mainly taken the form of transparency and information policies, with the aim to enhance market transparency and, in some cases, enable other climate‑related policies and actions in the financial sector. By 2023, supervisory and regulatory authorities or ministries in 77 countries and the EU had established such policies. 55 countries adopted disclosure policies and 70 countries adopted climate‑related finance guidelines, such as taxonomies. Climate‑related disclosure by financial and non‑financial corporates has improved, but many gaps remain in terms of data accessibility, interoperability, and completeness for complementary metrics. Scarce evidence on real‑economy impacts finds decreases in emissions‑intensive finance volumes but mixed effects on emissions reductions.
In light of growing climate‑related risks to the financial system, prudential policies across jurisdictions increasingly integrate those risks into policies aimed at maintaining financial stability. Climate-related prudential policies, relating to risk management and supervision, market discipline, and the level and quality of capital, had been adopted in 41 jurisdictions by 2023, mainly by central banks. Understanding of the effects of climate‑related prudential policies is primarily based on conceptual analysis and assumptions. Limited research finds mixed effects and trade‑offs between core financial and climate policy objectives, especially for policies related to the level and quality of capital. Limited conceptual research expects potential positive effects across policy objectives for climate‑related large exposure policies and some leverage and risk management and supervision policies, although effects may be small.
As the main aim of monetary policy is to maintain price stability, the degree to which it can consider climate change varies across jurisdictions, with few examples of adoption of climate‑related considerations. While conceptual research expects strong trade‑offs between pricing and climate objectives, theoretical and empirical evidence are missing.
Financial market participants increasingly implement climate‑related actions, primarily through engagement, divestment and exclusion, and portfolio construction practices. Initial evidence finds that non‑financial corporates respond to environmental preferences of investors, but it remains to be proven whether these responses result in emission reductions. Emerging research indicates that divestment and exclusions can have mixed effects, while the effects of climate‑related portfolio construction practices are not tracked yet.
Aligning finance with climate policy goals requires an ecosystem of climate-aligned policies and actions incentivising financing and investments towards activities aligned with climate goals. A wide variety of interventions can be tailored to climate-related considerations by public and private actors (UNFCCC SCF, 2023[1]), a selection of which are summarised in Figure 4.1. While climate-related considerations can relate to both climate change mitigation and adaptation, the focus in this chapter is mainly on mitigation, seeing the current challenges in resilience assessments discussed in Chapter 2.
Note: This is a non-exhaustive overview of types of public and private interventions that may influence the climate alignment of finance.
Source: Authors, based on (OECD, Forthcoming[2]) subject to further changes, and own research.
Aligning policies with climate goals across real-economy and financial sector policy areas, which are inherently linked, is a prerequisite for aligning finance with climate goals. Financing and investment decisions are still hampered by different policy uncertainties and disincentives (OECD, 2023[3]). Additionally, climate policy can be made more effective if policymakers with portfolios situated outside the traditional climate agenda can revisit the most misaligned policy instruments in their domains (OECD, 2015[4]). However, there may be both synergies and trade-offs with current core objectives and mandates of such policymakers. For example, as further addressed in Section 4.2, financial sector policies’ primary objectives are financial and price stability, market efficiency and transparency.
The Paris Agreement temperature goal, as well as ambitious greenhouse gas emissions reduction and net-zero targets across countries have sent a policy message to private sector actors to integrate climate considerations in their actions. In some cases, the private sector has also moved ahead in the absence of or beyond the ambition of existing climate-related policies. As for policymakers, private financial sector actors may also be faced with synergies or trade-offs between different financial and societal objectives.
Governments may use a range of policy instruments and interventions to stimulate climate‑aligned actions, notably by the private sector (companies and households), which can influence the alignment of real‑economy investments and underlying financing with climate goals. Building on existing analytical frameworks in this area, policy instruments influencing climate change outcomes can be grouped into five major categories: (1) economic policies, (2) regulatory policies, (3) government investment and consumption, (4) voluntary approaches, and (5) information policies (OECD, Forthcoming[2]; Nachtigall et al., 2022[5]; Dubash et al., 2022[6]; OECD, 2008[7]). Importantly, some policies may have a primary purpose other than climate action, such as industrial development. Generally, the use of these instruments can affect the attractiveness of private investment in activities they target.
Note: This is a non-exhaustive overview of real-economy public policy interventions that may influence the climate alignment of finance. The grey boxes provide examples of types of policies under policy areas.
Source: Authors, based on (OECD, Forthcoming[2]) subject to further changes.
Countries rely on different mixes of policies and instruments for climate change mitigation (Stechemesser et al., 2024[8]). Trends in the use of each type is changing over time (Nachtigall et al., 2022[5]; OECD, 2024[9]; OECD, 2023[10]). While efforts and data collection to track the reliance on the five categories are underway, relatively more comprehensive evidence is currently available for three broader policy groups: market-based policies (which is broadly the same as economic policies, i.e., (1) above), non-market-based policies (which broadly covers the other four categories (2-5)), and other policies (which include high-level policy documents with targets such as NDCs and infrastructure plans). Historically, policymakers relied more on market-based or economic policies (Figure 4.3, Panel A). More recently, non-market-based policies have been increasingly adopted by countries to mitigate climate change.
Economic policies can change the investment incentives for aligned and misaligned activities. The most used economic climate-related policies include subsidies, taxes, and fees (OECD, 2024[9]). Governments may use subsidies to attract private investments in climate solutions and rely on carbon taxes to discourage investments in carbon-intensive activities. Currently, carbon prices cover nearly a quarter of global emissions. As of 2023, 75 carbon taxes and emissions trading schemes are in operation worldwide, including in nearly all OECD countries (World Bank, 2024[11]). Several studies have found that carbon pricing tends to increase total investments by firms in abatement technologies such as installations of heat recovery solutions (Venmans, Ellis and Nachtigall, 2020[12]). Market-based climate policies, more broadly, can also reduce the negative effects of financing constraints (Costa et al., 2024[13]).
Regulatory policies directly restrict or mandate specific activities and hence related investments. Regulatory climate-related policies are increasingly relied upon. Some regulatory instruments, such as minimum energy performance standards (MEPS) for appliances and fuel efficiency standards for passenger cars, have been implemented and updated since the 1990s (OECD, 2023[10]). More recently other standards, such as building energy codes and MEPS for electric motors, are increasingly being adopted. Bans and phase-out requirements for some fossil fuel assets and equipment are increasingly used in some countries to shift consumption and production decisions (OECD, 2023[10]). These technology standards help mainstream low-carbon technologies by prohibiting the sale of conventional technologies based on fossil fuels (a ban) or prohibiting the use of the respective fossil-based technology altogether (a phase-out). Such policies support redirecting investments towards the production and diffusion of more sustainable alternatives (Trencher et al., 2022[14]).
Note: In Panel A, other instruments include targets, international cooperation, governance, and climate data.
Source: Authors, based on (Nachtigall et al., 2022[5]; OECD, 2024[9]; Chhun et al., 2024[15]).
A range of other policies can further contribute to creating a domestic enabling environment for more climate-aligned and less misaligned investments. Information policies such as corporate disclosure requirements are commonly relied-upon policies across countries (and addressed in Subsection 4.2.1). Real-economy information-related policies also refer to national targets and roadmaps, capacity-building activities, government-funded certification (Bhandary, Gallagher and Zhang, 2021[16]), expert groups (Steffen, 2021[17]), and consumer education (WWF & Frankfurt School of Finance & Management, 2019[18]). Government-backed frameworks and schemes can also result in private-sector voluntary approaches and actions to mitigate climate change. For example, the OECD Guidelines for Multinational Enterprises on Responsible Business Conduct are internationally agreed standards with expectations for companies to understand and respond to climate impacts associated with their own activities (OECD, 2023[19]), and are thus also referred to in Section 4.3.
Direct public investment, financing, and consumption also play an important role (OECD, Forthcoming[2]). Public investments by governments and subnational authorities, as well as financing provided by official agencies, institutions and banks that can take the form of grants, lending, equity investments, guarantees and insurances can contribute directly to the implementation of climate-aligned projects, activities, and solutions, as well as has the potential to help mobilise and incentivise significant volumes of private finance for climate-aligned investments. Many initiatives are underway, addressing for instance the greening of public budgets (OECD, 2024[20]), or alignment with the Paris Agreement of international development finance (OECD, 2019[21]) and of development finance institutions.
A set of domestic economic policies providing continued support to and incentives for greenhouse gas emission-intensive economic activities and investments, however, remains in place, thus impeding and delaying the alignment of finance with climate goals. This notably includes fossil fuel subsidies (IEA, 2023[22]), which negatively affect the relative risk-return profile of climate-aligned investments such as in renewable energy (Ang, Röttgers and Burli, 2017[23]). In 2022, the fiscal cost of global support for fossil fuels amounted to USD 1.48 trillion, nearly double the average over the past decade (Figure 4.4). This jump in 2022 was, however, largely due to government measures (such as new support for coal production and consumption) to offset exceptionally high energy prices, driven in part by Russia's war of aggression against Ukraine (OECD, 2023[24]). Some additional analysis also estimates implicit subsidies, from undercharging for environmental costs and foregone consumption taxes, which could amount to USD 5.7 trillion (Black et al., 2023[25]). Explicit and implicit fossil fuel subsidies combined represented around 7% of global GDP in 2022 (IMF, 2023[26]).
Note: The OECD-IEA combined estimate covers 82 countries. Fiscal cost of support for the fuel “Electricity” is derived from measures providing support for electricity generation or consumption.
Source: (OECD, 2023[24]; IEA, 2023[27]).
Policy instruments are much less frequent for climate change adaptation than for mitigation, and only limited evidence of their effects on investments is available. As of 2023, the OECD Pine Database included 90 adaptation-related policies implemented in 21 OECD member countries (Figure 4.3). Adaptation-related subsidies or tax breaks to developers and homeowners can encourage investments in climate-resilient infrastructure, for instance through stricter building practices to withstand extreme weather events. Adaptation-related regulations and standards ensure project holders incorporate resilience considerations into new investments (OECD, 2023[28]). Direct regulations, plans, and capacity building are found to be most effective and transformational (The Global Adaptation Mapping Initiative Team, 2021[29]). An example includes wildfire standards as part of building codes, which increase resilience-aligned investments in infrastructure (Baylis and Boomhower, 2021[30]).
Government policies can further influence international public and private investment flows to accelerate the net-zero transition and ensure they do not increase the vulnerability or fragility of systems (OECD, 2023[31]). Over the past decades, foreign direct investments in low-income countries have, at an aggregate level, been associated with increases in greenhouse gas emissions intensities in beneficiary countries (Wang et al., 2023[32]). Specific policies and enabling conditions can attract foreign direct investment contributing to the achievement of climate goals, including (i) governance, (ii) regulation, and (iii) targeted support measures (OECD, 2023[31]; OECD, 2022[33]). In addition, bilateral and multilateral public investments can crowd in private investments (OECD, 2023[34]). However, the magnitude of the effect is smaller for flows to and in EMDEs than in advanced economies (Haščič et al., 2015[35]).
