1.2.1 Fiduciary Responsibility

In the 2000s, the financial sector and the United Nations developed voluntary guidelines to incorporate finance and investments’ environmental and social impacts into decision-making. The Equator Principles were adopted in 2003 to serve as a common baseline and risk management framework for financial institutions to identify, assess, and manage environmental and social risks when financing projects, particularly large-scale infrastructural and industrial ones. In 2006, United Nations Secretary-General Kofi Annan invited a group of the world’s largest institutional investors to join a process to develop the Principles for Responsible Investment. In parallel, the United Nations Environmental Programme Financial Initiative (UNEP FI) has published several reports that define environmental, social, and governance (ESG) investments as the fiduciary responsibility of institutional investments and that legitimise these investments (UNEP FI, 2005; 2009; 2015). In response, the United States revised the Employee Retirement Income Security Act of 1974 (ERISA) to allow consideration of the expected return on alternative investments with similar risks, including ESG investments (Employee Benefits Security Administration, 2015).Footnote ¹

In the meantime, fossil-fuel divestment movements have emerged and spread worldwide. The landmark article by the co-founder of 350.org, McKibben (Reference McKibben2012), helped crystallise the core logic of divestment, and Carbon Tracker (2011) fuelled the student-led divestment movement across universities in North America and Australia. They attracted academic attention, leading to an increase in the analysis of campus-based campaigns. The concepts of the carbon budget and stranded resources and assets provided a scientific rationale for fiduciary duty in divestment (Caldecott, Reference Caldecott2017). Some activists have organised advocacy networks to bring cases against universities managing funds and pension funds, seeking fossil fuel divestment (Franta, Reference Franta2017; Bousso, Reference Bousso, Meijer and Nasralla2021). Pension funds and export credit agencies are large global investors that have invested heavily in fossil fuels (Gupta et al., Reference Gupta, Rempel and Verrest2020). Others have mobilised movements to nurture, gain attention for, and institutionalise new norms (Blondeel et al., Reference Blondeel, Colgan and Van de Graaf2019; Gunningham, Reference Gunningham2017).

Divestment movements have shown mixed results so far. On the one hand, well-known institutional investors and asset managers such as the Rockefeller Foundation, the Norway Pension Fund, and New York City’s pension funds announced that they would divest from coal and the fossil fuel sector to balance their financial and moral responsibilities (Hunt & Weber, Reference Hunt and Weber2019) and protect their share prices (Bassen et al., Reference Bassen, Kaspereit and Buchholz2021). Others shifted their portfolios away from high-carbon-emitting industries to reduce the carbon exposure of their investment portfolios. On the other hand, divestment did not significantly change the return or the risk of a globally well-diversified portfolio of industry indexes nor influence total financial risk for the investor (Plantinga & Scholtens, Reference Plantinga and Scholtens2021). Divestment even ended up transferring fossil fuel assets and carbon dependency to EMDEs (Gupta et al., Reference Gupta, Rempel and Verrest2020).

1.2.2 The Paris–Glasgow Financial Regime

The Paris Climate Agreement has enhanced the financial sector’s concerns about climate-related risks and stranded assets for financial stability. These are conceptualised in the Bank of England’s 2015 report and the subsequent governor’s speech, which called for their financial supervision (Carney, Reference Carney2015; Prudential Regulation Authority, 2015).

Since then, a variety of multilateral initiatives and networks have been organised to manage the risk and make orderly transitions. The Network of Central Banks and Supervisors for Greening the Financial System (NGFS) was established to enhance the role of the financial system in managing risks and mobilising capital for green and low-carbon investment. The NGFS defined and promoted best practices for financial supervisors and central banks so that they could help improve the solvency of individual financial institutions and enhance the resilience of the financial system (NGFS, 2019). The Task Force on Climate-related Financial Disclosures (TCFD) was organised in 2015 and published a framework and set of recommendations in 2017 to help companies and financial institutions consistently measure, manage, and report their climate-related risk exposures (TCFD, 2017). Investors, companies, cities, states, and regions have increasingly employed the reporting system of the Carbon Disclosure Project (CDP) since 2018, when the CDP aligned with the disclosure platform of the TCFD.Footnote ² The UNEP FI and 130 founding banks officially launched the Principles for Responsible Banking in 2019 to encourage signatory banks to take action to align their core strategies, decision-making, lending, and investment with the UN Sustainable Development Goals and the Paris Climate Agreement.

