In 1997 at COP3 in Tokyo, the world agreed to use carbon pricing as the principal financial mechanism to avert climate change. According to the Economist, by the end of 2021 more than 21% of the world’s emissions were covered by some form of carbon pricing, up from 15% in 2020, with some 64 countries either having a carbon tax and/or an emissions trading system. A quarter of a century later, the COP3 agreement is making a difference. Yet, if you were to listen to the financial services industry itself, most recently at COP26 in Glasgow, the world will be saved by tracking environmental, social, and governance (ESG) indicators, with scarcely a mention of full carbon trading. How can it be that the financial services industry isn’t promoting a market-based solution?

Organisations are looking at how to score well in the ESG rankings but is ESG a driver for change? It is likely that ESG has a place in a number of areas, but one of them might not be emissions. Professor Michael Mainelli questions the use of ESG in reducing emissions and will use this session to explore ETS history, assess its promise, and probe its relevance to the City. He argues that financial services role is to bind with markets to help people make better decisions, trillions of small economic decisions on sustainability. Decisions based on hard financial transactions will aid market enforcement and supply chain tracking. He observes that traditional market drivers could be applied, e.g. competition, open data, better regulation, and voluntary standards markets.

In order to better unite financial markets and government policies, since 2005 he and his firm, Z/Yen, the City of London’s leading commercial think-tank, have successfully promoted the use of a complementary financial instrument, policy performance bonds (aka sustain for climate change purposes as sustainability-linked policy performance bonds). The policy performance bond market rose to US$110bn in 2021, and this year saw the first issuance of a sovereign bond, Chile’s US$2bn sustainability-linked bond in March 2022. Michael recommends that financial services should lobby for costed carbon and financial cuffs on government policy (policy performance bonds). The implication for financial services is a shift from lipstick on financial institutions to the straightforward incorporation of emissions costs in everyday decision-making across the economy, not just for investment analysts.

This talk is being given by Professor Michael Mainelli, Chairman, Z/Yen Group, to UCL's venerable Chemical & Physical Society.