In Luxembourg we talk a lot about “green” or “sustainable” finance and the Luxembourg Stock Exchange is proud to call itself a “leading venue” for green bonds. But sustainable finance is still a niche sector as green bonds will make up only 0,4% of the total outstanding global debt even in 2021. In addition to the sector being small, it is also not as green as the name suggests, particularly in areas of the world where “green” bonds can even finance coal plants, such as in China. In Europe, there are soon to be stricter definitions in the European taxonomy for sustainable activities.
We tend to overestimate the benefits of “green” and we tend to underestimate the weight of “brown” finance, the investments that contribute to the climate crisis, such as investments in fossil fuels. And there is still a great deal of brown finance that creates new oil/gas fields, expands existing ones or builds coal plants that will emit greenhouse gases for many decades to come. Globally still nearly 1 trillion dollars are invested annually in fossil fuels – this is about as much as Indonesia’s annual GDP. The International Energy Agency’s World Energy Investment report talks of 746 billion dollars annual investment in oil and gas in 2018 and expects significant growth in 2019. Two thirds of this is aimed at developing new oil/gas fields when “the reserves in the currently operating oil and gas fields alone, even with no coal, would take the world beyond 1,5°C”. The IEA also reported over 200 billion dollars annual investments in coal supply and fossil fuel power plants. These large fossil investments go against the Paris Agreement and scientific consensus of necessary fossil fuel reductions.
And what is happening in Luxembourg, a financial center known for its leadership in “green” finance? What are the government, the regulator, the stock exchange and other key actors doing to reduce brown finance? It seems the discussion has already begun, albeit slowly, with the crux at the center of the debate being that Luxembourg’s positioning in brown assets can also influence its competitive position among the largest financial centers. And while Luxembourg is viewed as a green finance center, the discussion seems more advanced in other major financial centers. Mark Carney, the governor of the Bank of England, said recently that the “financial sector had begun to curb investments in fossil fuels – but far too slowly”. The Swiss central bank came under pressure to clean its 800 billion dollars from fossil fuels. Norges Bank and its asset management branch NBIM have divested from companies in coal and launched efforts to reduce the trillion-dollar “Oil Fund’s” exposure to oil and gas itself. According to the Financial Times, “Christine Lagarde wants key role for climate change in ECB review”. So what is Luxembourg doing?
We are not aware of exact statistics about how much CO2 the Luxembourg-domiciled funds emit annually, but back-of-the-envelope calculations signal these numbers are enormous. The Norwegians estimated how much CO2 their large pension fund emits and we use this as a benchmark. In its annual report, Norges Bank Investment Management states that “in 2018, the equity portfolio emitted 107 million tonnes of CO2-equivalents” – or three times more than all of Norway. And note that this is a number after the Norwegians divested from coal. In 2018 the Norwegian fund’s equity portfolio was less than a third of the Luxembourg fund industry’s total equity investments. Norges Bank invests in thousands of equities and follows the leading global equity indices. Assuming that as a whole, the composition of the Luxembourg funds’ equity portfolio is not very different from NBIM’s portfolio and global indices, this would mean that the overall equity portfolio of the Luxembourg funds emits 300-400 million tons of CO2 annually.
These numbers include direct emissions (scope 1) and emissions from purchased energy (scope 2), but do not include indirect emissions that originate from the value chain and from product use (scope 3). Globally scope 3 emissions are at least as much as scope 1 and 2 put together and they grow much faster – according to scientists from Yale University and Norwegian University of Science and Technology. For fossil fuel sectors scope 3 emissions are huge, e.g. oil major Royal Dutch Shell’s annual scope 3 emissions were 6-7 times more than its scope 1 and 2 emissions in 2018. If we consider also scope 3 emissions, then the equity portfolio of Luxembourg-domiciled funds emits probably at least 600 million tons of CO2-equivalent a year. These emission estimates are only based on equities in the Luxembourg funds that make up less than half of the total portfolio domiciled here. If we add emissions from fixed income portfolios the numbers would be even larger.
