Thursday,18 July 2024

“How climate change will transform finance”

5 min read

By Emmanuel Daniel

Emmanuel Daniel, chairman and founder of The Asian Banker and Wealth and Society, discussed what financial services industry and institutions will have to do to meet their commitments to the United Nations Framework Convention on Climate Change.

Emmanuel Daniel, chairman and founder of The Asian Banker and Wealth and Society, gave a keynote speech at the MPC21 Conference held virtually on 18 November 2021. He discussed what financial services industry and institutions will have to do to meet their commitments to the United Nations Framework Convention on Climate Change. Some will incorporate new technologies like blockchain and others will use market disciplines to price and fund the shift to an environmentally sustainable future. The balance sheet of financial institutions will also start to look very different as they make the difficult transition out of non-renewable energy sectors.

  • Major economies discuss ways to curb CO2 emissions without sacrificing economic stability and growth
  • In order to get proper support and funding a commercially viable ESG agenda is necessary
  • The establishment of a carbon trading market will allow countries or institutions to commoditise carbon, and keep it within target levels
  • So far, the finance industry is looking at carbon trading from a market perspective
  • However, as ESG concerns become more pressing, concrete goals and targets would eventually be put in place
  • New financial assets are expected to be tokenised, and openly traded, as blockchain applications increase in ESG
  • However, the development of finance will not end with institution-run platforms, instead individuals are expected to transact with each other

Here is the transcript:

Hello everybody. Thank you for inviting me to be the keynote speaker at this conference taking place in the US. I'm in Beijing, China right now. It gives me great pleasure to give you this opening keynote session. I hope that some of the points that I will raise in my presentation will be discussed in the sessions following this talk. 

It’s very interesting that this conference started off as a payments conference and then has moved on to become more of a digital commerce event. When we start to think of climate change in digital commerce terms, there are some very interesting implications for the finance industry that I'd like to be able to share with you today. 

Also by way of introduction, my name is Emmanuel Daniel, I'm the founder of The Asian Banker. I'm also the founder of Wealth and Society. Both those organisations are very important for the talk that I'm giving right now. The Asian Banker’s interesting because we're no longer Asian and we’re no longer ‘banker’ because we are a research organisation with offices in Dubai and we run conferences and training in Africa and in a lot of emerging market countries. We're not ‘banker’ anymore because as most of you know, the future of the financial services industry is not predicated by traditional commercial banks anymore. A lot of that is driven by technology and a whole range of new challenger institutions. In the Wealth and Society programme, we talk a lot about impact investment and climate change is huge, as part of that realm that we cover, not just in finance but with philanthropy, with foundations and so on. So with those points of introduction, it gives me great excitement to be able to handle this topic. I think that there are not many people who have been wrapping their minds around finance or the finance industry, and climate change. We hear a lot about what banks have to do to meet their lending objectives, their greening of their loans but what's interesting is that the transformation that is shaping finance itself is going to be very important in the governance of climate change. 

Major economies discuss ways to curb CO2 emissions and maintain growth

So my discussion today focuses on climate change. I want to talk about new age exchanges and the personalisation of finance. 

All of us are familiar with the Paris Agreement. In 2015, many countries around the world, all of the major economies got together and made some commitments to keep the global warming to below two degrees Celsius for as long as we can hold it. 

That goal, by the way, is very personal to me because in Singapore, I live right next to the sea. Where I live is exactly three metres above sea, above the tidal line. What's interesting is that three metres is exactly what the rise in coastal lines will be if we lose that two degrees Celsius target. 

All of the major economies made their commitments then the US walked out of the commitment and now it's back in again. 

China has upped its objectives. At the time of the Paris accord, they promised to lower carbon dioxide (CO2) emissions according to a gross domestic product (GDP) coefficient but now they have made very firm commitment to become carbon neutral by 2060 and to peak emissions by 2030. 

Now for a large emerging market economy like China, which is growing very quickly and which has a very strong industrial base now, the dependence on coal is very real. There was a time when you could actually see that the cities were clogged up with pollution. They've cleaned it up dramatically, I must say. In Beijing where I live, it used to be that they would count 50 clear days a year, and now, you'd be hard pressed to find five or 10 days where it’s not clear. 

