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March 22, 2023

Disclosure isn’t enough: It’s time to tax high-carbon investment

By David Donnelly, Marie Fricaudet and Nadia Ameli
Emissions cooling towers
An investment emissions intensity tax would penalise investors if their portfolio emissions intensity exceeded thresholds tied to net zero pathways. (Photo: Qilai Shen/Bloomberg)

The introduction of an investment emissions intensity tax to penalise investors based on the emissions their portfolios finance would challenge funds to match net zero declarations with actions.

This is supposed to be the golden age of climate disclosure. But despite their catastrophic emissions, business is booming for oil and gas majors: ExxonMobil’s share price hit an all-time high this February; BP executive pay doubled; Shell reported its highest profits in 115 years; while G20 countries subsidised oil, gas and coal to the tune of $3.2tn between 2016 and 2020.

And although fund managers are swimming in environmental, social and governance ratings, only a minority of ESG and climate-themed funds have portfolios aligned with Paris Agreement targets. Some still have significant fossil fuel-related holdings, justifying these with promised transition plans rather than actual emissions and investment plans.

Governments have pinned their hopes on the power of disclosure to direct capital towards low-carbon assets. It is not working — the current incentives to invest in the net zero transition are too weak. When it comes to sustainable investing, sunlight is not the best disinfectant.

That leaves high-carbon industries with booming capital flows, locking in future emissions. Meanwhile, low-carbon businesses struggle to secure the investment they need. It adds up to climate catastrophe.

It is time to consider the case for taxing investment portfolios based on the emissions they finance — not just on their returns.

An investment emissions intensity tax would penalise investors if their portfolio emissions intensity exceeded thresholds tied to net zero pathways. That would incentivise funds — and the companies in which they invest — to set a credible course for net zero emissions. Funds that fail to do so would shoulder a major tax burden. As a result, businesses that fail to reduce their emissions would struggle to secure affordable capital.

Unlike carbon or income taxes, this does not aim to boost revenue. Funds could minimise their tax exposure by aligning their portfolios to net zero targets. Instead, it is designed to change behaviour. An advance notice period before the investment emissions intensity tax is implemented would allow funds to engage with investees early and adjust their portfolios to avoid liabilities.

The scale of that change could be enormous. We studied its potential impact on OECD-based regulated funds: insurance, pension and investment funds which hold around 25 per cent of global corporate debt and equity securities. The results show that this tax could directly influence substantial investment flows — these funds represent an asset base of $44tn.

A backstop for carbon pricing

An investment emissions intensity tax has a set of distinct advantages, making it a powerful backstop for emissions trading schemes and disclosure and investment taxonomy policies.

First, the tax treats asset classes neutrally, giving funds the flexibility to implement their own net zero strategies. Low-carbon replacement of embedded fixed assets, an essential part of the net zero transition, can often only be funded with conventional equity or debt. An asset-neutral tax enables that.

Second, it can be implemented across borders. While carbon taxation is constrained by territorial limits, an investment emissions intensity tax accepts the reality that funds invest internationally.

Third, with little need for international co-ordination, the tax could be implemented within a decade. Speed matters in climate finance policymaking — just 4 per cent of global emissions in 2022 were covered by carbon prices aligned with global warming of 2C.

Fourth, it is powerful enough to include indirect emissions — those embedded in supply chains, or released when products are used. Even the most influential carbon accounting and disclosure initiatives, including the Greenhouse Gas Protocol and the Task Force on Climate-related Financial Disclosures, allow Scope 3 reporting to remain voluntary. Including those emissions in this tax will drive companies to focus on energy-efficient processes and product design and minimise greenwashing.

An obvious risk is offshoring — that regulated funds divest polluting assets to investors who are not covered by the tax. This risk can be reduced by setting tax thresholds by sector. This penalises the most polluting outliers within sectors, instead of creating excessive exposure (and offshoring risk) for the most emissions-intensive industries.

Outliers would be incentivised to reduce their emissions by the promise of keeping hold of their access to capital from regulated funds.

Even with all that optimism, all these schemes and all those headlines, climate disclosures do not have the power to divert capital away from fossil fuels quickly enough. An investment emissions intensity tax would challenge funds to match their net zero declarations with actions.

David Donnelly is a finance adviser for nature-based solutions at WWF-UK. The opinions expressed in this article are made in a personal capacity only and do not purport to reflect the views or opinions of WWF-UK. Marie Fricaudet is a PhD student at UCL Energy Institute and Nadia Ameli is an associate professor at UCL Institute for Sustainable Resources

A service from the Financial Times