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Financial markets and climate transition: Opportunities, challenges and policy implications

Updated: Sep 20, 2023

The accelerating threat of climate change raises the urgency of commitment to climate transition, including the important role of global financial markets to align investment with net zero. Financial markets and climate transition focuses on the critical contribution financial markets must play towards achieving an orderly transition to low-carbon economies, and the policies needed to support this. It explores the key elements that could factor into market pricing of climate transition risks and opportunities, offers frameworks and case studies, reviews the growing range of market products and practices and puts forward policy options that can support this transition.

Simultaneously, the OECD released a report on ESG investing and climate transition which serves as an input report to the G20 Sustainable Finance Working Group. Environmental, social and governance (ESG) investing is gaining traction as investors increasingly seek long term value and alignment with sustainability and climate-related objectives. This report highlights the main findings from recent OECD research on ESG rating and investing. It offers policy considerations to strengthen ESG practices to foster global interoperability and comparability, as well as encourage greater alignment of environmental metrics with a low-carbon transition.

Both reports were launched at an OECD Ministerial Meeting side event on 4 October 2021 which hosted a high-level panel discussion on Strengthening ESG approaches and market alignment to foster climate transition.

Preface by the OECD Secretary-General

Climate change is accelerating. Now more than ever, ambitious and effective global action to address the impacts and future risks of the climate crisis is critical and urgent. Recent momentum behind governments’ climate commitments is encouraging. However, turning increased political ambition on climate emergency into outcomes that ensure a net-zero transition by 2050 remains the major challenge. Climate finance continues to grow, yet at the end of 2019, developed countries remained USD 20.4 billion short of meeting the goal of mobilising USD 100 billion a year to support developing countries’ green transitions.

A growing number of corporates, financial institutions and institutional investors are also making increasing efforts to assess physical and transition risks, and to publish climate transition plans to achieve net-zero emissions. In turn, financial markets are beginning to integrate climate transition risks and opportunities into investment decision making.

Despite this progress, market participants remain constrained in ways that prevent the needed scaling up of investment to foster an effective and efficient climate transition. There is a lack of progress on globally coordinated carbon pricing. In addition, the Task Force on Climate-related Financial Disclosure (TCFD) has advanced disclosure of climate-related financial information, but data gaps and incomparable metrics continue to hinder portfolio reallocation decisions and effective pricing of capital. Lack of transparency and comparability of environmental, governance and social (ESG) rating methodologies, as well as inconsistent measurement of climate transition factors in environmental pillar scores, further impede portfolio allocations that better align with net-zero pathways.

Addressing these challenges will require a thorough reset of the financial system by incorporating climate risks and opportunities across relevant aspects of central banking, supervision, regulation, and market practices for making investment decisions. This includes identifying policies to address biased incentives, capability gaps and inadequate climate risk disclosure that impede a substantial scaling up of low-emissions, resilient investments.

There are significant opportunities to dramatically reduce emissions, shift away from carbon-intensive activities and promote green growth. Financial markets across advanced and developing economies have a critically important role to play in helping to achieve these ambitious climate objectives every step of the way on our path to net zero. Actions by financial authorities and market participants can help strengthen market practices, confidence and integrity by encouraging greater transparency on the current products, practices and tools being used in financial markets, and by supporting the reallocation of capital towards greener alternatives, while discouraging capital flows to carbon intensive projects.

Improving sustainable finance approaches and enhancing market alignment with the climate transition is vital. To support these efforts, this report provides a framework to understand the ways in which financial markets are building capabilities to help facilitate an orderly transition and to allocate capital that helps incentivise companies’ transitions. It also includes recommendations to strengthen the comparability of climate-related metrics used in ESG approaches; to encourage transparency and appropriate labelling of climate transition indices, funds and products; to develop climate transition finance indices and funds; to use climate transition plans that rely on science-based targets; and to develop climate transition finance principles that ensure interoperability of approaches across jurisdictions and international markets. To move this important work forward, the OECD will advance a policy framework to align and integrate ESG factors that support a just transition to climate-resilient, sustainable growth.

The threat of climate change must be addressed as a core economic and financial system challenge. The OECD is committed to supporting whole-of-government actions to foster an effective, efficient and just transition that can enable low-carbon, sustainable and inclusive economic growth.

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