Investment treaties (including provisions within broader trade agreements) are another important part of the policy framework influencing the climate alignment of finance (Gaukrodger, 2022[36]). These treaties typically protect investments by providing benefits in the event of a range of government actions, including expropriation, discrimination, or even lawful government actions. An investor can claim compensation, including potential lost profits if the government violates the treaty. While investment treaties generally do not impose climate-related requirements on investors, they often provide benefits to carbon-intensive activities. For example, about 10% of existing global fossil fuel production benefits from the treaties, while planned new oil and gas projects that will benefit from these treaties as they currently exist have been estimated to have an expected net present value between USD 60 and 234 billion (Tienhaara et al., 2022[37]). Investment treaty benefits not only incentivise investment but also affect government incentives to take climate action. Litigation and financial risks for governments under the treaties are substantial, with damages claims averaging over USD 700 million. At the same time, beneficiary investors do not have obligations under the treaties. The largest claims and awards involve fossil fuels. Such litigation and financial risks could delay climate action and need to be addressed by governments.
Any analysis of financial sector policies’ influence on the climate alignment of finance must acknowledge the core objectives of such policies. They oversee and guide the functioning of the financial system towards ensuring its stability, integrity, and efficiency. The core official entities implementing these policies are central banks, supervisory and regulatory authorities, and ministries (financial ministries in particular). Importantly, the exact mandates of these policymakers differ across jurisdictions.
Traditionally, financial sector policies did not consider climate change-related concerns. However, as the collective understanding of climate risks grows and the impacts of climate change intensify, climate risks are increasingly understood as being financially material (ECB, 2024[38]; FSB, 2023[39]; Stiroh, 2022[40]; FSB, 2022[41]; Bank of England, 2022[42]; Dikau and Volz, 2021[43]). Such risks to financial sectors, institutions, portfolios and assets arise from a misalignment of underlying economic activities and actors with a low-carbon pathway and resilient development (Dikau et al., 2024[44]).
Policymakers have started to consider climate-related considerations in financial sector policymaking. On the one hand, existing financial sector policies may have unintended consequences on climate goals. On the other hand, tailored financial sector policies can be adopted to address climate risks, which this report refers to as climate-related financial sector policies.
The climate-related financial sector policy data, which informs all of Section 4.2 was collected using a structured, multi-step approach to create a comprehensive database of climate-related financial policies spanning 2000 to 2023 (D’Orazio, 2023[45]). Relevant policies were identified by systematically retrieving official documents from the websites and databases of central banks, financial regulators, ministries, and banking associations. The search utilised specific keywords related to climate finance and financial regulation to ensure comprehensive coverage. The gathered documents were carefully read, validated, and cross‑checked to ensure accuracy and completeness to avoid duplication and errors. The complete methodology is presented in (D’Orazio and Thole, 2022[46]; D’Orazio, 2023[47]).
Climate-related financial sector policies have been increasingly adopted since the Paris Agreement. By 2023, 81 countries (37%) and the EU had adopted at least one such policy (Figure 4.5, Panel A), up from 43 countries in 2015. Of those, 43 were advanced economies (AEs) and 38 emerging and developing economies (EMDEs), including 33 OECD member countries and all G20 jurisdictions. These can relate to climate change mitigation and/or resilience. Most existing climate-related financial sector policies directly or indirectly relate to climate-related transition and physical risks, designed to support core objectives of safeguarding the stability and functioning of the financial system. However, they may still have an impact on the degree of alignment of finance with climate goals despite such outcome not being their objective.
Climate-related financial sector policies have been adopted by a range of policymakers (Figure 4.5, Panel B). As of 2023, governments (ministries) are responsible for 30% of these policies, supervisory and regulatory authorities for 26%, central banks for 28%, and stock exchanges and securities exchanges 9%. The remainder of policies were adopted by a combination of these policymakers. The mandates of each type of policymakers and the extent to which it can integrate climate change considerations vary across jurisdictions. This is notably the case for central banks (Dikau and Volz, 2021[43]). Notwithstanding these variations, and as illustrated and discussed in the remainder of this section, some policies are more likely to be adopted by certain authorities than others (D’Orazio, 2023[47]; World Bank, 2021[48]).
Financial sector policies that are designed with climate considerations in mind can cover different policy areas. While there are different ways to group such policies, and some may fulfil multiple purposes, they can be grouped in four common policy areas (D’Orazio and Thole, 2022[46]; D’Orazio, 2023[45]; D’Orazio, 2023[47]; Steffen, 2021[17]; Bhandary, Gallagher and Zhang, 2021[16]; Krogstrup and Oman, 2019[49]).
Climate-related transparency and information policies: Generally, they support the efficiency and integrity of financial systems. Tailored climate-related policies in this policy area can create further transparency and increase the accessibility of climate-related information, with the aim of strengthening the foundation for well-informed financial decisions (Steffen, 2021[17]; WWF & Frankfurt School of Finance & Management, 2019[18]). Over the past few decades, these are by far the most relied-upon types of climate-related financial sector policies (Figure 4.5, Panel C). Governments, primarily finance or environmental ministries, are the most common authorities to launch disclosure requirements, followed by supervisory and regulatory authorities.
Climate-related prudential policies: Prudential policies are typically implemented to support the stability of the financial system. Climate-related prudential policies aim to address risks posed by climate change to the stability of the financial system by integrating climate-related risks more thoroughly in prudential policy frameworks (D’Orazio and Thole, 2022[46]; D’Orazio and Popoyan, 2019[50]). Such policies have been mostly implemented by central banks, consistent with their broader mandates to safeguard the stability of the financial system (Figure 4.5, Panel C).
Climate-related credit allocation policies: They typically support certain economic development objectives by influencing the flow of credit to specific sectors. Climate-related credit allocation policies directly promote climate-related credit measures and investments (D’Orazio, 2023[47]). Such policies can be adopted by a range of policymakers, including governments, but have mainly been adopted by central banks (Figure 4.5, Panel C).
Climate-related monetary policies: Their primary aim is to maintain price stability in the economy. Climate-related monetary policies generally aim to better reflect climate risk in standard monetary policy instruments such as the collateral framework and the central bank portfolio, or even introduce additional green quantitative easing (Krogstrup and Oman, 2019[49]; Steffen, 2021[17]). No consistent data is currently collected on such policies, likely because they remain relatively limited.
Note: Data for monetary policies are not currently consistently collected. Climate-related disclosure requirements for banks are counted under transparency and information policies in Panel C. AEs is advanced economies, based on the high-income country classification of the World Bank. EMDEs is emerging markets and developing economies, based on the World Bank classification for upper middle income, lower middle income, and low-income countries.
Source: Authors, based on (D’Orazio, 2023[45]) and updated data.
Some policy measures can fall under multiple policy areas. Notably, disclosure requirements for banks (3% of total climate-related financial sector policies by 2023). In this chapter, they are primarily analysed in the section to climate‑related transparency and information policies, but they also qualify as climate‑related prudential policies. Additionally, there may be policies relevant to the financial sector that currently fall outside the scope of this analysis. For example, regulation could be developed with respect to ESG rating activities, as has been done in the EU (European Parliament, 2024[51]).
Note: This is a non‑exhaustive overview of financial sector public policy interventions that may influence the climate alignment of finance. The grey boxes provide examples of types of policies under policy areas.
4.2.1. Climate‑related transparency and information policies
Transparency and information policies within the financial sector policy domain can be implemented to enhance the comparability of financing decisions, supporting the efficient functioning of the financial system. Some transparency and information policies also help inform market supervision, supporting the stability of the financial system.
In this context, climate‑related transparency and information policies can serve multiple purposes and often provide a foundation for other climate-related financial sector policies and practices. They contribute to improved understanding of climate performance, reduced information asymmetries and increased comparability (NGFS, 2021[52]). This can enable financial sector players to reflect climate preferences in investment decisions (Section 4.3), as well as inform asset purchase programmes by central banks if they choose to tilt their portfolios towards better climate performers (explained in Subsection 4.2.3). Climate-related information can also be needed for climate-related prudential policy (the focus of Subsection 4.2.2).
Over the past two decades, climate-related transparency and information policies have grown significantly, and even more so since the adoption of the Paris Agreement. Between 2015 and 2023, they more than quadrupled, from 75 to 351 policies. By 2023, 77 countries and the EU had adopted at least one such policy (Figure 4.7, Panel A). This encompasses 42 AEs and 35 EMDEs, including 33 OECD member countries and all G20 countries. Across jurisdictions, there are differences in their stringency and level of bindingness, from purely voluntary to fully mandatory.
Note: AEs is advanced economies, based on the high-income country classification of the World Bank. EMDEs is emerging markets and developing economies, based on the World Bank classification for upper middle income, lower middle income, and low-income countries.
Source: Authors based on (D’Orazio, 2023[45]) and updated data.
Climate-related transparency and information policies can take different forms, notably disclosure requirements and financial guidelines (which include taxonomies and labelling policies). Climate-related disclosure requirements were the most common type of policy in this policy area until 2020 (Figure 4.7, Panel B). Between 2020 and 2023, climate-related finance guideline policies doubled.
Climate-related disclosure policies
Acknowledging differences in mandates across policymakers and jurisdictions, disclosure requirements aim to provide transparency, support market efficiency, and prevent information asymmetries or greenwashing claims. For example, regular disclosures on greenhouse gas emissions allow investors and other stakeholders to monitor progress on emission reduction targets. This could allow for capital allocation that considers greenhouse gas emission reductions (Monasterolo et al., 2017[53]).
Climate-related disclosure policies are widely relied upon. As of 2023, climate-related disclosure policies had been adopted in 55 countries and the EU (Figure 4.8). This encompasses 33 AEs and 22 EMDEs, including 28 OECD member countries and 17 G20 jurisdictions. There is a concentration of such policies in Europe, as well as in parts of the Americas and Asia-Pacific. Climate-related disclosure requirements adopted by policymakers in EMDEs remain more limited.
As of 2023, 40% of climate-related disclosure policies had been adopted by supervisory and regulatory authorities, and 37% by government ministries (Figure 4.7, Panel B). This is consistent with their mandates to ensure market efficiency, including through the availability of robust information and with the aim to address greenwashing issues. Central banks were behind 10% of such policies, and stock or securities exchanges 12%, while less than 1% were issued by a combination of policymakers.
Climate-related disclosure policies can require disclosure on a range of indicators, some of which were discussed in Chapter 2. Examples of indicators required in existing disclosure policies include Scope 1, 2 and 3 greenhouse gas emissions, climate targets, climate risks, transition plans, climate resilience strategies, climate-related engagement, or (for financial institutions) results of climate stress tests. Disclosure requirement policies may also be complemented by voluntary industry guidance on disclosure (as also discussed in Chapter 2). Climate-related indicators proposed in such guidance and policies can face a trade-off between allowing flexibility in indicator calculations to increase interoperability between jurisdictions and being specific about calculations to enhance transparency (OECD, 2023[54]).
Current climate-related disclosure policies are either exclusively covering climate-related indicators, or form part of wider sustainability or ESG disclosure policies. While both climate change transition and physical risks are covered, proposed indicators to assess progress on mitigation efforts are more frequent than those relating to resilience to climate change. Although the focus of the analysis in this section is on the former, one example of a disclosure policy covering adaptation more extensively is the UK’s Climate Change Act, which mandates adaptation reports by listed companies (UK Department for Environment, Food & Rural Affairs, 2021[55]). These reports were designed to inform the national adaptation strategies, supporting coordination and the consideration of interdependencies between public and private sectors.