The Glasgow COP 26 in 2021 reinforced the momentum for climate action in the financial sector. The Glasgow Financial Alliance for Net Zero (GFANZ) was founded to mobilise the entire financial sector to achieve the investment levels required for a net-zero transition. The Net-Zero Banking Alliance was organised under the GFANZ, requiring would-be signatory members to set and publicly disclose long-term and intermediate targets based on accepted science-based decarbonisation scenarios and to regularly review them to ensure consistency (UNEP FI, 2021). To increase the number of net-zero-committed financial institutions, the GFANZ has developed the tools, data, and methods needed to turn signatories’ commitments into action. It also gives guidance on the net-zero transition plans needed to demonstrate accountability for net-zero targets, phase out stranded assets, capitalise on emerging opportunities, reduce the risk to businesses and society of a disorderly transition (GFANZ, 2022b), and enhance microprudential regulations and supervision (NGFS, 2023).

Furthermore, the alliance has supported the G7 and G20 in launching and scaling up the Just Energy Transition Partnership (JETP) to accelerate capital mobilisation in support of a net-zero transition in EMDEs through private-sector leadership and public–private collaboration (GFANZ, 2022a). The JETP was established as an additional funding channel to the Green Climate Fund (GCF), that has mobilised a significant portion of climate finance since the COP 15 Copenhagen in 2009. The GCF is supported from a wide variety of sources, including public, private, bilateral, and multilateral ones. It takes a bottom-up approach that emphasises country ownership, employs a direct-access modality to provide funding through accredited implementing entities satisfying fiduciary standards, and uses results-based management to address criticisms directed at the Global Environment Facility and multilateral financial institutions (Mori et al., Reference Mori, Rahman and Uddin2019). However, implementation has fallen short of commitment. Approved projects amounted to US$48 billion from 2015 to September 2023, including GCF financing and co-financing. Private finance accounts for 35% of the total funding (Green Climate Fund, 2023). In contrast, the JETP has committed to providing a larger amount of blended finance than provided by the GCF, exclusively for decarbonising the electricity sector: US$8.5 billion to South Africa, US$20 billion to Indonesia, and US$15 billion to Vietnam (Farand, Reference Farand2023). Such initiatives can be a showcase of blended finance for climate change mitigation in other sectors and regions for rolling out and scaling, if they prove to deliver high performance.

1.2.3 Sustainable Finance

In the meantime, sustainable finance has been boosted. Sustainable investing assets – including impact/community investing, positive/best-in-class screening, sustainability-themed investing, norm-based screening, corporate engagement and shareholder action, negative/exclusionary screening, and ESG integration – increased from US$23 trillion in 2016 to US$35 trillion in 2020 in the United States, Canada, Japan, Australasia, and Europe (Global Sustainable Investment Alliance, 2021). Such assets accounted for 36% of total assets under management, going beyond niche investments.

The issue of five types of climate bond – green, social, sustainability, sustainability-linked, and transition bonds – has grown rapidly. It increased to surpass US$1 trillion in 2021 from less than US$100 billion in 2016. Among them, green bonds account for 58% of the cumulative amount, followed by social and sustainability bonds. While the United States issued the largest financial value of green bonds early in this period, China surpassed it in 2022. The Bank of China issued the largest financial value of green bonds for renewable energy, low-carbon transport, waste recycling, and water projects. The China Development Bank issued the largest value of certified new climate bonds for the use of low-carbon transport. China Three Gorges Corporation has emerged as the top non-financial corporate issuer in the world (Climate Bonds Initiative, 2023c; 2023d).

Green bonds are regarded as a short-term solution to the main barriers to low-carbon energy infrastructure – policy uncertainty and short-termism in the financial system (Hafner et al., Reference Hafner, Jones, Anger-Kraavi and Pohl2020). The Green Bond Principles’ recommendations for reporting the use of green bond proceeds by issues helped stakeholders understand the information by enhancing transparency, accuracy, and integrity, spurring issuance.

However, green bonds have shown mixed results in terms of carbon reduction. They have reduced emissions from issuer companies in the post-issuance period and increased ownership by long-term and green investors (Flammer, Reference Flammer2021). In contrast, they have not always unlocked new sources of capital for green investment or made green investments financially viable by themselves (Maltais & Nykvist, Reference Maltais and Nykvist2020). While these financial benefits depend critically upon how proceeds are used to generate climate and financial impacts, green bond issuers have shown little incentive to use their proceeds to achieve ambitious science-based targets (Tuhkanen & Vulturius, Reference Tuhkanen and Vulturius2022).

In addition, the issuance of green bonds raised concerns about greenwashing and threatened the credibility of the whole market for sustainable finance. ‘Greenwashing’ refers to the selective disclosure, exaggeration, or concealment of environmental performance (Li et al., Reference Li, Yang and Dong2025), misleading consumers about a firm’s environmental performance or the environmental benefits of a product or service (Delmas & Burbano, Reference Delmas and Burbano2011). There were no standards for defining what ‘green’ was, nor were there selection criteria or frameworks providing transparency on the use of proceeds, external validation, or reporting to investors within capital markets (Alfsen et al., Reference Alfsen, Alnes, Berg, Clapp, Dejonckheere, Lund, Schiessl and Torvanger2018; Sangiorgi & Schopohl, Reference Sangiorgi and Schopohl2021).

