Breaking the Bond: Primary Markets and Carbon-Intensive Financing

35 Pages Posted: 12 Jul 2021

See all articles by Christian Wilson

Christian Wilson

University of Oxford - Smith School of Enterprise and the Environment

Ben Caldecott

University of Oxford - Smith School of Enterprise and the Environment

Date Written: June 15, 2021

Abstract

To align capital flows with the goals of the Paris Agreement, financial institutions must decarbonise primary market transactions, as these continue to provide new capital to the real economy that can create carbon lock-in and the risk of stranded assets. In this paper we define a new metric, Primary Market Carbon Exposure (PMCE), as the proportion of primary market transactions that occur in carbon-intensive sectors. We calculate PMCE for US corporate bond exchange-traded funds (ETFs) and find that these funds systematically partake in carbon-intensive primary market transactions, with a PMCE of 14% from 2015 to 2020, despite tracking indexes that rebalance monthly. High yield ETFs have a higher PMCE than investment grade ETFs and provide more financing to upstream oil & gas. To avoid becoming capital providers of last resort for carbon-intensive sectors, ETF providers need to reduce PMCE in line with Paris Agreement carbon budgets. For policymakers, not only can passive funds contribute to carbon lock-in, but ETFs directly bought by central banks are financing carbon-intensive sectors. We demonstrate this for ETFs bought by the Federal Reserve in 2020.

Keywords: climate finance, passive investing, fossil fuels, divestment, capital flows

JEL Classification: G24, G12, Q35

Suggested Citation

Wilson, Christian and Caldecott, Ben, Breaking the Bond: Primary Markets and Carbon-Intensive Financing (June 15, 2021). Available at SSRN: https://ssrn.com/abstract=3883377 or http://dx.doi.org/10.2139/ssrn.3883377

Christian Wilson (Contact Author)

University of Oxford - Smith School of Enterprise and the Environment ( email )

United Kingdom

Ben Caldecott

University of Oxford - Smith School of Enterprise and the Environment ( email )

United Kingdom

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