So, the use of coal has been reduced, especially in large built-up areas. But it still forms a very important part of the economy for a number of reasons: to reduce the dependence on fossil fuel which China has to import almost entirely. Also the coal industry actually borrows a lot from the banking industry. So if you're going to tail down the use of coal, that has to be balanced with what's going to happen to bank lending and the financial sector as a whole. So these are some of the challenges that are not unique to China. These are common to a number of major economies, especially those which are very dependent on fossil fuel. Even a country like Singapore processes oil, although it is a very small island, it's got a huge refinery base which borrows from the banking industry. So the implications of that transformation are very real and huge and will take many years to work through.

Building a commercially viable ESG agenda

Now, in building a commercially viable ESG agenda, which is environmental and social governance, I put it as requiring three pillars. The first pillar has to do with regulation and taxation. So that would be the first line of attack where regulators and the state puts a cap on the amount of CO2 emissions. 

In the case of the US, they have programmes for a number of other emissions as well – including sulphur dioxide – and tax emissions that go beyond that cap. The problem with capping tax is that it has the effect of making businesses pass on that costs on to consumers and to the end user. So taxation and regulation is only one part of the formula of creating a viable ESG agenda. 

The second pillar is really profits or subsidies. As long as commercial entities are allowed to be profitable, they will be able to invest in new technologies and make the transition into environmentally friendly industries and so on. That involves costs. That involves investments. And that has to be a commercially viable idea that businesses as a whole can function. 

Then the third aspect that we don't think very much about but which is becoming very clear today, is the whole idea of investable assets. When we cap and trade, and a lot of that is actually driven by subsidies especially in the developed countries, but where they become commercially viable, the question is are the profits generated and able to fund a lot of these transitionary activities, whether it's deforestation and replanting of trees, or retooling and reskilling local people and investment in technology? Now, all of these are projects and there are hundreds, if not thousands of projects around the world that need to be funded. So regulation, commercial, mitigating and sustainable activities or other projects.

The establishment of a carbon trading market

Someone that I truly admire and I have had the opportunity to interact with much more closely recently and in fact, I did an interview with him on a programme called RadioFinance, Richard Sandor, we call him Doc, is actually one of the people I admire incredibly over the years. He is the founder of many things. And the funny thing about Richard is that as long as someone says he comes from the commodities trading world in Chicago, that immediately gives you a sense of the pedigree, the nuance, the DNA of a trader that makes markets possible. He is a pioneer in the commodities market. He was with the Chicago Board of Trade. He pioneered interest rates in interest rates derivatives. In fact, interest rates derivatives are the largest futures derivatives market because it affects how banks fund or deal with your funding costs as a business. 

So interest rates derivatives are very important. But more important for this conversation is that he also founded the Chicago Climate Exchange. If you speak with Dr. Richard Sandor you'll understand how passionate he is about using market principles to price discover the real worth of any commodity. So he introduced interest rate derivatives, various commodities and then carbon trading. 

By introducing market mechanism, the price discovery process becomes more transparent, more competitive and more commercial. He is a very important figure in the industry. He's called the father of financial futures and carbon trading. He pioneered the whole idea of carbon trading in the US at a time when corporations and markets weren't very sure that this is what they wanted to do. He was in China in about 2014 helping China start its own carbon trading market. In fact, it just started last month, the world's largest ETS, emissions trading system and Richard Sandor had a role in making that happen. So his argument is that when cap and trade first started in the US, there was great concern that it might be very expensive. As it turned out, the actual cost was much lower than the benefits that were accrued from having clean air, healthy environment, green cities and so on. And so he claims that since the inception of the Acid Rain Programme in 1995, cap and trade has helped to solve acid rain in the US and has made the US environmentally clean and green, and reduced the use of sulphur dioxide dramatically. 

Building that market required several elements in there. First, of course, we needed regulation to say that polluting industries must pay a price and that there is a cap to what they can pollute and if they reach that cap, they need to go out and buy carbon credits from less polluting industries that have not met the cap yet. So they’ve got carbon assets to sell. 

In that way, create a price mechanism for the cost of the impact of the carbon emissions that the US used to suffer from. What's interesting is that the US today has 16 operating carbon trading markets. So carbon trading is a real business in the US industry. China has been just following mostly what the US has constructed. In fact, China has become the world's largest carbon trading market from the word go. It had been experimenting with a number of pilot projects around the country but now it's has a national project. It has a number of different cities that trade carbon. All of the carbon being traded in China right now is focused on the energy sector. There are about 2,200 companies trading carbon and they already have an asset pool of about four billion metric tonnes of carbon dioxide available for trade. It is still early days and the price discovery mechanism is still being put in place. It is still a domestic market. It is still a market that is being driven by state-owned enterprises. But eventually as they learn, they want to be able to commercialise the market and have the price mechanism working on a totally commercial basis. 

