12 Apr 2023 3 min read

Climate change: a financial deployment crisis?

By John Daly

In the first in a series of blogs examining the complexities of carbon offsetting, we lay out the scale of the challenge ahead, and the role of regulation in driving much-needed capital flows to carbon reduction.


According to the Climate Policy Initiative (CPI), annual climate finance will need to increase from an estimated $650 billion a year in 2020 to $5 trillion a year by 2030.1 By 2050, spending will need to rise to $6 trillion a year to constrain the increase in global temperatures to 1.5°C by the end of the century.  


The CPI found that climate finance increased by 74% between 2010 and 2020 to reach $632bn. Over this period, approximately 75% of all climate investments were raised and deployed domestically. And over half (58%) of the climate projects funded domestically were from private sources.2

Given the large gap in financing represented by the dotted line in the chart above, how can capital be sourced and mobilised at the scale and speed that is needed?

Mandatory climate risk disclosures

Standardised emissions disclosure is critical, in our view, to allow investors to evaluate the climate transition risk embedded within companies. With universal coverage, market forces can identify the most efficient solutions, deploying capital to firms that find the best solutions for carbon reduction.

Mandatory climate-related risk disclosures are still at an early stage worldwide. But this is expected to improve in the near term, driven both by regulators and investor demand for reliable and comparable reporting. In the UK, mandatory Taskforce for Climate-Related Disclosures (TCFD) reporting for the largest UK-registered companies came into effect from April 2022.

In 2022, the U.S. Securities and Exchange Commission (SEC) proposed a bill mandating that companies disclose climate-related risks. If passed, the proposed rules will require companies to disclose Scope 1 and 2 greenhouse gas (GHG) emissions and Scope 3 emissions if material or if the registrant has set a GHG emissions reduction target that includes Scope 3 emissions.

And the International Sustainability Standards Board (ISSB) is set to announce its sustainability-related financial disclosures3 by the end of Q2 2023, which come into effect in January 2024. While initially voluntary, these are expected to become mandatory in time. In our 2021 Active Ownership report we expressed our strong support for these disclosure requirements and detailed the actions we have already taken to encourage their adoption.

Standardised measurement and disclosure of carbon emissions is a core requirement for compliance-based carbon pricing (either via carbon markets or a tax).

The implementation of policy or regulation that places a meaningful price on carbon emissions is considered by many in the asset management industry to be an important factor in delivering net zero.

Carbon pricing – regulated carbon markets

Carbon pricing via regulated carbon markets or direct taxation sends clear, long-term price signals, reassigning the societal cost of emissions back to emitters.

Taxation needs to be proportional and appropriately designed to change investor behaviour without having unintended consequences on the overall health of industry. And carbon leakage – the displacement of emissions to other regions with lower emission standards to circumvent taxation, aka ‘environmental arbitrage’ – needs to be considered.

Voluntary carbon markets

Some emissions abatement measures are limited by technology and real-world practicalities. Where companies cannot practically reduce these emissions, for example in hard-to-abate sectors such as construction and aviation, carbon offsets may be appropriate. 

The chart below forecasts that five to 10 gigatonnes of CO2 must be removed annually from the atmosphere by 2050 to align with a 1.5°C scenario.


Time to get ahead of the curve

The amount of capital needed to address climate change is huge and the timeframe is compressed. We believe creating the right conditions to mobilise private capital to flow to emissions reduction is paramount.

Governments are increasingly setting these conditions through legislation, mandatory emissions disclosure and taxation. This presents both opportunities and threats for investors.

Companies that proactively address climate transition risk are likely to be well placed to deal with this in our view. Those that are slow to decarbonise face greater investor scrutiny and risk higher taxes and a higher cost of capital, which we believe could be reflected in their competitive position and share prices.

In my next blog I’ll examine the pros and cons of carbon offsets.


1. Source: https://www.climatepolicyinitiative.org/wp-content/uploads/2021/10/Full-report-Global-Landscape-of-Climate-Finance-2021.pdf

2. Ibid.

3. IFRS Accounting Standards set out how a company prepares its financial statements. IFRS Sustainability Disclosure Standards set out how a company discloses information about sustainability-related factors.

John Daly

Senior Solutions Strategy Manager

John is a Senior Solutions Strategy Manager within the Solutions Group and has over 20 years of industry experience working in asset-management companies. He focuses on long-term global investment-grade credit and active liability investment strategies. His role encompasses designing developing and servicing investment strategies for DB pension schemes and other financial clients. John has been with LGIM since 2009 and has previously held institutional distribution roles at PIMCO and Fidelity. John holds a BSc in Business Economics from Cardiff University and is a CFA charterholder.

John Daly