In response, the Green Bond Principles were updated in 2021 to recommend transparency and disclosure and promote integrity in developing green bond markets (ICMA, 2022). A green taxonomy was developed as a classification system for sustainable activities and greener investment choices. The European Union implemented a green taxonomy in 2020 as part of the European Green Deal initiative. The Association of Southeast Asian Nations (ASEAN) published a taxonomy for sustainable finance to enable member states to implement an orderly transition and adopt sustainable finance. The International Sustainability Standards Board (ISSB) was organised according to the principles of International Financial Reporting Standards and backed by the G7 and the G20 to develop standards for a global baseline of sustainability and climate disclosures. By building on the work of market-led investor-focused reporting initiatives, including the Climate Disclosure Standards Board and TCFD, ISSB’s report aims to facilitate interoperability with disclosures that are jurisdiction-specific and/or aimed at broader stakeholder groups (IFRS Foundation, 2023).

1.3.1 Transformation of Investments

The Paris Climate Agreement and subsequent stringent climate policy have decreased capital expenditure on unabated fossil fuels (Figure 1.1a). Advanced economies and EMDEs had reduced such expenditure by US$200 billion by 2015, and China by US$40 billion by 2020. Upstream oil and natural gas investments account for 70% of the global decrease and 84% of that of EMDEs (Figure 1.1b). The decrease in investments in upstream oil and natural gas was statistically significant between 2016 and 2019, even after controlling for oil market tightness, global factors, and other typical firm-level control variables (Bogman et al., Reference Bogmans, Pescatori and Prifti2023).

Figure 1.1(a)

Global energy investment by type of energy, 2015–2023.

Source: Compiled by the authors based on data from the IEA (2024k).

Figure 1.1(b)

Global oil and gas upstream investment by economic category, 2015–2023.

Source: Same as Figure 1.1a.

Clean energy investments have steadily grown since the Paris Climate Agreement. Investments in renewables and energy efficiency in end-use increased by US$270 billion and US$60 billion from 2015 to 2022, respectively. However, these changes have not sufficiently offset the decrease in unabated fossil fuels (Figure 1.1a).

Abrupt divestment and reduction of fossil fuel investment ahead of a ramp-up of clean energy technologies hiked fossil fuel prices, causing a rebound effect and deterring a zero-carbon transition in the short term. The energy shift from fossil fuels to renewable energy sources increased electricity consumption in high- and upper-middle-income countries, whereas middle- and lower-middle-income countries were more sensitive to inflation, electricity pricing, and population growth induced by increasing electricity consumption. Abrupt divestment and reduction also made the electricity system vulnerable to climate change, as seen in the global heatwave- and drought-induced electricity crises in 2022 (Murtaugh & Ding, Reference Murtaugh and Ding2022). Russia’s war in Ukraine spurred energy price hikes, raising energy security concerns in energy-importing countries and triggering changes in energy and climate policies. The resultant windfall gains and energy security concerns encouraged fossil fuel producers to invest in oil and gas again. The rebound was remarkable in China, which invested more in oil and natural gas upstream and in coal in 2022 than in 2015 (Figures 1.1b and 1.1c). As a result, the European Parliament decided on the inclusion of natural gas and nuclear as transitional activities in the EU taxonomy (European Commission, 2022).

Figure 1.1(c)

Global coal investment by economic category, 2015–2023.

Source: Same as Figure 1.1a.

1.3.2 EMDEs and China

Ramping up clean energy technologies requires the transformation of the electricity model and whole-system changes for large-scale integration of intermittent renewable-energy-sourced electricity (RES-E). An RES-based electricity system is consistent with the liberalised model, which is constituted by vertical unbundling, wholesale markets, retail competition, decentralised prosumers, and network-based governance (Mori, Reference Mori and Mori2022). The model allows private participation and ownership in generation even under the dominance of state-owned utilities in the grid, thus incentivising developers to invest in RES-E projects (Geddes et al., Reference Geddes, Bridle, Mostafa, Roth, Sanchez, Garg, Scholtz and Saliem Fakir2020). The model also accepts flexibility in supply through flexible generation, storage, demand response, and interconnection through markets, thus satisfying the technical prerequisites for large-scale intermittent RES-E integration (Iychettira, Reference Iychettira2021).