Most climate-related disclosure policies adopted to date address non-financial companies, which, as addressed in Section 3.2 of Chapter 3, represent an important financial asset class, while only few address financial institutions or both. While disclosures by non-financial institutions aim to inform the general public and financial market participants, disclosures by financial institutions can serve prudential goals by informing financial supervisory authorities, which can base their prudential initiatives on the information disclosed (further discussed Subsection 4.2.2).
Note: AEs is advanced economies, based on the high-income country classification of the World Bank. EMDEs is emerging markets and developing economies, based on the World Bank classification for upper middle income, lower middle income, and low-income countries.
Source: Authors based on (D’Orazio, 2023[45]) and updated data.
Looking at the effects of these policy developments, climate-related disclosure practices by non‑financial and financial companies have been improving. Notably, disclosure of simple GHG emissions‑based indicators has become relatively well available globally. Companies representing 77% of market capitalisation disclosed Scope 1 and 2 emissions and 60% Scope 3 emissions disclosure in 2022 (Figure 4.9). While this is in great part due to the implementation of disclosure public policies in this area, in some cases, companies already disclosed (at least partly) on a voluntary basis, which may reduce the effect from and additionality of mandatory disclosure policies and requirements.
Despite increases in climate‑related disclosure and reporting, many gaps remain. In 2022, climate‑related information was available for less than 20% of listed companies that, however, represent 77% of market capitalisation, indicating a size bias in disclosure (Figure 4.9). Moreover, research for a smaller sample of companies finds that only half of companies disclosing any Scope 3 emissions disclose Scope 3 emissions data needed for informing robust assessments, including emissions associated with the use of produced products is typically not reported (LSEG, 2024[56]). Additionally, disclosure of emissions in EMDEs is overall lower than in advanced economies.
Note: This analysis includes 43 970 listed companies globally with a total market capitalisation of USD 98 trillion.
Source: (OECD, 2024[57]).
Further, disclosure on non‑emissions‑based indicators relevant to assessing climate risks and performance tend to be more limited. For example, very few of the largest financial institutions disclose information related to portfolio construction, engagement and governance practices, which, as discussed in Chapter 2, Subsection 2.3.2, are relevant for assessing progress towards their climate performance and net‑zero commitments (OECD, 2023[54]). Some of these gaps will at least partially be resolved over the next few years due to new mandatory disclosure requirements (Box 4.1).
Assessments of the effects of climate‑related disclosure policies in relation to climate goals are scarce and face inherent data challenges. A lack of reference data on Scope 1, 2, and 3 greenhouse gas emissions before the start of mandatory disclosure complicates impact assessments. Further, current research often only includes Scope 1 and 2 CO2 emissions due to the lack of consistent Scope 3 data (e.g., (Shi, Bu and Xue, 2021[58])). Besides, few studies analyse the effects of disclosures for asset classes beyond listed equity, although there is evidence that debt, for example, plays an important role for financing emission reducing projects (Emambakhsh et al., 2022[59]).
Enhanced climate‑related disclosure alone cannot be expected to reduce emissions, but can enable investors and financial institutions to act based on increased transparency. As further discussed in Section 4.3, such actions include engagement with investees, as well as portfolio management to reduce exposure to emissions‑intensive assets and increase the share of climate solutions. Besides informing their investors and creditors, the data gathered and reported by non‑financial companies also allows them to take action in relation to their operations, for example, to identify opportunities for energy saving either for reducing production costs or because they interpret mandatory climate disclosures as a signal for more rigid real-economy or financial policies to come (He, Xu and Shi, 2023[60]).
Climate‑related data disclosure by companies is critical to inform climate‑related decisions and actions in the financial sector. Analysis by the Net-Zero Data Public Utility, a global initiative providing a centralised repository of company-level climate data that is transparent and freely accessible, finds that the potential number of companies covered by climate‑related disclosure requirements is expected to triple by 2030 to over 120 000 (Figure 4.10). Moreover, while a significant share of companies disclosing climate‑related data are doing so on a voluntary basis, the share of companies disclosing information in response to recent and upcoming mandatory climate‑related disclosure requirements is foreseen to increase rapidly and at scale by 2030.
Despite the rise of mandatory climate‑related disclosure policies, corporate climate‑related data could remain difficult to access, limiting its effectiveness. Of the nearly 40 000 companies covered by mandatory disclosure requirements as of 2024, less than 7 000 (17%) are in easily discoverable locations and accessible formats (Figure 4.10). Digital tagging of climate data is expected to ramp up from 2026 onwards resulting in an improvement of the accessibility of these disclosures in company reports. In the European Union, for example, over 40 000 companies are set to be reporting under the EU Corporate Sustainability Reporting Directive (SCRD) with digital tagging by 2026, once the digital reporting mandate is adopted into the European Single Electronic Format regulation. Official repositories, which improve the ability to explore and analyse data, are expected to significantly expand their coverage. Based on the current trajectory of announced disclosure regulations, over 50% of disclosures from companies covered by existing or expected disclosure requirements will be digitally tagged and located in official repository by 2030, while, unless further action is taken, over 40% will remain non‑machine readable and/or located outside of official repositories.
Note: Covered companies refer to the upper bound of the estimated number of companies covered by requirements relating to disclosure of company‑level GHG emissions, including those still in consultation periods not yet officially finalized and comply‑or‑explain. “No Active Official Repository, Digitally Tagged” reflects the tagging of EU Corporate Sustainability Reporting Directive disclosures (assuming tagging mandate is adapted into European Single Electronic Format regulation for 2026) prior to the existence of European Single Access Point. Company disclosures not held in an official repository may still be extractable. Machine readable data refers to structured data that can be automatically read and processed by a computer (e.g., xml, json, csv). Digitally tagged refers to the act of applying machine‑readable labels that align with a digital taxonomy to enable data to be read automatically.
Source: Net‑Zero Data Public Utility.
In all cases, the effects of disclosure policies on GHG emissions would be mostly indirect, and tracing effects on actual real‑economy decarbonisation is difficult. Thus, existing literature in this field mostly focuses either on the effects of disclosure by financial institutions on inflows into their funds, or the effects of corporate disclosure on their funding opportunities and very sparsely effects of corporate disclosure on their emissions. Initial evidence finds decreases in emissions‑intensive finance volumes and mixed effects on emissions reductions due to mandated corporate disclosure:
On the one hand, examples from the UK and the US find that mandatory disclosure led to a decrease of approximately 8% in Scope 1 and 2 GHG emissions (Downar et al., 2021[61]; Tomar, 2024[62]). On the other hand, other studies have found limited or no effects of disclosure on emissions but acknowledge important data and design limitations (Zhang and Liu, 2020[63]).
Mandatory consolidated and high quality disclosure that can stimulate and support active investor interest was assessed as more impactful in the UK (DEFRA, 2010[64]; Sullivan and Gouldson, 2012[65]; Cong, Freedman and Park, 2020[66]). For example, UK firms already disclosing emissions at the installation level drastically reduced emissions after the introduction of disclosure requirements at the corporate level (Downar et al., 2021[61]).
A recent study by the central bank of France found that mandatory climate disclosure regulations introduced in France have contributed to French investors curbing their investments in fossil fuel companies by 40% (Mésonnier and Nguyen, 2021[67]).
Asset owners and managers in EMDEs cite the lack of information about corporates’ emissions or transition as a key deterrent to transition investments in such jurisdictions (WEF, 2022[68]).
Climate‑related finance guidelines
Climate‑related finance guidelines are widely adopted by different policymakers across jurisdictions (Figure 4.7). By 2023, such guidelines had been adopted in 70 countries and the EU. This encompasses 36 AEs and 34 EMDEs, including 30 OECD member countries and all G20 jurisdictions. As of 2023, government ministries had adopted 37% of climate‑related finance guidelines, supervisory and regulatory authorities 20%, central banks 23%, stock/securities exchanges 11%, and the remainder by a combination of the previous categories. Many climate‑related financial guidelines are non‑binding policies, providing guidance on best practices in green product design, risk management or decarbonisation, with the aim to support and guide rather than mandate the greening of individual financial institutions (D’Orazio, 2023[69]).
Climate‑related finance guidelines typically take the form of climate‑related financial principles and guidance, or taxonomies and labelling criteria (D’Orazio, 2023[69]). For these categories, policy tools are often not referred to as climate‑specific, but rather ‘green’ or ‘sustainability’ finance guidelines.
Climate‑related finance principles are broad guidance policies that provide general recommendations on integrating climate consideration into financial practices. They can also be referred to as guidance, framework, or protocol, among other names used across jurisdictions. Climate‑related finance principles were, by 2023, relatively widely spread. Many of these policies are part of broader packages that also include guidance on risk management outline strategic principles or roadmaps. Government ministries and stock/securities exchanges have been the most prolific climate-related finance guideline issuers.
Climate‑related taxonomies classify activities, for example, as green, transition relevant, or supporting adaptation (Tandon, 2021[70]). Climate‑related labelling guidance outline requirements to name a financial product as ‘climate’ or ‘green’. Taxonomies and labelling guidance relate to disclosure requirements (see previous subsection) when disclosed information is an input to the classification process or when the disclosure of taxonomy alignment is required for labelling financial products. Such labels are often the basis of currently available evidence of finance going to activities that support climate goals (as shown in Chapter 3). Since the adoption of the Paris Agreement, sustainable and green taxonomies have been increasingly developed, remaining mostly voluntary. Currently, around 75% of AEs, but less than 10% of EMDEs have a sustainable or green finance taxonomy (World Bank, 2024[71]). Green bond frameworks can be established independently from taxonomies or build on them or other disclosure requirements. Some jurisdictions have also adopted more general labelling, naming and communication guidelines to clarify the intent and strategies of financial products beyond green bonds, such as green funds.
Literature on the effects of climate‑related guidelines on volumes of investments and financing for activities contributing to climate goals, and on GHG emissions reductions is scarce. Due to the broad nature of climate-related finance principles, identifying and tracing impact channels may not be possible. Such principles may also frame or be adopted together with other policies, making it difficult to isolate the effect on emissions from such principles policies individually (D’Orazio and Dirks, 2021[72]).
Overall, the aim of, and thus expectation from, such policies is that they improve the credibility and transparency of activities or financial assets supporting climate actions, allowing investors to choose products reflecting their preferences. In other areas, such as food labels, labelling containing greenhouse gas emissions or climate‑related information has been shown to significantly alter consumption choices towards less emission‑intensive and more environmentally friendly products (Muller, Lacroix and Ruffieux, 2019[73]; Camilleri et al., 2018[74]). For the financial sector, current analysis points to greater inflows into funds labelled as more sustainable (Becker, Martin and Walter, 2022[75]; Scherer and Hasaj, 2023[76]). The additionality of the policy effect is, however, difficult to demonstrate as such policies may respond to investor demand as well as redirect finance from self‑labelled funds to funds labelled according to the policy. While climate‑related taxonomies and green bond frameworks may increase flows to funds using such labels, there is currently no evidence that they influence emissions reductions. For the time being, econometric studies of the effects on decarbonisation face data availability challenges, as many taxonomies and frameworks have only been recently adopted.
