Three Ways Capital Markets Can Accelerate Climate Finance in Asia and the Pacific

Asia and the Pacific is central to global climate change efforts, but robust capital markets are needed to mobilize private climate finance. Sustainable finance frameworks, transition finance, and carbon markets can build deeper markets that empower climate action.

Asia and the Pacific relies on fossil fuels for nearly 85% of its energy, produces about half the world’s greenhouse gas (GHG) emissions, and its residents are six times more likely to be affected by disaster events than those elsewhere. Clearly, the fight against climate change rests significantly on success in this region.

Building a greener future, with all its attendant costs, requires strong private sector participation and robust capital markets. Indeed, by creating new investment opportunities and tailored financial instruments, capital markets have the potential to act as a major catalyst in mobilizing climate finance, especially from private sources.

Many challenges stand in the way, however, including regulatory fragmentation, lack of standards, and inadequate pricing mechanisms for carbon trading. A vulnerability to climate risks and dependency on carbon-based fuels only underscores the urgent need to expand climate finance initiatives.

Yet, across emerging Asia, businesses and businesspeople still turn mainly to banks for corporate finance. This is because capital markets remain shallow and only offer a limited alternative source of local currency and longer-term finance.

In addition, the capital markets that do exist across emerging Asia are predominantly focused on larger corporates, resulting in a lack of depth. Only some economies, such as Japan, the Republic of Korea, or Singapore, have advanced markets with well-established regulatory frameworks.

To enable capital markets to successfully support climate finance, therefore, the necessary core conditions need to be satisfied, involving strong regulatory frameworks, reliable benchmark interest rates and yield curves, and robust financial market infrastructure.

To then empower capital markets to effectively mobilize climate finance from the private sector and support the region’s transition to a sustainable development path, three critical actions stand out as major priorities.

Build an Enabling, Sustainable Finance Ecosystem. This includes frameworks for green, blue, and nature-based finance. Such frameworks are crucial for setting policies, taxonomies, and standards that can be harmonized across jurisdictions. The interoperability of these frameworks is of particular importance, as inconsistencies can lead to higher compliance costs, market inefficiencies, and reduced investor confidence—all of which will hinder private sector interest.

Progress is being made in developing sustainability frameworks, such as the International Sustainability Standards Board’s global sustainability disclosure standards. Also promising is the development of regional taxonomies such as the taxonomy for sustainable finance adopted by ASEAN, now in its 3rd version.  

Nationally, many countries are developing their own taxonomies to support greening of economic activity, such as the recent launches of the Philippines’ Sustainable Taxonomy Guidelines, Mongolia’s SDG Finance Taxonomy, the Republic of Korea’s K-Taxonomy, or Indonesia’s Taxonomy for Sustainable Finance. These examples demonstrate the growing international and regional interest in creating cohesive frameworks.

Stronger capital markets are crucial to deepening and broadening climate finance and achieving global climate goals.

While these are important first steps, more needs to be done to ensure interoperability of these frameworks to enable an ecosystem able to catalyze capital markets for climate finance.

Embrace Transition Finance. Investments that directly support the decarbonization of industries, also referred to as transition finance, are crucial to Asia, where many industries require substantial financial support to accelerate this process. Unfortunately, there’s a significant financing gap in this area—estimated at about $1.1 trillion in Asia and the Pacific compared to $4 trillion globally. Governments alone cannot fill this void, necessitating increased private sector involvement.

Initiatives like the ASEAN Transition Finance Guidance with a recently released second version or the People’s Republic of China’s “transition finance” taxonomy provide clear standards to help direct capital towards companies committed to credible transition efforts. Additionally, mechanisms like the Asian Development Bank’s Energy Transition Mechanism, a scalable, market-based approach to finance working toward early retirement of coal assets within member countries, are supporting the region’s shift towards sustainable energy sources. While such initiatives do support green and just transition, more efforts are needed from the public and private sectors.

Support the Development of Carbon Markets. Carbon markets, designed to trade carbon emission credits, offer economic incentives to reduce GHG emissions. While Asia and the Pacific has advanced the development of carbon markets, this varies widely across countries. For example, national emissions trading systems in the People’s Republic of China and the Republic of Korea are relatively advanced, while other countries such as in Viet Nam and Indonesia are in the nascent stages of implementing carbon pricing mechanisms. These gaps create valuable opportunities for further regional cooperation and knowledge exchange.

One important area of cooperation could be in effectively pricing GHGs to reflect their true environmental costs, addressing the adverse impact of their emissions. Accurate pricing is critical for ensuring the viability and attractiveness of carbon markets. Furthermore, enabling the trade of carbon credits between countries and regions can have a significant impact, given the global and regional public goods of addressing climate change. Various initiatives highlight current regional efforts to foster collaboration and innovation in emissions reduction. Japan’s Joint Crediting Mechanism, for example, has created opportunities for multiple cross-country collaborations on emission reduction projects, and Singapore’s ambition to become Asia’s carbon trading hub is worth noting.

Stronger capital markets are crucial to deepening and broadening climate finance and achieving global climate goals. By establishing robust, sustainable finance frameworks, embracing transition finance, and supporting development of carbon markets, Asia and the Pacific can crowd-in urgently needed, private climate finance. The potential for capital markets to drive meaningful change in climate finance is increasingly promising.

Source: blogs.adb.org