Reducing Carbon using Regulatory and Financial Market Tools

55 Pages Posted: 16 Feb 2023 Last revised: 11 Jan 2024

See all articles by Franklin Allen

Franklin Allen

Imperial College London

Adelina Barbalau

University of Alberta

Federica Zeni

World Bank

Date Written: February 12, 2023

Abstract

We study the conditions under which debt securities that make the cost of debt contingent on the issuer's carbon emissions, similar to sustainability-linked loans and bonds, can be equivalent to a carbon tax. We propose a model in which standard and environmentally-oriented agents can adopt polluting and non-polluting technologies, with the latter being less profitable than the former. A carbon tax can correct the laissez-faire economy in which the polluting technology is adopted by standard agents, but requires sufficient political support. Carbon-contingent securities provide an alternative price incentive for standard agents to adopt the non-polluting technology, but require sufficient funds to fully substitute the regulatory tool. Absent political support for the tax, carbon-contingent securities can only improve welfare, but the same is not true when some support for a carbon tax exists. Understanding the conditions under which the regulatory and capital market tool are substitutes or complements within one economy is an important stepping stone in thinking about carbon pricing globally. It sheds light, for instance, on how developed economies can deploy finance to curb carbon emissions in developing economies where support for a carbon tax does not exist.

Keywords: Carbon Emissions, Taxes, Voting, Sustainability-Linked Debt, Welfare

JEL Classification: D62, G32, H23, Q52

Suggested Citation

Allen, Franklin and Barbalau, Adelina and Zeni, Federica, Reducing Carbon using Regulatory and Financial Market Tools (February 12, 2023). Proceedings of the EUROFIDAI-ESSEC Paris December Finance Meeting 2023, Available at SSRN: https://ssrn.com/abstract=4357160 or http://dx.doi.org/10.2139/ssrn.4357160

Franklin Allen (Contact Author)

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Adelina Barbalau

University of Alberta ( email )

Edmonton, Alberta T6G 2R3
Canada

Federica Zeni

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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