In contrast, the electricity system in many EMDEs and China is characterised by a state monopoly or a hybrid model (Urpelainen & Yang, Reference Urpelainen and Yang2019), which is consistent with the conventional fossil-fuel-based, vertically integrated, and hierarchical electricity supply system. Only 32% systems undertook full vertical unbundling and 18% went through both vertical and horizontal unbundling in developing countries in 2015, against 69% and 43% respectively in developed countries (Foster et al., Reference Foster, Witte, Banerjee and Moreno2017). State-owned electric utilities play a dominant role in these systems, along with independent power producers. The systems have no or limited wholesale markets or space for choosing retail suppliers (Gratwick & Eberhard, Reference Gratwick and Eberhard2008).

In addition, many EMDEs and China will suffer from large amounts of stranded costs if they encounter abrupt divestment and smaller investments in generation capacities. They have regarded coal power as the baseload generation, developing capacities to supply electricity for all at an affordable price and to satisfy growing demand. This is why they have so many relatively new coal power plants.

Perceived high risks of stranded assets and energy security concerns have motivated EMDEs to prioritise policies to improve economic sustainability and resilience ahead of those switching from fossil fuel to green energy policies and technological efficiency in power generation (Taghizadeh-Hesary et al., Reference Taghizadeh-Hesary, Rasoulinezhad, Shahbaz and Vo2021). The requirement for electricity sector reform imposes an additional political bottleneck in these regimes’ resistance to the transition to RES-based electricity systems, making governments hesitant to advance changes in the complementary elements. This situation prolongs fossil fuel lock-ins, making it more difficult for renewable investments to gain higher economic returns than fossil fuel ones (Firdaus & Mori, Reference Firdaus and Mori2023). This is why investment patterns have been kept intact instead of using divest–invest strategies (Rosenbloom & Rinscheid, Reference Rosenbloom and Rinscheid2020).

The dual challenges accrued to the hybrid model and high stranded costs have reinforced the barriers to decarbonising the electricity sector. Setting aside the unfavourable and uncertain policy environment, the dominance of state-owned utilities having a large portion of coal power generation in their portfolios and their poor creditworthiness as off-takers squeeze the space for private and international developers to gain profits from renewable energy investments, shrinking demand for renewable energy financing (Liebman et al., Reference Liebman, Reynolds, Robertson, Nolan, Argyriou, Sargent, Sachs, Woo, Yoshino and Taghizadeh-Hesary2019). State-owned utilities are reluctant to develop, or incapable of developing, renewable energy projects that would leave their coal assets stranded. Underdevelopment of the capital market makes it difficult to provide and access long-term financing. Due in part to banks’ perception of renewable investments as risky, short debt tenures and high debt-financing costs make renewable energy developers reluctant to access bank loans (Nguyen et al., Reference Nguyen, Chuc, Dang, Sachs, Woo, Yoshino and Taghizadeh-Hesary2019). The limited availability of non-recourse financing deters investments (Sarangi, Reference Sarangi, Sachs, Woo, Yoshino and Taghizadeh-Hesary2019).

The OECD and G20 agreement on ending official export credit for unabated coal power plants (OECD, 2021a) posed an additional challenge. The official export credit has supported EMDEs to build new coal power capacity and thus has been criticised as a source of coal lock-in (Davidson, Reference Davidson, Gao, Busby, Shearer and Eisenman2023; Sauer et al., Reference Sauer, Anadón, Kirchherr, Braeckman and Schulhof2022). Subsequently, over 200 globally significant financial institutions established coal exclusion policies and accelerated coal divestment (Trivedi & Srivastava, Reference Trivedi and Srivastava2023). The agreement and policies force EMDEs to give up new coal power projects so long as they depend on international finance. While the amount of coal power investment has decreased since 2015, the decrease was accelerated in 2023 (Figure 1.1d).

Figure 1.1(d)

Global coal power investment by economic category, 2015–2023.

Source: Same as Figure 1.1a.

Figure 1.1(e)

Global nuclear power investment by economic category, 2015–2023.

Source: Same as Figure 1.1a.

GFANZ’s JETP and ADB’s Energy Transition Mechanism (ETM) were launched to address these triple challenges. JETP deals have been announced for South Africa, Indonesia, and Vietnam and are under negotiation with India. The ETM agreed to provide finance to Indonesia, the Philippines, and Vietnam. These partner countries have vertically bundled hybrid electricity models but with varied extents of private participation, wholesale market development, and retail competition (Figure 1.2). One extreme is South Africa, where state-owned utility companies dominate the whole system. The other extreme is India, where private participation is widely accepted in generation, and various types of privatisation have been undertaken in distribution with varying performance (Dubash et al., Reference Dubash, Kale, Bharvirkar, Dubash, Kale and Bharvirkar2018). State-owned utilities become less dominant in generation as private developers increase RES-E supply (Figures 1.3a and 1.3b). Others fall in between. The Philippines is an exception; the country has undergone vertical unbundling, developed a nationwide wholesale spot market, and increased retail competition to a limited extent.