4.2.2. Climate‑related prudential policies
Prudential policy mainly aims to maintain financial stability. Financial stability is understood as the capacity of a financial system to absorb severe shocks and maintain the provision of financial services (Tamez, Weenink and Yoshinaga, 2024[77]). Microprudential regulation is concerned with the financial health of individual institutions, while macroprudential regulation addresses risks to financial stability at an aggregate level as a result of the combined effects of financial institutions’ behaviour.
As climate change can affect the value of physical and financial assets to an extent that threatens financial stability, policymakers need to integrate climate risks into existing prudential policy frameworks (NGFS, 2020[78]; Tamez, Emre and Gullo, 2024[79]). At micro level, climate risks affect individual banks. Such risks need to be integrated into their risk assessments and disclosures (Smoleńska and van ’t Klooster, 2022[80]; BIS, 2022[81]; NGFS, 2020[78]). At macro level, the impacts of climate change and related policies on all economic activities are increasingly highlighted as a systemic risk to the financial system (FSB, 2022[82]), requiring the aggregate effects of financial institutions’ exposure and vulnerability to climate‑related risks need to be integrated into macroprudential policies (Grill, Popescu and Rancoita, 2024[83]).
Traditional prudential policies can have unintended consequences on climate goals. For instance, there is some evidence that incumbent GHG emissions‑intensive assets and underlying finance benefits from the current prudential framework (Gasparini et al., 2024[84]; D’Orazio and Popoyan, 2019[50]), notably by undervaluing the risks associated with such assets (Campiglio, 2016[85]). Moreover, prudential reforms following the 2008 global financial crisis have introduced short-term risk management requirements, in order to address the vulnerabilities at the root of this crisis, such as frequent reporting in banking (Kraft, Vashishtha and Venkatachalam, 2017[86]) or liquidity coverage requirements for financial institutions (Ameli et al., 2019[87]). In addition, some medium-term requirements have also been introduced to encourage banking institutions to ensure stable funding conditions at a longer horizon. However, those requirements may not always be tailored to favour investments in climate solutions, which are often in need of high upfront capital and long-term financing, are less liquid as well as perceived as riskier (WEF, 2013[88]; Narbel, 2013[89]; Gersbach and Rochet, 2012[90]; Thanassoulis, 2014[91]; Ang, Röttgers and Burli, 2017[23]). Further documented side effects of the current prudential framework include the potential to disincentivise cross-border lending to EMDEs (Linehan, 2024[92]; Attridge, Getzel and Gregory, 2024[93]), in particular for infrastructure projects and SMEs (Beck, 2018[94]).
Degree of adoption of climate‑related prudential policies
The integration of climate change‑related risks into prudential policies can relate to different dimensions of the Basel III framework. This framework is an internationally agreed set of measures that aims to strengthen the regulation, supervision, and risk management of banks (BIS, n.d.[95]). The Basel III framework has three pillars relating to capital (broadly covering minimum capital requirements (Pillar 1), risk management and supervision (Pillar 2), and market discipline (Pillar 3)), as well as policies relating to liquidity and large exposures (BIS, n.d.[96]).
Individual climate‑related prudential policy instruments can cover various aspects of the Basel III framework, and primarily include:
Capital‑related policies:
Capital requirements aim to ensure that credit institutions1, particularly banks, have enough capital to absorb losses and continue operating during periods of financial stress, which can result from the effects of sudden economic shocks on banks. Climate‑related capital requirements would thus focus on adjusting capital adequacy ratios of banks according to the level of exposure and vulnerability of their portfolio to climate‑related risks and impacts (D’Orazio and Popoyan, 2019[50]). This can be done through adjusting capital adequacy ratios with so‑called green supporting or brown penalising factors, adjusting capital requirements for specific sectors highly exposed to climate‑related risks or that can benefit from the climate transition, and adjusting counter‑cyclical and systemic risk buffers (originally introduced to mitigate the effects of system‑wide economic shocks).
Risk management and supervision policies aim to ensure that financial institutions effectively manage risks to prevent excessive risk‑taking that could threaten their stability and the broader financial system. This can result in holding more capital if additional risks are identified. Climate‑related risk management and supervision policies aim to enhance financial system stability through regulating banks’ identification and management of climate‑related risks. This mainly includes expanding conventional risk management practices, integrating climate risks in stress tests, adjusting requirements for the quality and level of capital, or specifying lending limits (Bhandary, Gallagher and Zhang, 2021[16]; WWF & Frankfurt School of Finance & Management, 2019[18]).
Market discipline policies aim to enhance the transparency and accountability of financial institutions, notably to encourage prudent behaviour. Climate‑related market discipline mainly refers to climate‑related disclosure policies for banks. Climate‑related micro‑prudential policies can support the integration of climate risks for individual banks into their disclosures (Smoleńska and van ’t Klooster, 2022[80]; BIS, 2022[81]; NGFS, 2020[78]). As Subsection 4.2.1 already addressed disclosure policies, they will not be explained again here but will still be counted in aggregate prudential policy statistics in Figure 4.11.
Liquidity‑related policies are designed to ensure that financial institutions maintain sufficient liquid assets to meet their short‑term obligations and continue operating during periods of stress. Similar to capital requirements, liquidity requirements can be adjusted to better reflect climate related risks to banks’ operations (Baranović et al., 2021[97]; D’Orazio and Popoyan, 2019[50]).
Large exposure‑related policies aim to limit the concentration of risk by ensuring that financial institutions do not have excessive exposure to a single counterparty or group of related counterparties. Policymakers could restrict the share of banks’ portfolios that are exposed to particularly high climate‑related risks (Miller and Dikau, 2022[98]) to limit their vulnerability to shocks. Similar exposure restrictions already exist for other risks.
Climate‑related prudential policies have mostly been implemented for capital‑related policies (Figure 4.11, Panel B). By 2023, 41 countries and the EU had developed climate‑related capital‑related policies (Figure 4.11, Panel C). This encompasses 20 AEs and 21 EMDEs, including 18 OECD member countries and 12 G20 jurisdictions. Consistent data collection on climate-related liquidity policies and lending limits through large exposure policies does not yet exist, likely because such policies are rare.
Within climate‑related capital-related prudential policies, climate‑related risk management and supervision policies are most common, often combined with related disclosure policies for financial institutions. Policymakers, mainly central banks, have particularly relied more on enhanced supervisory reviews (relating to Basel III Pillar 2) for climate‑related prudential policy. Looking at sub‑categories of climate‑related risk management and supervision policies:
Adoption of climate‑related prudential policies enhancing minimum capital and leverage requirements for banks (relating to Basel III Pillar 1) has been scarce. As of 2023, only one country had adopted a capital adequacy requirement with a green supporting factor. Hungary’s central bank introduced green preferential capital requirements in 2020, focusing on projects with energy savings and renewable energy components (Magyar Nemzeti Bank, 2022[99]). No country has currently adopted capital adequacy requirements with a brown penalising factor, with the aim to increase capital requirements for investments in high‑emitting activities (Krogstrup and Oman, 2019[49]).
Climate stress tests have been, to date, the most common climate‑related risk management and supervision policies adopted or piloted. By 2023, banking authorities (notably central banks) had conducted a climate risk assessment, such as climate stress tests, in around 80% of AEs and 20% of EMDEs (World Bank, 2024[71]). Climate stress tests can evaluate risks based on the balance sheets of individual institutions or on a macroeconomic level based on aggregate exposures (Baudino and Svoronos, 2021[100]). Ideally, they provide both supervisors and participating banks with information on how to adapt operations to cope with likely scenarios. Climate stress tests generally aim to understand and test the resilience of banks in several climate scenarios, with the NGFS scenarios being the most prominent framework (Dunz et al., 2021[101]). Several EMDEs have generated tailored scenarios to their particularly high vulnerability to physical climate risks, such as from droughts or typhoons (World Bank, 2024[71]). Most literature focuses on outlining methods and applying them, highlighting the importance of smooth and immediate transition induced by policies to avoid adverse impacts on financial stability (Jung, Engle and Berner, 2023[102]; Allen et al., 2020[103]; Battiston et al., 2017[104]; Baudino and Svoronos, 2021[100]; Dunz et al., 2021[101]).
Note: AEs is advanced economies, based on the high‑income country classification of the World Bank. EMDEs is emerging markets and developing economies, based on the World Bank classification for upper middle income, lower middle income, and low‑income countries.
Source: Authors based on (D’Orazio, 2023[45]) and updated data.
A limited number of countries have considered amending Internal Capital Adequacy Assessment. For example, Brazilian policymakers issued an amended Internal Capital Adequacy Assessment Procedure (ICAAP), in which their central bank required the explicit integration of climate (environmental) risks in banks’ assessments of capital requirements (Banco Central do Brasil, 2011[105]). In the UK, the Bank of England has also provided guidance for banks to consider climate‑related financial risks as part of their ICAAP (Bank of England, 2019[106]). The EU plans to enable supervisory authorities to adjust capital requirements including systemic risk buffers when financial institutions fail to adequately integrate climate risk into their operations starting in 2025 (Council of the European Union, 2021[107]).
Some countries have included climate considerations in other risk management and supervision policies. For example, Philippines’ Sustainable Finance Framework defines climate risk management as a responsibility of senior management and board of directors (Republic of Philippines, 2021[108]). A few countries, such as Morocco and Nepal, currently require banks to integrate environmental risk explicitly into credit risk ratings.
Available evidence on the effects of climate‑related prudential policies
Based on existing analyses across conceptual, theoretical, and empirical research, climate‑related prudential policies are found to have mixed effects on finance towards low‑GHG activities, while bringing trade‑offs with financial stability (Table 4.1). Conceptual, theoretical, and empirical analysis do not always come to the same conclusions in terms of direction and size of effects. Conceptual research currently expects potential positive effects across policy objectives for climate‑related large exposure policies, as well as for some leverage and risk management and supervision policies, although effects may be small.
As adoption of these policies has been scarce, existing studies focus on conceptualisations, back‑of‑the‑envelope calculations, theoretical and modelled effects. Furthermore, potential climate adjustments to existing policies have not all received the same attention in the literature. A substantial part of the literature on prudential policies concentrates on green supporting and brown penalising factors, but very few scientific and grey literature publications discuss the effects of climate‑related liquidity or large exposure measures. Moreover, empirical research on the effects of individual policies can be difficult to discern as policies are often coupled. For example, guidelines and non‑binding recommendations for climate risk integration into management are often coupled with disclosure measures.
Conceptual and theoretical research expects that a capital adequacy ratio with a green supporting factor would bring challenges to financial stability (Dankert et al., 2018[109]; Dafermos and Nikolaidi, 2021[110]; Dunz et al., 2021[101]; Oehmke and Opp, 2022[111]), while such research does not currently expect clear positive effects on limiting climate risks and increasing climate‑related finance volumes.
Some research points to a lack of evidence that low‑carbon investments are substantially less risky, which would be needed to lower climate‑related financial risk and enhance financial stability, justifying lower capital requirements (Dankert et al., 2018[109]; Coelho and Restoy, 2022[112]; Dafermos and Nikolaidi, 2022[113]). Other conceptual research suggests that climate‑adjusted capital requirements, where carefully calibrated, could be effective in reducing climate‑related financial risks and in supporting a smooth rather than abrupt climate transition (Oehmke, 2022[114]; Baranović et al., 2021[97]). Further theoretical research finds a decline in climate‑related financial risks, albeit small (Dafermos and Nikolaidi, 2021[110]).