Now, the real challenge in carbon trading, as it were, is this. In the markets where carbon trading is very well established like in the European Union (EU), I must remind some of the people who may be familiar with this that when the EU started its emissions trading systems, there were a lot of criticisms that the trading process itself may not end up in price discovery. It is subject to distortions. It is even subject to fraud. But the final goal in carbon trading is to find the best possible price, which is commercially viable but at the same time, which is sufficient for all of the activities required to make the transition into an environmentally-sustainable economy.

That price – various estimates between $50 to $60 – but in California, with a lot of regulation but not as much as in the EU, with taxation but not as much as in the EU, California operates at about $18 per metric tonne. In China and in the Regional Greenhouse Gas Initiative (RGGI) markets, it's about $5 to $7. Now the question then is how do we achieve the desired price, which is about $50 to $55? And the EU and the UK are doing very well. The carbon trading assets are valued at about $67 and these are commercially valued, that means these are market driven that's because of the supply and demand is highly restricted and regulation pushes from the back. So my earlier slide, regulation and taxation markets, and the utility of carbon trading all have to work together to find the desired price. So even as Richard Sandor is a passionate builder of markets, the idea is that in carbon trading, how do you reach prices which are commercially usable in making that transition to carbon neutrality?

Industries that will look more interesting in a sustainable world. I'm personally very interested in the hydrogen market and liquefied hydrogen. I follow companies like Plug Power and Ballard. But what's interesting is that some of the renewable energy like solar and wind have increasingly become commercially viable because the technologies required to do the installations have been falling dramatically. And some of that, I must say, is because of the price points, the manufacturing costs in China. The windmills and solar panels that used to cost much higher than they do now, the prices have become affordable and usable. Not just that the prices of future technologies have to fall but that the money being raised to make the research and development (R&D) has to be substantial enough and market incentives, tax incentives, subsidies, etc., have to come together to make that possible. 

Climate change through the lens of finance

This is a picture of the earth as seen from the International Space Station. I was going to put the map of the world but I heard Neil deGrasse Tyson made a speech recently and he said that the world only became concerned about the environment when we were able to see the earth back from the moon, then we realised that the Earth has no boundaries, no borders. We all breathe the same air, we all live on one planet that we share. Therefore, the whole idea that we live on a shared planet, and this is the only planet we have, became a pressing concern and it's driving the spirit of ESG today. But the point I want to make here is that around the world today, in many countries, there is an incredible number of social activities designed to create sustainability and to create activities that are nonpolluting, and helps humanity live in harmony with nature. But all of these projects need to be funded. 

These should be thought about in a global sense, not in a territorial sense like which country you come from or which economy is the worst polluter. The finance industry's response to the ESG agenda is as follows. There is a markets response, which I've outlined. There's a balance sheet response and there is a reporting, risk and returns’ response. 

An interesting thing about markets is that I've just seen some new data that the World Bank says that there are 64 carbon pricing instruments. It can be any form of carbon trading, 64 carbon pricing instruments and markets basically, all of these 64 put together generate $53 billion in revenue in 2020-2021 in the last year. So, that's a real revenue generating industry that the financial markets has created that exists right now, even as many bankers think that they are new to the industry and the topic, the value proposition or the revenue generating capability of markets in carbon trading and in ESG are real and generates this amount of income according to the World Bank. 

So, there’s markets and there’s balance sheet. Balance sheet is interesting because the global banking industry driven by the financial stability forum, the Bank for International Settlements, has put the banking industry on track to green their loans, meaning the loan book will be focused on activities that are carbon neutral and are sustainable. Now, for this to happen, there has to be a dramatic change in many economies. 

As I said, there are economies even as innocently looking as Singapore, which are highly dependent on processing hydrocarbons as well as countries like Indonesia, Venezuela, Brazil, which are highly dependent on petroleum exports and other countries like Japan, China, even India, which are net importers of hydrocarbon. So, the hydrocarbon industry has multiple facets. Sometimes, even innocently, you might not be realising that you're actually supporting the hydrocarbon industry even if it doesn't seem that you were. 

At the same time, the hydrocarbon industry goes back to the banking industry and says, ‘We are now investing in R&D and in activities around carbon neutral structures. Can you give us a loan?’ Then the question is, should the finance industry support traditionally polluting industries in their investments, in activities that may be borderline. It helps them deal with energy more efficiently, which then brings down the effects of pollution and at the same time, keeps the industry going. These are some of the issues that that the banking industry faces. 