Figure 1.2

Electricity systems in selected emerging markets and developing economies.

Figure 1.2 Long description

Image of a figure presents a comparative overview of the electricity sectors in six countries: China, India, Indonesia, the Philippines, South Africa, and Vietnam. It is organized across five key segments of the electricity supply chain: Regulation (regulatory bodies and their influence), Generation (market nature and roles of state or private entities), Transmission (system operators and market structure), Distribution (local or regional operators and monopoly status), and Supply (tariff determination and competition). For example, China lists the National Electricity Commission and SGCC/CSG; India lists the Central Electricity Regulatory Commission and POWERGRID with a competitive market; Indonesia shows the Ministry of Energy and Mineral Resources with a regulated national monopoly (PLN); the Philippines includes the Energy Regulatory Commission, NPC, and Transco/NGCP; South Africa lists Eskom with a regulated national monopoly (NTC); and Vietnam lists the Ministry of Industry and Trade (MOIT) and EVN with a regulated national monopoly (EVN-NPT). Data sources are cited at the bottom, referencing several studies and reports such as Cen (2021), Dubash et al. (Reference Dubash, Kale, Bharvirkar, Dubash, Kale and Bharvirkar2018), and EVN (2021).

Figure 1.3(a)

Percentage of installed power generation capacity by ownership in India, 2001–2022.

Source: Compiled by the authors based on data from the Central Electricity Authority, India (2022; 2023).

Figure 1.3(b)

Percentage of installed RES-E capacity by ownership in India, 2001–2022.

Source: Compiled by the authors based on data from the Central Electricity Authority, India (2022; 2023); data is missing for 2011, 2013, 2015, and 2016.

The extent of coal lock-in also varies among them. Coal-abundant economies such as India have historically used coal as the primary source of power generation. Long-term coal supply contracts with coal-mining and transport companies (Carl, Reference Carl, Thurber and Morse2015), long-term power purchase agreements with large industrial and commercial customers (Kumar & Chatterjee, Reference Kumar and Chatterjee2012; Rose et al., Reference Rose, Stoner and Pérez-Arriaga2016), and cross-subsidy for residential use and agricultural irrigation (Rahman et al., Reference Rahman, Mori and Rahman2022) have reinforced infrastructural, institutional, and social lock-ins (Mori, Reference Mori, Ekins, Kim and Kacaribu2024). In addition to the lock-ins, these economies have piled up new coal power plants. Although rapid increases in RES-based electricity have gradually reduced the proportion of coal power used in India and South Africa, the lock-ins block rapid shifts in the energy mix compared with China (Figure 1.4).

Figure 1.4

Percentage of coal in the energy mix of power generation in ETM and JETP countries and China, 2000–2022.

Source: Compiled by the authors based on data from the International Energy Agency (IEA, 2024h; 2024i; 2024d; 2024a; 2024j; 2024b).

Oil- and natural-gas-abundant economies such as Indonesia shifted their primary energy source towards coal in the 2000s and 2010s to address future depletion, mostly financially backed by China (Mori, Reference Mori2020). The Philippines and Vietnam have increased coal imports to increase coal power generation. These young coal power plants and supporting infrastructure discourage governments and power producers from retiring their plants much earlier than the natural ends of their lifetimes.

Seeing that the JETP and ETM are small, slow, and demanding, partner countries pay more attention to bridging technologies and transition finance to address the challenges they face. Investments in oil and gas upstream and power generation capacities have rebounded in EMDEs since 2021 (Figure 1.1c). EMDEs and China have noticeably increased nuclear power investments since 2022 (Figure 1.1e). ASEAN adopted the category of ‘Amber’ in its taxonomy to denote activities that contribute to sustainability but that require remedial measures to transition (ASEAN Taxonomy Board, 2021; 2023).

1.5.1 Multiple System Transitions

We can understand these necessary synchronised system transitions as multiple transitions of different sociotechnical systems. They can be defined as the third phase of net-zero energy transitions (Markard & Rosenbloom, Reference Markard, Rosenbloom and Araújo2023).