At the same time, conceptual and theoretical research disagree on the effect of a green supporting factor towards increasing climate‑related finance volumes. Some conceptual research questions the effectiveness of a green supporting factor, arguing that companies may finance emissions‑intensive activities through sources other than loans (Oehmke, 2022[114]) and that the reduction in the cost of capital may be too small to influence investment decisions, similar to the empirically limited effect of the European Small and Medium Enterprise Supporting Factor (Dankert et al., 2018[109]; EBA, n.d.[115]; 2DII, 2018[116]). Other theoretical research finds that lowering capital requirements for low‑carbon investments through a green supporting factor may scale up green investments, but only in the short term (Dunz et al., 2021[101]) or if the green supporting factor remains small (Oehmke and Opp, 2022[111]). A large green supporting factor may crowd in investments, including GHG‑intensive ones.
Note: Colouring is based on the available literature, following the majority where dissenting; grey and academic literature was considered, literature had to provide structured argument and preferably some calculations to be included as conceptual, more literature was classified as theoretical evidence if it included models or simulations; literature relying on empirical data were classified as empirical.
Source: Authors, based on (D’Orazio, 2021[117]; Dafermos et al., 2022[118]; Dafermos and Nikolaidi, 2021[110]; Dunz et al., 2021[101]; Thomä and Gibhardt, 2019[119]; 2DII, 2018[116]; Benmir and Roman, 2020[120]; Oehmke and Opp, 2022[111]; Chamberlin and Evain, 2021[121]; Oehmke, 2022[114]) (Coelho and Restoy, 2023[122]; D’Orazio and Popoyan, 2019[50]; Grunewald, 2020[123]; Monnin, 2021[124]; Coelho and Restoy, 2022[112]; Battiston and Monasterolo, 2024[125]; Dikau and Volz, 2021[43]; Dikau and Volz, 2018[126]; Miguel, Pedraza and Ruiz-Ortega, 2024[127]; Lamperti et al., 2021[128]) (Baranović et al., 2021[97]; Miller and Dikau, 2022[98]; Schoenmaker and Van Tilburg, 2016[129]; Zhou et al., 2022[130]).
Conceptual and theoretical research on a capital adequacy ratio with a brown penalising factor also cautions about the financial stability effects of introducing this policy instrument. More studies expect positive effects on limiting climate risks. There are diverging expectations on the effect of this policy measure on increasing climate-related finance volumes.
Theoretical research estimates lower economic output and higher loan defaults due to higher costs of capital for brown firms (Dafermos and Nikolaidi, 2021[110]; Oehmke and Opp, 2022[111]). Some theoretical work suggests the brown penalising factor should be targeted and limited in scope to avoid destabilising larger parts of the economy (Chamberlin and Evain, 2021[121]). For instance, the European Insurance and Occupational Pensions Authority is exploring the effects of a penalising factor applied to fossil fuel-related assets only (EIOPA, 2023[131]).
Conceptual and theoretical research currently agree that the brown penalising factor would reduce climate-related financial risks. A brown penalising factor is expected to reduce climate-related financial risks by disincentivising exposure to potentially stranded GHG-intensive assets and increasing capital to better bear losses when climate-related risks do materialise (D’Orazio, 2021[117]; Berenguer, Cardona and Evain, 2020[132]; Oehmke and Opp, 2022[111]).
Some conceptual and theoretical research expects that a brown penalising factor would increase finance volumes to low-carbon activities, as it limits banks’ lending to brown assets and indirectly reorients lending to low-carbon activities (D’Orazio, 2021[117]; Dafermos and Nikolaidi, 2021[110]; Thomä and Gibhardt, 2019[119]). Other conceptual and theoretical research highlights the risk of limiting capital to GHG-intensive companies that are transitioning (Coelho and Restoy, 2022[112]) and loans being substituted for larger finance volumes of other types of financing (Thakor and Song, 2023[133]). Some research also highlights the importance of the specific design of this policy measure. A large brown penalising factor could crowd in low-carbon loans, while a brown penalising factor that is too small may even crowd out low-carbon loans (Oehmke and Opp, 2022[111]; Thakor and Song, 2023[133]). Additionally, the effectiveness of this policy measure in increasing climate-related finance volumes is expected to be dependent on fiscal climate policies, such as carbon taxes (Oehmke and Opp, 2022[111]; Dafermos and Nikolaidi, 2021[110]).
Based on limited research, other climate-related prudential instruments related to the level and quality of capital are also expected to have trade-offs between policy objectives.
Conceptual research expects sectoral capital requirements to have negative effects on financial stability as the specification at the sector level may be too broad to effectively target only the most risk-exposed firms (D’Orazio, 2021[117]; Coelho and Restoy, 2022[112]). Theoretical research suggests that sectoral capital requirements enhance financial stability only when implemented alongside a carbon tax. In the absence of such a tax, higher sectoral capital requirements for high‑emitting firms may simply drive these firms to raise capital outside the banking system rather than promoting a shift away from fossil-intensive practices (García-Villegas and Martorell, 2024[134]). Both conceptual and theoretical research expects a reduction of climate-related financial risks due to the reduced exposure to GHG-intensive activities (D’Orazio, 2021[117]; García-Villegas and Martorell, 2024[134]) and a possible increase in climate-related finance volumes (D’Orazio, 2021[117]).
Other conceptual research points to mixed expectations on the effect of a climate-related countercyclical risk buffer. Similar to risk buffers varying with the business cycle, slowing credit expansion and reducing the risk of financial bubbles forming, climate-related countercyclical risk buffers may mitigate excessive credit growth towards GHG-intensive activities (D’Orazio and Popoyan, 2019[50]; Coelho and Restoy, 2022[112]). However, varying risk buffers are especially difficult to calibrate and may lead to more disruptions than other instruments when suddenly introduced (Coelho and Restoy, 2022[112]). There is no research on potential effects on climate‑related capital flows of countercyclical risk buffers.
Further conceptual research identifies the potential of systemic risk buffers to reduce climate-related financial risks, in particular, as it can be adjusted individually to reflect geographic and sectoral differences in exposure (Monnin, 2021[124]; Grunewald, 2023[135]; Busies et al., 2024[136]). There is no similar research on the effects on financial stability or increases in climate-related investment.
Within climate-related risk management and supervision policies, most existing research focuses on climate-related stress tests, finding mostly positive effects in terms of improved climate risk management, but little effect on climate-related finance volumes. Conceptual research expects such policy instruments to have a positive effect on financial stability by better informing policymakers on financial stability (D’Orazio, 2021[117]; DeMenno, 2022[137]; Schoenmaker and Van Tilburg, 2016[129]). Moreover, the supervisory process around climate-related stress tests is expected to offer more opportunities to improve banks’ risk management and highlight priority areas to decrease climate risks (Coelho and Restoy, 2022[112]; Battiston and Monasterolo, 2024[125]). Empirical research suggests banks change their climate‑related risk management practices after participating in a climate stress test. For example, the ECB’s climate stress test required closer coordination between risk teams and management in participating banks, which may also facilitate incorporation of climate issues beyond the stress test (Calipel and Fidel, 2023[138]). Banks participating in the French supervisory agency’s climate pilot stress test subsequently increased lending for green purposes (Fuchs et al., 2023[139]).
Some research on climate risk management policies more generally, in combination with disclosure policies, highlights the importance of capacity building. For example, Chinese regulation incentivising green lending, through integrating climate risks in risk management and related disclosure, found that larger, state‑owned banks reduced their credit risk by incorporating environmental and social factors (Zhou et al., 2022[130]). However, smaller local banks experienced increased credit risk.
There is almost no research in relation to climate‑related sectoral leverage ratios, internal capital adequacy ratios, green asset ratios, and liquidity‑related instruments. Conceptually, a climate-related sectoral leverage ratio may be a transparent policy instrument to limit over-leveraging GHG-intensive sectors, potentially reducing climate-related financial risks (D’Orazio, 2021[117]). Little research has contributed to understanding the effects on financial stability or climate-related financial volumes. Further, the effects of internal capital adequacy assessment processes may be limited, but more research is needed. For example, the adoption of such a policy in Brazil required the explicit integration of climate (environmental) risks in banks’ assessments of capital requirements. This led large banks to reallocate capital away from exposed sectors, but small banks expanded their lending activities to these sectors, with no substantial impact on climate-related finance volumes overall (Miguel, Pedraza and Ruiz-Ortega, 2024[127]). Literature on liquidity-related instruments, which remains scarce and only conceptual, expects positive to neutral effects on financial stability, mixed effects on the reduction of climate-related risks, and increases in climate-related financial flows (D’Orazio, 2021[117]; Baranović et al., 2021[97]).
A slightly larger number of conceptual research, and some initial theoretical research, on climate-related considerations for large exposure policies currently suggests positive effects across policy objectives. Both lending limits and concentration charges restrict financial institutions from holding large exposures to specifically defined sectors and thus limit their exposure to risks in those sectors (D’Orazio, 2021[117]; Baranović et al., 2021[97]; Miller and Dikau, 2022[98]). One expected advantage of lending restrictions is that it more directly limits identified climate risks and does not necessarily weigh on banks’ capital requirements (Baranović et al., 2021[97]). However, it may be complex in operational terms, and sectors may need to be defined narrowly to strengthen resilience (Coelho and Restoy, 2023[122]). As activities exposed to climate-related risks differ within sectors, especially for GHG-intensive sectors with transitioning activities, climate performance needs to be defined at a granular level. This links back to the challenges discussed in Chapter 2 in relation to assessing progress towards climate alignment and applies to a range of policies discussed in this chapter.
4.2.3. Climate-related credit allocation policies
Credit allocation policies typically support certain economic development objectives by influencing the flow of credit to specific sectors that may otherwise not have sufficient access to credit (Dumlao, 2024[140]). These policies may overlap with climate-related prudential or monetary policies, depending on the stated purpose of the credit allocation policy. While this section covers their use for climate-related purposes, they have been and remain primarily driven by industrial policy goals.
Climate-related credit allocation policies directly promote climate-related credit measures and investments (D’Orazio, 2023[47]). Such policies are, for example, green lending quotas and concessional loans or direct credit guidance to priority sectors contributing to climate goals. Climate-related credit allocation quotas can, for instance, require bank lending to go to certain sectors or activities that contribute to climate change mitigation or resilience.
Climate-related credit allocation policies are more frequently adopted in Asia. As of 2023, over 30 such policies had been adopted in 16 countries (Figure 4.12, Panels A and C). This encompasses 6 AEs and 10 EMDEs, including 6 OECD member countries and 8 G20 jurisdictions. In a few countries, existing credit allocation policies with industrial policy goals were adjusted to integrate climate or sustainable development goals (e.g., in France and India). In other countries, climate-related credit allocation policies were established to focus on specific sectors, encourage lending or limiting credit towards specified sectors (e.g., in China and Fiji). Two-thirds of these policies are adopted by central banks (Figure 4.12, Panel B).
Experience with credit allocation policies for industrial policy goals suggests that the introduction of minimum quotas can lead to the accumulation of non-performing loans, negatively impacting financial stability (World Bank, 2024[71]; Dikau and Volz, 2021[43]). The analysis of the effects of credit allocation policies has mostly focused on their support for attaining (sustainable) development goals and is often combined with an analysis of other policies, such as refinancing (discussed in Subsection 4.2.4). There is limited theoretical or empirical evidence of the effect of specific climate-related credit allocation policies across policy objectives.