At the same time, there are industries like fund management insurance which can be far more directly invested actively and consciously in activities that are neutral and sustainable. The reporting risk and returns part is very interesting. The finance industry, whether it's banking or even corporate finance and capital markets are very fond of coming up with reports to show how committed they are to different goals. In the past, it used to be, if you remember, the Sarbanes-Oxley Act, required to see more governance and ownership of the responsibility of decisions made by corporations. And now, the finance industry has its pioneering reports, largely driven by Mark Carney, sustainable finance disclosure in the EU, task force on climate-related financial disclosures in the UK, green taxonomy – very European idea – and then in the US, it has been simplifying ESG reports as part of the annual reporting of listed corporations.

The finance industry's response to the ESG agenda

Another element that I'd like to describe in terms of the finance industry's response to the ESG agenda is the understanding of risk. Today, we talked about green risk, which is a little bit different from the green swan. This will be different from the black swan, which all of us would have been familiar with from Nassim Taleb’s book. 

The idea of the green swan is that there can be a catastrophic incident in the world that is driven by environmental calamities. So how would the finance industry look like if it was invested or lending into such activities? 

We are starting to form an idea of risk management, which takes into account the green risk or the green swan. Mark Carney, the former governor of the Bank of England, is driving the private sector finance industry's response to the Paris accord. He will be chairing and he's the leader of the Glasgow Financial Alliance for Net Zero (GFANZ), basically, a loose conglomeration. It's about more than 160 institutions worldwide, driven also by his very good friend, the chief executive of Standard Chartered Bank and several other key personalities in the industry. I'm following what he's doing very closely. 

I think the finance industry wants to table some objectives, some concrete goals, that it will be setting for itself between now and the meeting in Glasgow in November. So, the Alliance brings together all kinds of different financial institutions: banks, fund managers, exchanges. 

The Bank for International Settlement hasn't put in place any capital requirements or capital ameliorating programmes to reward banks that have become carbon neutral or becoming more sensitive in the quality of their loan book. But we might see something like that in the future. 

By the way, Mark Carney, I had a conversation with him recently. You can watch that on It’s very interesting what the finance sector is doing, leading up to the to the Glasgow conference, UN Climate Change Conference (COP26). These conferences are held once every five years and they give the name to the next meeting, which will be in 2026. 

I want to introduce you to a very good friend of mine who started an exchange. The exchange is called AirCarbon Exchange. Basically, it's an exchange that trades in carbon assets, which is Ethereum-based. 

He trades in three types of assets, which is Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), which is the aviation industry’s carbon offset programme. So the aviation industry has committed to become carbon neutral by 2030, but also to put in place structures where both the airline companies and travellers like you and me can do our carbon offset by purchasing carbon offset assets to various markets. So one of the nicest markets that have been created is this market by my good friend, Thomas McMahon.

Blockchain technology in the carbon trading market

One interesting thing about AirCarbon Exchange is that it's blockchain based. This is where I want to start introducing some of the technological innovations taking place in finance that are going to make a huge difference in the governance structure of carbon trading. The original carbon trading market, by the way, still exists. I think it's called carbon trade acts out of London. That's spot market, meaning that you trade carbon and if you have carbon assets to sell to a corporation that needs to buy that. you get cash in return. You get to keep the cash. So that's what carbon trading used to be, or it still is in some markets. But what we want to see is that the asset created, the revenue created being applied to projects: it can be tree planting, rescaling, retooling entire communities and it can be anywhere in the world. 

In the case of AirCarbon Exchange, they support some programmes in Guatemala, in Indonesia, and so on. What's interesting is that these assets are held in trust by a trustee company and the database is kept in a token and that token is traded actively. The projects get a cut of the revenue every time that token is traded. So if there was a forest in the Amazon region and I have a project where I want to create sustainability by reducing deforestation and increasing diversity in in the ecology and I want to have it funded and make the community itself sustainable, that becomes an impact project. 

That's why I introduced you to the fact that I run this organisation called Wealth and Society where we look for such impact projects. These projects are monetised and funded by the buyers of the carbon assets in AirCarbon Exchange. Then when the owners of these tokens trade with each other, the trading fees is then passed on back to the projects or part of it so that they get an income from income stream from the trade itself. So this is the interesting thing about where finance is taking carbon trading and carbon exchanges. 