• Phase I: Emergence and adoption of niche technologies such as wind and solar powers

• Phase II: Whole-system change and decline within a single energy or electricity sector

• Phase III: Multiple transitions of different sociotechnical systems

• Phase IV: Transitions in hard-to-abate and carbon-intensive sectors

Attention to financial system transitions may potentially overcome the limitations of the traditional financial risk–return thinking in finance theory. Financial risk–return thinking can be expanded to argue that changes in capital costs induced by climate-related transition costs will be propagated to the financial and real sectors and will eventually advance system transitions towards net zero. However, the geographical concentration of sustainable finance and the slow implementation of the Paris–Glasgow financial regime raise concerns about the speed of behavioural changes that changes in capital costs will generate in electricity systems.

Previous research has investigated a variety of aspects of financial system transitions. These include the effects of green bonds on corporate net-zero emissions and sustainable development (Bhutta et al., Reference Bhutta, Tariq, Farrukh, Raza and Iqbal2022), sustainable business model innovation in the banking sector (Yip & Bocken, Reference Yip and Bocken2018), macroprudential policies such as climate-related stress tests (Dunz et al., Reference Dunz, Naqvi and Monasterolo2021; Monasterolo et al., Reference Monasterolo, Zheng and Battiston2018), and microprudential policies such as disclosure requirements and environmental and social risk management standards (Cato, Reference Cato2022).

Recent publications have begun to cover the impacts and responses of the energy and financial sectors (Claeys et al., Reference Claeys, Le Mouel, Tagliapietra, Wolff and Zachmann2024). Researchers have proposed causal mechanisms for the propagation of climate-related risks and have investigated changes in capital costs and their impacts through scenario analyses, from the real to the financial sector (Campiglio et al., Reference Campiglio, Daumas, Monnin and von Jagow2022; Daumas, Reference Daumas2023).

However, all of these studies are based on traditional financial risk–return thinking and optimal risk–return investments in the mainstream finance theory. They have not provided the theoretical foundation, analytical frameworks, or empirical evidence that support transformative finance or finance for electricity system transitions.

Multi-sector transition research has been growing within sustainability transition research to unpack the complexity of multi-system interactions (Ohlendorf et al., Reference Ohlendorf, Löhr and Markard2023). However, the field is still small and niche and focuses mostly on transitions of upstream and downstream sectors of the supply chain, such as automobile and battery manufacturing, mineral-extractive sectors, and electricity generation and abatement technology manufacturing sectors (Finstad & Andersen, Reference Finstad and Andersen2023). While analytical frameworks have been developed to understand why ongoing multi-system interactions among upstream and downstream sectors have not evolved into cross-system coupling (Andersen & Geels, Reference Andersen and Geels2023) current multi-sector transition research has not recognised transitions in financial systems, and thus has not observed synchronised changes in the financial and energy sectors as such.

1.5.2 Financial System Transitions

Transformative finance or finance for transformative changes is presented as a counterargument to traditional financial risk–return thinking and optimal risk–return investments. It includes exploration of the shift of capital allocation towards long-term sustainability investments and priority on financial return from investing in system change, performance evaluation of clients from financial value towards integrated value (Schoenmaker & Schramade, Reference Schoenmaker and Schramade2021), and fostering in-house skillsets and mindsets to map out unquantifiable systemic uncertainties and maximise system change impact focusing on long-term benefits (Loorbach et al., Reference Loorbach, Schoenmaker and Schramade2020). Transformative finance may be an element of financial system transition that would accelerate net-zero real-sector transitions and overcome the short-termism that has blocked the financing of long-term sustainability investments. Newell (Reference Newell2021) goes further to require greater social and democratic control over the ownership, direction, regulation, production, consumption, and financing of energy.

However, these proposed financial system transitions demand changes that may be too radical for incumbent financial actors to accept under current institutional and organisational arrangements.

1.5.3 Multiple System Transitions in Highly Coal-Dependent Small EMDEs

In addition, little research has paid attention to small EMDEs that are highly dependent on coal and on international finance. They were hit hardest by the OECD and G20 agreements on the end of official export credit for unabated coal power because most of their energy production capacity development has relied on international finance. There is much research on highly coal-dependent large EMDEs such as China and India, which are far less dependent on international finance. These economies can mobilise domestic finance to increase coal power and ensure national energy security, energy for all, and international finance to increase RES-E and mitigate increases in CO₂ emissions. In contrast, small EMDEs have less domestic financial capital and thus cannot mobilise finance to take the same energy transition strategy as China and India.

