Transparency principle for carbon emissions drives sustainable finance

TL;DR

Implementing a Carbon Equivalence Principle in financial products enhances transparency, aligns incentives for carbon reduction, and promotes sustainable finance through project restructuring and innovative solutions for carbon sequestration and net-zero design.

Contribution

Proposes a novel Carbon Equivalence Principle requiring financial products to disclose equivalent carbon flows, integrating physical and financial data for better sustainability incentives.

Findings

Carbon flow transparency can align financial incentives.

Project restructuring can mitigate stranded asset risks.

Net-zero and carbon-negative project designs are financially viable.

Abstract

Alignment of financial market incentives and carbon emissions disincentives is key to limiting global warming. Regulators and standards bodies have made a start by requiring some carbon-related disclosures and proposing others. Here we go further and propose a Carbon Equivalence Principle: all financial products shall contain a description of the equivalent carbon flows from greenhouse gases that the products enable, as well as their existing description in terms of cash flows. This description of the carbon flows enabled by the project shall be compatible with existing bank systems that track cashflows so that carbon flows have equal standing to cash flows. We demonstrate that this transparency alone can align incentives by applying it to project finance examples for power generation and by following through the financial analysis. The financial requirements to offset costs of carbon flows enabled in the future radically change project costs, and risk that assets become stranded, thus further increasing costs. This observation holds whichever partner in the project bears the enabled-carbon costs. Mitigating these risks requires project re-structuring to include negative emissions technologies. We also consider that sequestered carbon needs to remain sequestered permanently, e.g., for at least one hundred years. We introduce mixed financial-physical solutions to minimise this permanence cost, and price to them. This complements previous insurance-based proposals with lesser scope. For financial viability we introduce project designs that are financially net-zero, and as a consequence are carbon negative. Thus we see that adoption of the Carbon Equivalence Principle for financial products aligns incentives, requires product redesign, and is simply good financial management driving sustainability.