What's interesting about AirCarbon Exchange, and I always tease Tom about this, is that it's actually a cottage industry. So this is yet another transformation that has been taking place. You do not need to be a formal exchange to start off a carbon exchange, partially because a lot of regulators deal with carbon exchange. It's not a security in the traditional sense that should be regulated by the securities industry, at least not in several markets that Tom operates in. Therefore, it actually creates the opportunity for multiple markets to be created. The critical success factor of these markets is the same as the way in which Richard Sandor explained to me: When you create markets, you go door by door and you knock on the door, and you get on board someone who needs to trade and to buy carbon credits, which they may have been buying on the over-the-counter (OTC) market where the fees can be as much as 50% of the trade because the parties are not familiar with each other, the broker is not necessarily transparent. So, the brokerage fees tend to be very high, where else in a transparent market, where you actually see all of the assets, the transactions, the trades taking place, and the liquidity being created. The fees are smaller and more commercially adaptable and viable. So what's interesting today is that new exchanges are being created in the commodities world, specifically in carbon trading by people like Thomas McMahon.

In this blockchain realm, we see today a whole range of financial assets being predicated or being captured in tokens like Solana in Tezos then traded openly between a willing buyer and a willing seller. In some cases, there are exchanges created to facilitate this trade and to be able to see the liquidity being created and the transactions taking place in a safe environment. In some places, the token itself are created by anyone and everyone. 

We are now entering a realm where if I had an impact investment project anywhere in the world – in Southeast Asia, in the jungles of Brazil, in South Africa – I can have it tokenised and have it traded, globally. 

I'm also familiar with another development taking place in key economies, in Kenya actually, something called community currencies where there is a currency operating in a closed community for which payment is made for work that is generated within that community. So when you have a large unemployed fraternity of young people, you create employment, which is important for that community and you value that employment and you give it a value on a token within that community, which is then circulated within the community as being kind of a quid pro quo for payments. All of that can now be captured on a blockchain. 

These are real things that are happening around the world. In fact, you will see one of those interviews on RadioFinance that I've done with this organisation in Kenya. At the same time, these tokens take a life of their own, they become markets of their own. Not all tokens become successful markets but several have the chance to become and when they do, they carry a value of their own and there's a certain respect for the value created in that token and for the community that it supports. 

Based on these developments taking place, we see the finance industry’s ability to respond to building a more sustainable world, sustainability and impact in society because it's a token-based approach, you now disintermediate, the large institutions and their role, which adds cost. Maybe there is a lack of transparency and it's difficult to put together.

Deconstructing platforms towards personalisation

I'm completing a book right now, which I hope will be out by November this year. From this book, there are several ideas that are relevant to sustainable development and impact investments, although I didn't design it that way. So it's called ‘The Winning Bank’. But basically what I'm describing is that world of finance is moving from a realm of platforms as we know these to be today – the Facebooks and the Amazons of the world – to personalisation, where tokens can be created by individuals and small closed communities, that the world will become increasingly everybody to everybody, not institutions to retail, or something like that but it will be all-to-all ecosystem. A network of ecosystems that are able to integrate and interrelate with each other. We are also creating a world where the whole dimension of financial inclusion needs to be restated. The reason I say that is because when we look at the fintech phenomenon today, just think about it. Given the amount of layers that are created by a lot of the innovations taking place in fintech, there is no way that fintech that is driven by institutions is going to make finance cheaper. It's going to make finance more expensive. In fact, the whole idea of the platform revolution in finance is to onboard as many customers as possible and then to start charging them high credit fees, high transaction fees. The whole platform phenomenon is not designed to make finance more inclusive. It's actually designed to onboard as many people as possible, just like all of the social media platforms do today and then to and then to extract rent from them. 

But the transformations that are taking place today are deconstructing platforms and because of blockchain, because of cryptocurrencies, the value of the transaction is retained by individuals transacting with individuals. So the institutional approach to finance will collapse. 

Institutions will need to start thinking what their role will be in finance going forward. So I want to put together all of these ideas to all of you. I hope that it'll give you an opportunity to discuss the whole idea of climate change and the future of finance in one conversation. In my interpretation, it's really about finance. transforming finance. Thank you very much. I hope you enjoyed this presentation and have a good rest of the conference.

Keywords: Climate Change, ESG, Paris Agreement, Carbon Trade Market, Fintech, Banks, Interest Rates Derivatives, Co2, Financial Revolution, Platforms, Trade, Financial Assets, Blockchain, Tokens, Personalisation
Region: Global
People : Emmanuel Daniel, Richard Sandor, Mark Carney
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