Note: AEs is advanced economies, based on the high-income country classification of the World Bank. EMDEs is emerging markets and developing economies, based on the World Bank classification for upper middle income, lower middle income, and low-income countries.
Source: Authors based on (D’Orazio, 2023[45]) and updated data.
4.2.4. Climate-related monetary policies
The most frequent aim of monetary policy is to maintain price stability. Price stability typically refers to an overall indicator of prices of produced goods and services, with monetary policy aiming to maintain low and steady inflation (Tamez, Weenink and Yoshinaga, 2024[77]). Monetary policy is usually the realm of central banks, sometimes of specific monetary authorities. It involves the use of tools such as interest rates and central bank asset holdings (Friedman, 2015[141]). The individual interpretations of stability differ, and several central banks also have additional aims in their policy objective (Dikau and Volz, 2021[43]). Other important macroeconomic objectives include exchange rate stability, economic growth, and job creation (Tamez, Weenink and Yoshinaga, 2024[77]).
In the context of pursuing price stability, monetary policy frameworks should, at a minimum account for the impact of climate change on price stability (Tamez, Weenink and Yoshinaga, 2024[77]). The integration of climate considerations into monetary policy formulation does not, however, automatically mandate central banks to utilise monetary policy instruments to contribute climate change adaptation or mitigation measures. As the use of monetary instruments reflects complex trade-offs and national contexts, the degree to which monetary policies can explicitly address climate considerations varies across jurisdictions and authorities (NGFS, 2021[52]).
Traditional monetary policies seem to benefit GHG emissions-intensive investments. Central banks’ asset purchase programmes, for example, tend to be tilted towards emissions-intensive sectors, at least partially because asset purchase programmes focus on steadily performing, predictable incumbents while their novelty and unconventional funding structure put green investments at a disadvantage (Matikainen, Campiglio and Zenghelis, 2017[142]; Battiston and Monasterolo, 2019[143]; Papoutsi, Piazzesi and Schneider, 2022[144]). Within the scope of conventional financial stability mandates, such findings indicate a potential to adjust purchasing programmes and other monetary policies towards encouraging an orderly climate transition (Monnin, 2018[145]).
Degree of adoption of climate-related monetary policies
Monetary policies explicitly considering climate considerations are an emerging policy area, and such policies are currently limited (Figure 4.7, Panel A). There are three common monetary policy areas, through which central banks can integrate climate-related considerations into monetary policy, namely credit operations, collateral policies, and asset purchases (NGFS, 2021[52]).
Credit operations refer to the central bank's lending activities to financial institutions, usually through short-term loans or liquidity provisions. They aim to ensure that banks have access to sufficient liquidity to meet their short-term obligations to help maintain stability in the financial system. To access these credit offers, banks must fulfil requirements, for example, in terms of the collateral they pledge. Climate-adjusted credit operations could steer central bank lending towards projects and actors that are less exposed to climate risks or aim to enhance climate change mitigation and resilience efforts. Climate-related considerations in this area can involve offering more favourable terms, such as lower interest rates or longer maturities, for loans that support environmentally sustainable projects or companies with strong environmental performance. Closely related are credit allocation policies (covered in Subsection 4.2.3), targeted refinancing operations and differentiated reserve requirements (explained below).
Collateral policies, also referred to as collateral frameworks, define the range of assets that commercial banks can pledge to secure central bank credit operations, as well as the risk control measures that apply to them (NGFS, 2021[52]). Climate-related considerations can be integrated by adjusting the eligibility or valuation of collateral based on the climate-related characteristics of underlying assets. For instance, central banks might offer better collateral terms for green bonds associated with low GHG- assets or lower the value of assets tied to fossil fuel activities.
Asset purchases and holdings involve central banks buying and selling a variety of financial assets from both public and private sectors, typically to influence the amount of money circulating in the economy, exerting greater influence on longer-term interest rate levels and spreads while improving market liquidity (NGFS, 2021[52]). Climate-related considerations here may involve prioritising the purchase of green bonds or other securities that fund sustainable projects, while reducing exposure to or divesting from assets associated with high GHG emissions.
No consistent data collection is available for climate-related monetary policies, as these policies remain limited. Hence, the discussion here on the possible design of such policies builds on anecdotal evidence of a limited number of countries adopting such policies, as well as conceptual and theoretical analysis.
Climate-related credit operation policies can integrate climate considerations through (1) adjusting pricing of their credit offers to reflect counterparties’ climate-related lending, (2) adjusting the pricing to reflect the composition of pledged collateral, or (3) adjusting counterparties’ eligibility (NGFS, 2021[52]). This could take the form of lowering the interest rate of central bank lending facilities depending on the bank’s portfolio decarbonisation (compared to a benchmark). It may entail making the interest rate depend on the climate characteristics of pledged collateral or only granting banks eligibility if they comply with thorough climate-related disclosure requirements. Closely related, targeted refinancing operations offer favourable conditions to access credit depending on green lending and thus can encourage financing green projects with longer time horizons. Reserve requirements can pursue monetary and prudential aims (IMF, 2022[146]). For climate purposes, they can be differentiated by the share of green lending and thus also potentially incentivise green financing.
Existing climate-related credit operations, although limited to date, tend to consist of additional lending facilities for banks financing transition-relevant projects. Often it is a form of conditioning low interest rates on lending to projects in specific areas, such as renewable energy or general mitigation and adaptation projects. For example, the Bank of Japan grants favourable conditions when banks commit to on-lend to projects such as renewable energy development and disclosure according to TCFD guidelines (BOJ, n.d.[147]). Some central banks have enhanced their climate-related credit facilities by coupling those with advantageous refinancing schemes. This enables banks to access favourable interest rates or maturities when their credit is due and they require refinancing. For instance, in the case of Bangladesh’s Green Transformation Fund, the refinancing was linked to machinery imports aimed at improving water efficiency, waste management and increasing renewable energy use in exporting sectors (Green Finance Platform, n.d.[148]). A few countries introduced differentiated reserve requirements to encourage lending towards climate‑critical activities. For example, Indonesia and the Philippines reduced reserve requirements to incentivise the provision of green lending for green projects, acknowledging no evidence yet on how to design such policies without interfering with traditional monetary policy objectives (World Bank, 2024[71]).
While not yet widely relied upon, another lever to integrate climate considerations into monetary policy can be the collateral framework. It can consider climate through four potential adjustments: (1) adjusting discount rates (haircuts), (2) adapting eligibility criteria with negative screening, (3) adopting eligibility criteria with positive screening, (4) aligning collateral pools of counterparties with sustainability objectives (NGFS, 2021[52]). So far, only a few central banks have adapted their collateral frameworks with climate-related considerations. For example, the European Central Bank included sustainability-linked bonds as an eligible asset for collateralisation, acknowledging that assets contributing to the transition of the economy often are more complex than previous eligibility requirements allowed (ECB, 2020[149]). Hungary’s central bank, for example, applies preferential haircuts to green bonds (NGFS, 2024[150]).
Another type of climate-related monetary policy that has been adopted by some countries is the explicit integration of climate considerations into central bank portfolio asset purchases, for example by aligning bond purchase programmes (such as BoE, ECB). Such programmes typically cover the corporate sector but can be extended to sovereign bonds, including in the context of central banks’ management of foreign exchange reserves (Fender et al., 2020[151]). Asset purchases on the open market are a normal tool of central banks to fulfil their price stability mandate. In times of very low interest rates, several central banks have also used outright purchases, also known as quantitative easing (QE) to pursue their mandate (ECB, 2022[152]). Climate-related adjustments to asset purchase programs could also be implemented for quantitative easing. Additionally, some authors have considered so-called “green QE”, purchase programs of only green assets (Abiry et al., 2022[153]).
Generally, there are two approaches to considering the climate in asset purchases, namely introducing asset purchase tilting or negative screening (NGFS, 2021[52]). Both positive tilting and negative screening are based on available definitions and classifications of what the portfolio is tilted towards or what should be excluded from the eligible asset universe. Different approaches can be followed to define this, ranging from defining “green” or clean assets solely as certified green bonds (Schoenmaker, 2021[154]) to using the NACE sector code for differentiation, applying a carbon footprint metric, or coming up with a combination of all (Dafermos et al., 2022[118]; Battiston and Monasterolo, 2019[143]; Battiston et al., 2017[104]).
Available evidence on the effects of climate-related monetary policies
In terms of analysing effects of climate-related monetary policies, very limited theoretical analysis and no empirical analysis exists to date. Moreover, the different types of potential climate-related monetary policy instruments have been researched in varying depth, with currently more analysis on green tilting in asset purchases and haircut adjustments in the collateral framework.
Based on the best-available research, which is at this stage mostly conceptual, the effects of climate-related monetary policies are mostly expected to result in strong trade-offs between climate considerations and core pricing-related objectives (Table 4.2). Across monetary policy measures, existing research on the effects of climate-related monetary policies expects increases in climate-related finance volumes, a mix of positive and negative effects in terms of reducing climate-related financial risks, but no or negative effects on the effectiveness of monetary policy.
Only very limited conceptual research exists on climate-related credit operation policies, pointing to trade-offs between monetary and climate policy objectives (NGFS, 2021[52]). The adjustments of credit operations have not yet been researched through theoretical or empirical analyses. Some experiences with climate-related credit operation policies point to the importance of robust definitions and classifications of ‘green activities’ to make such policies effective (NGFS, 2024[150]).
With respect to climate-related collateral framework policies, most existing research has focussed on adjustments of discount rates, expecting no effect on monetary policy effectiveness, but positive effects on climate-related risk reductions and climate-related finance volumes. Both conceptual and theoretical research currently suggest minimal or no effects of adjusting haircuts or aligning collateral pools (NGFS, 2021[52]; Giovanardi et al., 2023[155]; Schoenmaker, 2021[154]). Increasing haircuts for GHG-intensive investments is expected to be more suitable than reducing haircuts for low-carbon investments, as the latter may be seen as more market-intrusive (McConnell, Yanovski and Lessmann, 2021[156]). Both conceptual and theoretical research expect positive effects on the reduction of climate-related financial risks, as the integration of climate risks into haircuts and eligibility may enhance protection from longer term risks that were not included so far (Dafermos et al., 2022[118]; Boneva, Ferrucci and Mongelli, 2021[157]; Schoenmaker, 2021[154]; McConnell, Yanovski and Lessmann, 2021[156]; Oustry et al., 2020[158]). Expanding eligibility for green investments, that may have unconventional financing structures, may increase climate-related finance volumes, and improve the financing landscape for low-carbon projects (Giovanardi et al., 2023[155]; Vestergaard, 2022[159]). Overall, adjusting collateral policies is expected to affect climate-related finance volumes positively (Schoenmaker, 2021[154]; McConnell, Yanovski and Lessmann, 2021[156]).
Note: Colouring is based on the available literature, following the majority where dissenting; grey and academic literature was considered. Literature had to provide structured argument and preferably some calculations to be included as conceptual. Literature was classified as theoretical evidence if it included models or simulations. Literature relying on empirical data were classified as empirical.
