Public and private investments and public subsidies continue to support activities incompatible with a sustainable future — the development of new fossil fuel reserves, overfishing, land-degrading agricultural practices and more. Governments and financial institutions enable practices that harm society and the environment, misuse valuable financial resources, distort the market and expose those institutions to financial risks.
These financial flows must stop and be redirected to support a sustainable, decarbonized economy. Subsidies are non-market benefits that governments give to individuals, businesses or institutions. They include benefits like direct funding, preferential tax treatment, non-commercial loans or guarantees, or preferential pricing schemes. When subsidies support activities that conflict with climate and sustainable goals, they can cause environmental harm and create economic inefficiencies that unfairly hinder sustainable industries.
For example, subsidies for fossil fuels reduce the prices of carbon-intensive energy relative to the price of clean energy, creating an unfair advantage for fossil fuels and shrinking the market for clean energy alternatives.
Harmful subsidies do not happen in a vacuum: they are often the result of political lobbying. The world's largest corporate greenhouse gas (GHG) emitters and their industry associations use political spending to influence policies that preserve government support and impede climate policy. Therefore, political spending that props up harmful industries and delays climate action needs to be highlighted and phased out.
While subsidies use government resources that are not otherwise commercially available, public and private financial institutions also perpetuate harmful practices through the use of financing that is offered on commercial terms.
Capital flows will shift as governments and the private sector invest in the green economy, creating better goods and services that cut demand for high-carbon technologies. To eliminate harmful capital flows, however, public and private institutions should also be challenged to constrain the availability of financing for harmful activities by setting clear engagement policies, stringent screening criteria, and criteria for divestment. Shifting capital flows may increase the cost of capital — the return expected by the company’s investors and lenders, primarily based on the perceived risk — and, over time, reduce the amount of capital available for harmful activities.
Ultimately, financial decisions to undertake unsustainable activities are made at the corporate level — capital investments to, for example, build a coal plant (capital expenditures or “capex”) or to maintain that plant and buy more coal to operate it (operating expenditures or “opex”). Investors in these companies can influence those decisions. Achieving a sustainable future will require changing company-wide capex decisions in the most climate-relevant sectors.
Eliminating harmful financing by disinvesting or changing the behavior of investee companies not only reduces societal harm. It also presents opportunities for financial institutions to eliminate their exposure to climate-related risks and expands the availability of resources to scale public and private investments for more sustainable activities.