Apart from the studies initiated by the Economic Research Institute for ASEAN and East Asia (ERIA), few practical financing and energy transition strategies have been argued for so far. ERIA has published collections of papers on the role of finance in low-carbon energy systems (Anbumozhi et al., Reference Anbumozhi, Kalirajan, Kimura and Yao2016), low-carbon energy transitions (Anbumozhi et al., Reference Anbumozhi, Kalirajan and Kimura2018), and renewable energy (Phoumin et al., Reference Phoumin, Taghizadeh-Hesary, Kimura and Nepal2023) in Southeast and Northeast Asia. These books have explored how green finance has induced energy efficiency and increased the use of renewables in energy production and consumption. However, most of them did not focus on the gap between the achieved reduction in fossil fuel consumption and carbon emissions, and the reduction required to achieve the net-zero target. Few have gone beyond the changes in the energy mix to give insights for overcoming the dual challenges of the hybrid electricity model and coal lock-ins and reconciling international coal divestment, net-zero targets, and national energy security.

1.6.1 Aims, Scope, Research Questions, and Structure

The book fills these three research gaps on the multiple-system transitions of finance and energy systems, practical strategies for financial system transitions, and their applicability in EMDEs. The book assumes the 2050 net-zero emissions target as given and limits the scope to the Paris–Glasgow financial regime, which we define as the financial regime associated with the goals of the Paris Agreement and reinforced in the process for the Glasgow COP 26. The book also covers net-zero transitions in the financial sector that are involved in electricity system transitions towards net zero in EMDEs.

For this purpose, the book raises two research questions:

1. (1) Why has the Paris–Glasgow financial regime and financing net zero been slow in progress?

2. (2) Why are highly coal-dependent small EMDEs attracted to the shift to natural-gas-based electricity systems instead of RES-based ones?

To answer the first question, we identify possible underlying factors and mechanisms in both the financial sector and the electricity sector that would retard the Paris–Glasgow financial regime and the financing of net zero. Then we employ a simplified cost–benefit framework to illustrate the cost–benefit schedules associated with net-zero transitions and demonstrate how the underlying factors and mechanisms that we have identified here can change transition costs and benefits.

To illustrate the cost–benefit schedules, we employ the Global Change Analysis Model (GCAM) to estimate the cost of technological changes and assess the costs and benefits of changes in other complementary elements in an electricity system through empirical case studies. The illustration answers the second research question.

Based on these answers, the book proposes practical net-zero finance and electricity system transition strategies that are suitable for highly coal-dependent EMDEs.

The remainder of the book is organised as follows. Chapter 2 develops a framework that explains plausible causal mechanisms for the propagation of climate-related transition risks between the financial and electricity sectors, based on a literature review. The framework may help readers to understand how the financial and real sectors react to climate-related transition risks, and what underlying factors play key roles in their behavioural changes.

Chapter 3 builds an analytical framework that illustrates different pathways towards RES-based electricity systems by grid paradigm – the super-grid, distributed smart-grid, and flexible grid paradigms – by developing from the work of Fox-Penner (Reference Fox-Penner2020), Markard and Hoffmann (Reference Markard and Hoffmann2016), and Mori (Reference Mori and Mori2021b). The framework enables us to identify different sets of changes that are required in the transitions by grid paradigm. The framework suggests that the financial sector must go beyond financing technological and organisational changes at the company level to induce changes in infrastructural and institutional elements to advance electricity system transitions towards net zero.

Chapter 4 estimates the technological costs of electricity system transitions towards net zero in Southeast Asia. By conducting several scenario analyses with different combinations of technological applications using the GCAM, the chapter suggests that heavy technological transition costs give additional stimulus to the energy switch from coal to gas for power rather than to transitions to an RES-based electricity system. Net-zero emissions targets will impose substantially heavier technological transition costs in the Southeast Asian region (except Indonesia): more than 10% of annual GDP for new installation of RES-E capacity and 2–3% for stranded costs owning to the early retirement of fossil fuel power plants in 2026–2035. The availability of CCUS mitigates the transition costs by 3% in 2031–2035 but increases it by 1% in 2036–2040, while a global gas price hike reduces the transition costs by 1.5–2% of GDP annually in 2021–2050.

Chapters 5 and 6 employ the analytical framework built in Chapter 3 in empirical country case studies with inductive, longitudinal multi-case designs to assess the costs and benefits of infrastructural, institutional, and organisational changes associated with electricity system transitions towards net zero in Vietnam (Chapter 5) and in the Philippines (Chapter 6).

We take Vietnam and the Philippines as empirical case studies for two reasons. First, the Southeast Asia region rapidly increased installed coal power capacity in the 2010s and thus has many young coal power assets that will incur higher costs to asset owners if stranded. The region is likely to choose natural gas as the primary response to credit rationing and deter the net-zero energy transition. Particularly, Vietnam and the Philippines perceive natural gas and LNG power generation as bridging technology and have begun LNG imports on a large scale (Nitta & Shiga, Reference Nitta and Shiga2023) despite suspicion of underutilisation of LNG infrastructure (as expressed by Take, Reference Take2023). The Philippines regards natural gas as a clean and indigenous source of energy and a balancing energy that can satisfy the grid’s intermediate or mid-merit supply requirements (Philippines Department of Energy, 2021a).