Source: Authors, based on (NGFS, 2021[52]; Schoenmaker, 2021[154]; McConnell, Yanovski and Lessmann, 2021[156]; Dafermos et al., 2022[118]; Gros and Shamsfakhr, 2023[160]; Benmir and Roman, 2020[120]; Giovanardi et al., 2023[155]; Vestergaard, 2022[159]; Oustry et al., 2020[158]; Bressan, Monasterolo and Battiston, 2021[161]) (Abiry et al., 2022[153]).
Within climate-related adjustments of asset purchase program policies, existing research tends to point to limited effects on monetary policy effectiveness, while potentially reducing climate-related risks and increasing climate-related finance. Such research remains conceptual and theoretical.
Existing research highlights that the expected effects of tilting or screening asset purchase programs depend on the exact definition of ‘green’ investments. Some research questions whether the green bond market is sufficiently deep for central banks to heavily invest in it, and whether monetary policy may be less effective if it has to rely on a very restricted subset of the market (Schoenmaker, 2021[154]). This could be especially constraining when tilting and screening methods are applied not only to corporate asset purchase programs but also to foreign reserve portfolios, which usually consist of short-term sovereign bonds and have to fulfil strict currency and liquidity requirements (see Chapter 3 Section 3.2 for evidence on current volumes of climate-related debt securities compared to the universe). To address the limited depth of the green bond market for corporate asset purchase programs, some researchers suggest buying bonds issued by national and regional development banks which then invest in green bonds and other climate solutions directly (Boneva, Ferrucci and Mongelli, 2021[157]). However, theoretical research has also shown that asset purchase tilting can be designed to not interfere with monetary policy effectiveness (Schoenmaker, 2021[154]). Furthermore, theoretical research suggests mixed interactions with fiscal policies such as carbon pricing, describing the potential of dedicated green asset purchase programs (‘Green QE’) to hedge the effects of a carbon tax or sharpen its effect (Papoutsi, Piazzesi and Schneider, 2022[144]; Benmir and Roman, 2020[120]).
Conceptual evidence suggests that both tilting and screening approaches would support the reduction of climate-related financial risks (NGFS, 2021[52]). Conceptual and theoretical research on potential increases in climate-related finance volumes due to climate-related tilting or screening of asset purchase programs emphasizes two effects. Financed emissions of central bank portfolios could be reduced dramatically (Schoenmaker, 2021[154]; Papoutsi, Piazzesi and Schneider, 2022[144]; Boneva, Ferrucci and Mongelli, 2021[157]). Additionally, research has addressed green quantitative easing as a mechanism to signal liquidity and lower the risk of green assets (Campiglio et al., 2018[162]; Ameli et al., 2019[87]). However, it is assumed that it may only marginally improve the financing situation for green projects or reduce emissions (Gros and Shamsfakhr, 2023[160]; Ferrari and Landi, 2023[163]; Abiry et al., 2022[153]).
Furthermore, any effect of asset purchase programmes could not be a reliable continuous support for green investments as monetary policy considerations would take precedence over supporting a smoother transition. If core price stability objectives require selling assets, this would supersede climate-related allocations (ECB, 2021[164]).
On other monetary policies, theoretical analyses expect, for example, that a formal green interest rate allows the possibility of achieving both price stability and sustainability objectives (Roy, 2024[165]; Muller, 2021[166]). Further conceptual research argues that green-targeted long-term refinancing operations contribute more effectively to price stability objectives than asset purchase programs and would thus be well suited to counter the inflationary pressures expected from climate change disruptions (van ‘t Klooster and van Tilburg, 2020[167]).
Generally, as already pointed to in previous sections on climate-related transparency and information, and prudential policies, dissecting the effect of individual policies is challenging, as they are often part of policy packages. For example, stocks of climate-related financial policy in G20 countries are associated with lower emissions (D’Orazio and Dirks, 2021[72]). The adoption of climate-related financial policies in those countries went hand in hand with the development of the financial sector and economic development, which generally see emissions decrease.
Investors and financial institutions can take a variety of actions to influence the climate alignment of finance. Depending on their mandates, expectations, and perceived leverage in their relationships with investees and borrowers, financial sector actors can focus on different actions to reach their climate-related targets and implement climate transition plans. Such actions can notably relate to engagement, portfolio composition, strategy, and governance (as introduced in Chapter 2, Subsection 2.3.2). They can also take the form of voluntary disclosures (in the absence of or complementing disclosure policies discussed in Subsection 4.2.1, thereby providing data points to inform assessments and estimates as discussed in Chapters 2 and 3), as well as litigation, research including in cooperation with think tanks and NGOs among others (OECD, 2023[168]).
Private actions by financial sector actors can be direct responses to climate policy ambition and implementation or be established in the absence of policies based on voluntary frameworks and soft guidance. Such frameworks and guidance can come from coalitions, industry associations, and government-backed processes. For example, the OECD Guidelines for Multinational Enterprises provide government-backed recommendations to multinational enterprises (both non-financial and financial corporates) towards responsible business conduct, including in relation to risks and impacts of their activities on climate change (OECD, 2023[169]). Climate-related financial sector coalitions, such as the Institutional Investors Group on Climate Change (IIGCC), the Net Zero Asset Managers initiative (NZAM), and the Net-Zero Asset Owner Alliance (NZAOA), provide more specific guidance to asset owners and asset managers. Examples of coalitions for banks and insurers include Net-Zero Banking Alliance (NZBA) and Forum for Insurance Transition to NetZero. Members of these alliances combine significant shares of global assets, as shown in Chapter 3 (Figure 3.12).
The growing adoption of climate-related targets and plans, as part of broader strategies of financial institutions, is a key step towards aligning their portfolios with climate goals. Climate-related target setting and transition planning, based on climate-alignment assessments, set the strategic direction. Emissions reduction targets have received strong attention both among practitioners and researchers, resulting in wider adoption and methodological refinement of underlying measurements (CPI, 2024[170]; OECD, 2024[57]). Among 941 large global financial institutions (including 629 that are members of Net-Zero Alliances supported by the Glasgow Financial Alliance for Net Zero (GFANZ)), 42% had adopted a partial GHG emissions reduction target as of 2023, up from 4% in 2020 (
Figure 4.13). No financial institution in this sample had established a comprehensive emissions target, i.e., externally validated and climate‑aligned targets, covering 90% or more of the relevant portfolio for both the near and long term. As targets set by financial institutions contribute to setting the foundation for actions to be directed towards net‑zero transition and climate resilience plans, they are not sufficient in themselves to reduce GHG emissions and increase climate resilience, especially as they are not legally binding (McDonnell and Gupta, 2023[171]).
Note: This data covers 941 large financial institutions, including 629 members of Net‑Zero Alliances supported by the Glasgow Financial Alliance for Net Zero (GFANZ). The indicator describes whether institutions have set clear and comprehensive targets for climate action (primarily reducing their emissions), whether those are quantitative targets or general, and whether they are disclosed transparently. No target is no evidence of a climate target. Planned target means a commitment to adopt a target. Initial target is a target has been adopted but it is partial, or information is incomplete. Partial target is transparently assessed aligned long‑term and near‑term targets, covering a portion of the relevant portfolio. Comprehensive target is an externally validated aligned long‑term and near‑term targets, covering 90% or more of the relevant portfolio.
Source: Authors, based on (CPI, 2024[170]).
Climate‑related targets and commitments are typically actively pursued through a combination of engagement activities and portfolio construction practices, including divestment from carbon‑intensive assets and scaled‑up investments in climate solutions (NGFS, 2024[172]; OECD, 2023[54]; McDonnell and Gupta, 2023[171]; NewClimate Institute, 2022[173]; PRI, 2021[174]), which are the focus of this section. Climate‑oriented portfolio construction practices to increase climate‑aligned activities and reduce exposure to misaligned activities relate to integrating climate alignment into existing and new investments such as (re)weighting, positive screening, and explicit funding of climate solutions. Divestment and exclusion from climate‑misaligned activities represent the most drastic form of portfolio (re)construction and are thus discussed separately. For specific targets and asset classes other activities may be possible, such as direct management decisions for private equity holdings, e.g., in real estate and SMEs.
4.3.1. Climate‑related engagement
Positive climate‑related engagement by investors and financial institutions with clients and stakeholders aims to encourage climate alignment of the financial assets they hold. Investor stewardship, or active ownership, is “the use of investor rights and influence to protect and enhance overall long‑term value for clients and beneficiaries, including the common economic, social, and environmental assets on which their interests depend” (PRI, 2023[175]). Generally, there are three types of possible engagements: engagement with investees in the real economy, market engagement with other financial market participants, and policy engagement with policymakers (NGFS, 2024[172]). For policy advocacy guiding documents in the investor community highlight the importance of aligning policy advocacy by underlying companies with climate goals advocated for by investors themselves (UNEP FI, 2023[176]).
Some financial sector actors rely on engagement with investees in the real economy to decarbonise their portfolios. Investors and financial institutions can in particular engage with companies to encourage or request them to consider climate change in their business decision‑making processes, through direct dialogue with directors and key executives, shareholder meetings and courts (OECD, 2022[177]). In 2023, 12% of 941 large financial institutions disclosed on engagements with clients and investees positively influencing climate‑related business practices and transparency (Figure 4.14). This share has remained stable over the past few years, although financial institutions planning to undertake climate‑related engagements have doubled, representing about half of the institutions in the sample in 2023. Still, 32% disclosed no climate‑related engagement activities in 2023.
Engagement can be done independently or as part of a group (such as through coalitions discussed above). Since requests are more likely to be accepted, the larger the holding of the requesting shareholders, alliances and coalitions are particularly attractive for actors focusing on stewardship. The significant increase in institutional investors’ assets under management over the past fifteen years and the fact that a large portion of their assets tracks or replicates stock market indices have led to institutional ownership concentration, particularly for large firms (Medina, de la Cruz and Tang, 2022[178]). As most indices are weighted by market capitalisation, they tend to favour large companies over small ones. Therefore, the holdings of investors that follow these indices are concentrated in fewer and larger companies (Medina, de la Cruz and Tang, 2022[178]). Such increasing concentration of ownership and decision‑making in capital markets may have important implications for stewardship actions by these largest institutional investors.
Climate‑related engagement actions can follow available voluntary guidance, but policymakers could do more to guide good practices of market participants. Existing guidance by coalitions and industry associations for investors highlights the importance of communicating clear expectations and laying out an escalation path if expectations are not met (e.g., where implementation falls short of firms’ transition plans and targets over time), including but not limited to divestments (IIGCC, 2024[179]). Where consistent with domestic mandates, policymakers can consider promoting guidance for investors and financial institutions who wish to engage in climate‑aligned investing on the design and implementation of effective engagement strategies in relation to climate‑related factors (OECD, 2022[180]).
Note: This data covers 941 large financial institutions, including 629 members of Net-Zero Alliances supported by the Glasgow Financial Alliance for Net Zero (GFANZ). The indicator measures whether the organisation commits to engaging shareholders or clients on climate action and whether there is evidence of the organisation taking the necessary steps by mandating climate reporting requirements or through active ownership on portfolio companies. Positive engagement activities are measured by evidence of shareholder authority and voting rights, proven impact or engagement on business practices and models, with no evidence of negative actions that oppose the transition. No engagement is no evidence of climate-related engagement actions. Planned engagement is a commitment to engage on climate. Initial engagement is first steps at engaging on climate (including with suppliers), but possible presence of negative engagement, too. Positive engagement is indications of (general) positive engagement (including on business practices and transparency), and no negative action.