What can Luxembourg do? A key step would be improving transparency and public understanding of the actual exposure of Luxembourg fund industry to fossil fuels and other emission-intensive sectors. Another step could be showing an example by “cleaning up” at least the national pension fund, Fonds de compensation (FDC), from fossil fuels. At the end of 2018 the FDC had investments in more than half of the 50 largest global emitters, the “Carbon Majors”, including companies like Gazprom, ExxonMobil, Coal India, Pemex, Shell, BP, Chevron, Peabody, Total SA, BHP Billiton, ConocoPhillips, Petrobras, Lukoil, Rio Tinto, Petronas, Rosneft, ENI and others. While investors with 11 trillion dollars in assets divested from fossil fuel and Blackrock – with 7 trillion dollars assets under management – just announced to join them, the FDC’s investments in coal actually increased between 2015 and 2018. There are today two coal-related companies on FDC’s exclusion list, and we are still to see a genuine FDC move away from fossil fuel companies. Especially as its own responsible investment policy says that “the detailed analysis and assessment of climate risks is an integral part of the sustainable development process implemented in the investment strategy.”
Luxembourg could also discourage funds that specialize in fossil fuel investments and are supervised by the CSSF. These include the iShares Global Energy ETF with over 870 million dollars of assets and holdings in Exxon, Chevron, Shell and dozens of other oil companies. Another example is Riverstone Energy which “has made 20 investments spanning oil and gas, midstream, and energy services in the Continental U.S., Western Canada, Gulf of Mexico, Latin America, Europe.” Other examples include Warburg Pincus Energy, Carlyle International Energy Partners and many more.
Luxembourg may also rethink why it welcomes the fundraising daughter companies of large fossil fuel companies, such as subsidiaries of coal companies (e.g. Energa Finance AB, Eskom Holdings SOC Ltd and Coal Energy S.A.), oil/gas and oil service companies (ENI Finance International S.A., Gaz Capital S.A., Hellenic Petroleum Finance Plc, MOL Group Finance S.A., Rosneft Finance S.A., Vier Gas Transport GmbH, Schlumberger Finance B.V., Schlumberger Finance France and TMK Capital S.A.) and gas utilities (Union Fenosa Preferentes S.A., Naturgy Finance BV).
The Luxembourg Stock Exchange has been named as the Exchange of the Year by Environmental Finance for three consecutive years. But its largest listed equity that dominates the LuxX index is Arcelor-Mittal with 200 million tons of annual CO2 emissions. ArcelorMittal has higher emissions per ton of crude steel produced than the global average and could not improve it for at least a decade even if it tried. It also has more than 200 million tons of coal reserves. The company is not only listed but it also raises debt here, e.g. it has seven large outstanding bonds at the Luxembourg Stock Exchange. Considering the substantial benefits the company enjoys in Luxembourg, the question arises if ArcelorMittal and Luxembourg could work together more effectively in areas like climate change mitigation.
The Luxembourg Stock Exchange proudly calls itself “The European centre for high-yield bonds”. Historically high-yield markets often included substantial fossil fuel debt for example in the US and in Scandinavia. Luxembourg is no different, one of its major high-yield bond issuers is Pemex or Petroleos Mexicanos. It has around one hundred bonds with a total of nearly 100 billion dollars in issuances in Luxembourg. Pemex is not only the world’s most indebted company, but also the 8th largest global greenhouse gas emitter based on total emissions of the last three decades. It overtakes the whole Russian coal sector or most of the largest oil majors such as Shell, and we have not even mentioned Pemex’s massive health and environmental impacts. The Luxembourg Stock Exchange also welcomes assets from the national oil companies of Brazil, Venezuela, Chile, Nigeria but also international oil/gas and oil service companies including Royal Dutch Shell, Tullow Oil, SNAM, Schlumberger, Equinor (Statoil), Hellenic Petroleum among others.
These examples show that brown finance is very significant in Luxembourg – even without looking into the banks and insurers that work here. The Luxembourg fund industry’s portfolios emit hundreds of millions of tons of CO2 a year and the Luxembourg Stock Exchange does not seem to have a conflict between its green marketing and providing services for oil/gas companies and other emission-intensive sectors at the same time.
Luxembourg has ambitious national emission reduction goals and is making substantial efforts to deliver on these. But its total national emissions – around 10 million tons of CO2 annually – are tiny in comparison to the emissions through its large finance sector.
Luxembourg’s trump card in the global climate fight is navigating its finance sector away from fossil fuels. In the past the country could step beyond its short-term direct national interests and find progressive solutions at European or even global level. In terms of reducing global greenhouse gas emissions, the country has by far the largest potential to contribute through navigating its investment fund sector, stock exchange, banks and insurers away from fossil fuels. The challenge for our leaders is how to do this fast enough to maximize global impact without reducing the attractiveness of Luxembourg as a financial center.