Second, the two countries exhibit a sharp contrast in the electricity model: in Vietnam, there is vertically integrated, centralised, monopolistic supply by state-owned electricity utilities (Electricity Vietnam, EVN) with partial liberation of generation; in the Philippines, there is unbundled, market-based supply by oligopolistic generators, single private system operators, and regionally monopolised distribution units with hundreds of distributed energy resources and microgrids. An in-depth comparative analysis of the two countries can provide valuable implications for countries struggling with transitions from coal-based electricity systems to other electricity models.Footnote ³

Chapters 5 and 6 reveal that high transition costs associated with infrastructural and institutional changes prolong the transition process, causing a loss of momentum for the transition to RES-based electricity systems. Coupled with predicted growing electricity demand, these factors prompt the two countries to choose a fuel switch from coal to LNG to immediately respond to credit rationing rather than transitioning to RES-based electricity systems.

Chapter 7 explores how the Paris–Glasgow financial regime rebalances the cost–benefit schedules associated with electricity system transitions towards net zero; the chapter focuses on the JETP and ETM, comparing them with GCF. We find that the current commitment to ETM and JETP has not yet filled the financial gap for net zero, either quantitatively or qualitatively. Few programmes have been specified for disbursement. The long procedural process and institutional reform requirements delay actual disbursements, posing challenges for private financing and scaling.

Finally, Chapter 8 discusses why the JETP and ETM and the Paris–Glasgow financial regime have not generated transformative changes in electricity systems in highly coal-dependent small EMDEs, using the research results presented in Chapters 3–7. We find that in these cases the benefit of electricity system transitions towards net zero is substantially smaller than the cost, and the ETM and JETP have only marginally filled the gap quantitatively and qualitatively. Transition and transformative finance may facilitate transformative changes in incumbent electricity companies and move electricity systems towards net zero, but traditional financial risk–return thinking, optimal risk–return investments, and short-termism must be overcome to make transition and transformative finance work.

1.6.2 Scholarly Contributions

We highlight three scholarly contributions of this book. First, the book provides a novel analytical viewpoint of net-zero finance. Net-zero finance is different from divestment and renewable energy finance (Donovan, Reference Donovan2020; Raikar & Adamson, Reference Raikar and Adamson2019), not to mention the incorporation of social and environmental concerns into energy systems (Dorsman et al., Reference Dorsman, Arslan-Ayaydin and Karan2016). It proposes the facilitation of transformative changes in systems, and synchronised changes in the complementarity elements of systems, in the move towards net-zero GHG emissions. It goes beyond technological fixes or product-and-process changes at the company level (Clayton et al., Reference Clayton, Spinardi and Williams1999). This is why net-zero finance must be analysed and evaluated from the viewpoints of system transformation or sustainability transition. The book takes electricity systems as a case to evaluate net-zero financial mechanisms under the Paris–Glasgow financial regime and identify underlying factors and cruxes that can make them work effectively.

Second, the book argues for finance system transitions and explores their interaction with electricity systems transitions. Traditional financial risk–return thinking and optimal risk–return investments in mainstream finance theory assume that changes in the cost of capital, triggered by changes in technology, policy, and perception, are propagated into the real sector, eventually generating behavioural changes and changes in the economic structure. In contrast, the financial sector is assumed to maintain the current investment rules: maximising financial returns instead of the integrated value that incorporates environmental and social ones, abiding by fiduciary duties that focus only on financial return, managing quantifiable risks instead of creating and capturing integrated value, and short-termism instead of long-term return.

The book presents a counterargument to these implicit assumptions based on the cost–benefit schedule of electricity system transitions towards net zero and proposes practical strategies for finance system transitions. Then it argues that net-zero finance system transitions can rebalance the costs and benefits of electricity system transitions towards net zero, expanding net-zero transitions economy-wide.

Third, the book provides novel empirical findings on the costs and benefits of electricity system transitions towards net zero in Southeast Asia, particularly in highly coal-dependent small EMDEs. It employs mixed methods: quantitative scenario-based analysis and empirical case studies of Vietnam and the Philippines. The former estimates the cost of technological changes in Southeast Asia, whereas the latter investigates the costs and benefits of the changes in other complementarity elements and combines the results. The latter approach also tests the validity of the proposed analytical framework for electricity system transitions and indicates elements that should be counted on to investigate the costs and benefits.

While our empirical case studies do not quantitatively estimate costs and benefits, their basis on empirical evidence makes the results convincing and applicable to coal-dependent small EMDEs in other Southeast Asian countries and beyond the Southeast Asian region.