Source: Authors, based on (CPI, 2024[170]).
While climate-related engagement by financial institutions already seems to influence clients’ climate transparency and target setting, their effectiveness in terms of reducing emissions is assessed as limited. Initial econometric evidence finds that investor demand for climate-related information results in greater corporate disclosure and contributes to firms’ decisions to lower future carbon emissions (Kahn, Matsusaka and Shu, 2024[181]; Cohen, Kadach and Ormazabal, 2023[182]). Anecdotal evidence also indicates how investor engagement contributed to the uptake of climate targets among large listed companies (CA100+, 2024[183]). However, evidence of the effectiveness of engagement actions in reducing emissions is mixed. While individual cases suggest room for effective pressure and tangible effects (such as the decommissioning of coal plants), studies on a broader level find varying rates of success of shareholder climate-related demands being implemented (Kölbel et al., 2020[184]). One possible explanation relates to the cost of implementing the requested change, which is often higher for environmental requests than social or governance requests, with the latter having a higher observed success rate (Kölbel et al., 2020[184]). For costly environmental requests, the timing of shareholder resolutions may be particularly important (van der Kroft et al., 2024[185]). Moreover, the effectiveness of climate-related shareholder resolutions also varies across jurisdictions (2DII, 2024[186]).
4.3.2. Climate-oriented portfolio construction
Climate considerations can be embedded in all types of portfolio construction practices. Climate‑oriented portfolio construction by investors and financial institutions changes the composition towards climate‑aligned assets and away from climate‑misaligned assets. Such practices can range from simple exclusion of companies that do not align with climate goals to full integration of climate‑alignment considerations into the investment process, governance, and decision‑making (OECD, 2020[187]).
Climate‑oriented portfolio construction practices notably include:
Divestment and exclusion, excluding assets that do not align with certain climate objectives.
Norms‑based/inclusive screening practices, which include assets that comply with climate policy goals, international climate standards or "best‑in‑class" firms based on climate performance scores.
Climate‑oriented rebalancing practices, which adjust portfolio exposure towards assets with higher climate performance scores, either through climate‑tilted indices or active management.
Thematic investing, which focuses on specific climate themes (e.g., mitigation, adaptation) which may prioritise specific climate objectives over maximising financial returns.
Climate impact investing, which seeks financial returns by targeting non‑financial climate outcomes through active engagement, shareholder activism, or divestment from climate‑misaligned activities.
Full climate‑alignment integration, which systematically includes climate risks and opportunities across all aspects of investment processes, without relying solely on benchmarking or exclusions.
Generally, climate‑related disclosure (Subsection 4.2.1) and climate‑alignment assessments based on credible metrics and approaches (Chapter 2) are important information inputs for such practices (OECD, 2020[187]). These practices can be adopted to reduce exposure to risks from potential policy responses to climate change and/or contribute to the alignment of finance with climate goals. The remainder of this subsection focuses on divestment and exclusion practices, and climate‑oriented tilting practices.
Divestment and exclusion practices
Climate‑related divestment policies and exclusion policies are key actions for financial institutions to reduce exposure to climate‑misaligned activities and influence market behaviour, typically following failed engagement efforts. Climate‑related divestment policies are used by financial market participants to sell or exit from existing carbon‑intensive holdings (PRI, 2022[188]). Divesting from assets within, but not across, a sector can send important market signals and enhance the competitive position of best‑in‑class actors in the sector. Exclusion policies are guidance and processes by financial institutions to avoid future capital allocation in emissions‑intensive activities in their portfolios.
Divestment and exclusion actions can be motivated by the implementation of targets following failed attempts to engage and escalate stewardship. OECD principles and standards on responsible business conduct highlight that, where it is possible, continued relationship and engagement towards improvement over time is preferable. The need for disengagement should only take place after failed engagement attempts, where corrective actions or transitions are not feasible, or because of the severity of the adverse climate impact (OECD, 2023[169]). Both types of actions can be done for equity and fixed-income assets, but differences in asset characteristics can have important implications for the effectiveness of these actions (NewClimate Institute, 2022[173]).
In terms of implementation, climate-related divestment commitments relating to divestment from coal companies and assets doubled between 2020 and 2023 (IEEFA, 2023[189]; IEEFA, 2023[190]). Estimates of European pension funds divestment practices find that the majority is not divesting from fossil fuels. As of 2023, 60 (18%) out of 342 large European pension funds adopted fossil fuel-related targets (CPI, 2024[191]). An earlier estimate for 2019 finds that 129 (13%) of the 1 000 largest European pension funds had publicly committed to divest or already divested from fossil fuel holdings (Egli, Schärer and Steffen, 2022[192]). Looking at broader ESG practices, some evidence indicates that exclusion policies tend to be relatively more frequently adopted than divestment policies (NewClimate Institute, 2022[173]).
Despite an increase in the adoption of fossil fuel divestment and exclusion practices and actions, the global share of financial institutions with such policies remains limited. As of 2022, half of the largest 50 asset managers and less than a fifth of the largest 50 asset owners had exclusion policies targeted at emissions-intensive investee companies and clients (NewClimate Institute, 2022[173]). Only about a sixth of them had publicly committed to divest or already divested from fossil fuel holdings (NewClimate Institute, 2022[173]). An analysis in 2024 of 26 large banks found that none were committed to phasing out all financing for coal activities in line with 1.5°C warming, and only 2 were committed to ending project financing of new oil and gas fields (TPI, 2024[193]). Considering a larger pool of over 941 large financial institutions (including Alliance members), 46% of them had at least an initial divestment target in 2023, up from 15% in 2020 (Figure 4.15). Only 3% have a comprehensive fossil fuel divestment target, meaning financial institutions have comprehensive fossil fuel exclusion or phase-out policies or no remaining fossil fuel assets.
Note: This data covers 941 large financial institutions, including 629 members of Net-Zero Alliances supported by the Glasgow Financial Alliance for Net Zero (GFANZ). The indicator describes whether the institution has announced a clear target to divest from fossil fuels, with a clearly defined scope, and matched by fossil fuel exclusion policies. No phase out or exclusion goal(s) is no evidence of a fossil fuel related target. Phase out or exclusion target planning means there is a commitment to adopt fossil fuel related goals. Initial phase out or exclusion goals means the financial institution has a divestment goal, or other undefined fossil fuel policies. Partial phase out or exclusion goals means the financial institution has partial or undefined fossil fuel exclusion or phase-out policies. Comprehensive phase out or exclusion goals means the financial institution has comprehensive fossil fuel exclusion or phase-out policies or has no fossil fuel assets.
Source: Authors, based on (CPI, 2024[170]).
The effects of divestment and exclusion practices on reducing GHG emissions are uncertain. While some evidence finds that divestment policies by banks accelerated coal decommissioning (Green and Vallee, 2024[194]; Haushalter, Henry and Iliev, 2023[195]), several trade-offs and potential unintended consequences need to be considered, notably:
Divestment and exclusion policies may increase the climate performance of financial institutions and investors adopting such policies, but they lose the ability to engage with and influence investees. Excluding investments from hard-to-abate firms removes the possibility to influence management decisions through engagement (NewClimate Institute, 2022[173]). Some research suggests that for any individual financial institution, engagement offers the highest potential to achieve real-economy impact (Caldecott et al., 2024[196]) or to generate socially desirable outcomes (Broccardo, Hart and Zingales, 2020[197]) compared with divestment strategies aiming at affecting cost of capital or liquidity.
Divestment may also result in carbon leakage rather than actual GHG emission reductions in the real economy. There is an important difference between reducing emissions in an investment portfolio and reducing emissions in the real economy. Divesting from assets associated with adverse climate impacts removes the adverse climate impacts of investors’ portfolios without necessarily reducing the overall impact on society and the environment, in case of purchase of the asset by another investor, or may in fact slow needed transition in high-emitting assets and sectors (OECD, 2023[169]). The credible threat of divestment, however, may incentivise more rapid actions on firm side to eventually transition to net-zero emissions.
Divestment and exclusion policies can affect the cost of capital of financial assets being targeted, which in turn may reduce the capacity of underlying entities to transition. A wider literature assesses “sin stocks”, finding that they tend to have a lower stock price and higher cost of capital (Hong and Kacperczyk, 2009[198]). Emerging evidence also shows that divestment pledges can affect the cost of capital in bond markets and liquidity, even slowing the expansion of certain sectors (Caldecott et al., 2024[196]; Cojoianu et al., 2020[199]). Such conceptual research hypothesised that in this context, divestment and exclusion policies may be most effective when capital for the affected firms is not easily substitutable. On the other hand, the lack of capital caused by divestment may prevent firms from investing in costly mitigation and adaptation projects and thus counteract the overarching alignment goal (Kacperczyk and Peydró, 2022[200]; Kahn, Matsusaka and Shu, 2024[181]).
Climate-oriented tilting practices
Investors following a positive portfolio tilt strategy on climate goals overweigh assets with a better climate performance in their equity portfolios, typically while maintaining sector weights compared to a target index or benchmark. They do so by reducing their ownership of climate-misaligned assets and substituting towards climate-aligned assets (Atta-Darkua et al., 2023[201]). Climate-oriented rebalancing practices remain a small but not insignificant share of financial market practices. In 2021, ESG-related tilts totalled 6% of the investment industry’s assets (Pastor, Stambaugh and Taylor, 2023[202]).
Across financial sector actions and investment practices, it remains difficult to assess impacts on GHG emissions as available data generally does not allow to distinguish whether financed emissions decrease due to engagement with companies who in turn reduce emissions or due to reweighting towards already lower-emitting companies and away from emissions-intensive companies. Moreover, portfolio rebalancing practices are dependent on climate ratings, which are heterogenous across providers (as discussed in Chapter 2), meaning it is unclear whether such practices are currently contributing to real-economy decarbonisation (OECD, 2022[203]).
Another example of climate-oriented portfolio construction practices is the explicit increase in investments in “climate solutions” (IIGCC, 2024[179]). Impact investors have followed this approach, but studies find mixed results on their ability to push the capital and financing frontier faced by some green projects (Chen, 2022[204]; Cole et al., 2023[205]; Hartzmark and Shue, 2022[206]; Kölbel et al., 2020[184]). For conventional investors, banks, and asset managers, the mainstreaming of such climate-orientated portfolio construction remains, in most cases, limited to investment opportunities that fulfil their respective risk-return criteria. An estimate for large European pension funds finds that only 35 (10%) out of 342 funds adopted climate investment targets by 2023 (CPI, 2024[191]). An analysis in 2024 of 26 large banks showed that 15 had set specific quantitative targets to increase their total financing of climate solutions (TPI, 2024[193]).
Overall, the theoretical underpinning of portfolio construction practices (both negative/divestment and positive tilting) assumes that financing constraints will result in a higher cost of capital for emissions‑intensive firms and thus, in combination with engagement strategies and escalation processes, increase pressure to lower emissions. It therefore relies heavily on the responsivity of firms to the cost of capital to induce climate action. Existing empirical evidence cannot consistently confirm such expectations.
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← 1. Credit institutions mainly refer to banks and certain other instutitions fulfilling banking services (e.g., (EBA, n.d.[115])).