The G7 is relevant once more and financial reform must be a priority

This year, there was renewed relevance to the G7 process and its outcomes.

The forum is typically criticised for its lack of representation. This, together with the financial crises that unfolded at the end of the 1990s in a number of emerging Asian economies, is what drove the creation of its pendant, the G20. The G20 prides itself on representing 90% of the world’s GDP, and on the game-changing decisions it made in response to the great financial crisis of 2008.

The current geopolitical context, however, has broken the G20 – at least temporarily. The group, which includes Russia and China, is deeply divided on the matter of the ongoing Russian aggression in Ukraine. This has brought the work done by this forum to a standstill.

The global polycrisis we currently face – which spans the climate, inflation, and geopolitical crises, to name a few – requires a globally brokered solution, and this means the G7 has once again an important leadership role to play.

Other multilateral fora, starting with the UN and the International Monetary Fund, remain important. But the space offered by the G7 is unique as a coalition of like-minded countries which can, at least in theory, come together and lead by example in the solutions they offer.

Three reasons to reform global finance

This renewed relevance of the G7, and the sense of urgency that comes with its meetings, is particularly marked when it comes to the finance and global climate agenda for three major reasons.

First, as the UN secretary general has recently reminded us we are running out of time. Second, while resolving the climate crisis will require a multi-pronged approach, a lot of it lies in getting money to the right places and at the right scale. And third, because G7 countries bear an important responsibility in generating this problem in the first instance.

It was therefore only fair to expect the G7 – both through state leaders, and through finance ministers and central bank governors – to come out strong this year with an ambitious financial system reform agenda for climate safety.

In particular, there were expectations for the G7 to propose step changes along the three pillars of the finance system reform agenda:

• public finance reform to enable a just transition everywhere;
• public finance coordination for G7 countries’ domestic transition;
• private finance alignment with the transition imperative.

However, the communiqués agreed upon in May by G7 leaders and the group of finance ministers and central bank governors were generally disappointing on the financial system reform agenda, with mixed results on all three pillars.

On the first pillar, the action required was systemic and structural reform of the international financial architecture, in order to durably alleviate fiscal pressures experienced by low and middle-income countries. This would enable them to engage in their own national transitions without compromising on their development goal.

The chief positive outcome here is the G7’s continued pressure on multilateral development banks, and the G7’s call for them to expedite the ongoing review of their business models to deploy more financing capacity.

However, no new solutions were found to address the fiscal pressures faced by low and middle-income countries. Expectations are high that such solutions may be brokered at the forthcoming Summit for a New Global Financial Pact, which will see a number of world leaders gather in Paris later this month at the invitation of President Macron.

Under the second pillar, it was very positive to see the publication by G7 leaders of a clean energy economy action plan, which signalled a commitment to work against “zero-sum competition” when it comes to strengthening supply chain resilience and the consequences this may have in terms of subsidies, trade rules and the like.

It was also positive to see leaders task their finance ministers with finalising a “partnership for resilient and inclusive supply chain enhancement”. The exact scope and outcome of this partnership remains to be seen, of course. However, it would have been welcome to see leaders make strong, explicit decisions at the outset on this; for example, by committing finance ministers to a clear process and sustained efforts to engage in regular fiscal policy coordination.

No recognition for global disclosure baselines

The biggest gaps are to be found in the private finance pillar. To be sure, there were positive developments here. Both finance ministers and leaders acknowledged and encouraged transition planning as a key tool to promote net-zero alignment – in the case of ministers, for both the public and private sectors. There was no collective commitment to mandatory corporate sector transition planning, but it’s an important starting point.

However, developments on disclosure standards for climate were worrying. Here, the G7 reiterated its commitment to consistent, comparable and reliable disclosure standards on sustainability and climate. But while it supported work done on this front by the International Sustainability Standards Board (ISSB) which is to publish final reporting standards on climate and sustainability by end of June, the G7 backed away from recognising these standards as the basis for the global baseline.

Previous G7 texts, especially in 2022 under the German presidency, clearly welcomed the ISSB’s work towards achieving a global baseline on disclosures (see for instance the 2022 leaders’ communiqué). This backsliding is a red flag regarding the G7’s commitment to achieving globally interoperable disclosure frameworks.

There is also a lot of work left to do on banking regulation for climate safety. Central bank governors committed to “addressing the implications of climate change that are relevant to their respective mandates”, but nothing specific was agreed upon. More controversially, they reaffirmed that “our financial system is resilient”.

Wanting to assuage markets after recent turmoil is understandable and indeed the financial system can be qualified as stable right now. But resilience denotes something else: capacity to withstand future challenges. Can the financial system be qualified as resilient in the face of the climate challenge?

This issue in and of itself warrants more ample discussion, but the way core capital requirements are calibrated for banks is telling enough. Calibration relies heavily on historical data sets which under-price the risk generated by fossil-fuel related activities. The result is that the very regulation destined to secure financial system safety and soundness ends up feeding its vulnerability in the long-run.

The finance ministers’ communiqué notes that financial stability is a pre-requisite for the transition. This is true but, as the example above suggests, the transition itself is also key to financial system resilience. The question is: how do governors intend on contributing to the transition, if this is what will ensure financial system resilience which is at the heart of their mandate?

Every passing day increases the cost of the climate crisis and of the efforts that collectively we will have to deploy to address it. The G7 has a unique role to play in accelerating those efforts, but has left much to be desired from its meetings under Japan’s steer. It should continue to convene in 2023 to address outstanding issues and offer the finance action we need – and expect – from them for collective climate safety.