Introduction

This paper is a multi-asset class framework designed to guide financial institutions in decarbonising the real economy by strategically allocating capital to regions and sectors that require the most effort to achieve net-zero emissions. The report outlines an approach that integrates fiduciary duties with decarbonisation goals and encourages collaboration with policymakers and multilateral banks. It aims to close the global investment gap needed to meet climate goals, estimated at USD 7.3 trillion annually until 2050.

Compass-FRWD: A multi-asset class decarbonisation framework

The framework operates by following a structured process:

• Identifying emissions gaps: It first compares the current policy scenario to a net-zero scenario, highlighting where the largest emissions gaps exist across regions and sectors.
• Capital allocation: Based on these emissions gaps, the framework allocates capital proportionally to the effort needed to decarbonise specific regions and sectors.
• Net Zero Deviation Index (NZDI): The NZDI is a key tool used to track how closely actual capital allocation aligns with net-zero targets. The aim is to progressively reduce this deviation over time, ensuring the portfolio’s capital flows support decarbonisation.
• Iterative portfolio adjustments: The framework allows for iterative adjustments to portfolios, ensuring they evolve based on new data and regional constraints. This process involves ongoing collaboration with financial institutions, policymakers, and stakeholders to optimise capital allocation.

By following these steps, Compass-FRWD helps guide financial institutions in making informed, decarbonisation-focused investments.

Compass-FRWD: Asset screening

To ensure investments align with net-zero targets, the report recommends a rigorous asset screening process. This involves using both taxonomy-based approaches (which classify climate-aligned activities) and pathway-based approaches (focused on an entity’s long-term net-zero plans). These complementary approaches are designed to strengthen the robustness of investment decisions.

Focus on impactful fixed-income instruments: Green, social, sustainability, and sustainability-linked bonds

Fixed-income instruments, especially Green, Social, Sustainability, and Sustainability-Linked (GSSS) bonds, are highlighted for their significant potential in driving decarbonisation. Green bonds alone reached USD 1 trillion in cumulative issuances by 2024, led by sovereign and corporate issuances. However, challenges persist, particularly regarding voluntary standards and the risk of greenwashing.

Sustainability-linked bonds (SLBs) are also seen as crucial, particularly for sectors without sufficient green projects. The report calls for more transparency and stricter standards to ensure SLBs’ credibility, especially in high-emitting sectors.

Challenges to scaling up

The report stresses the need to increase climate finance by five times to meet decarbonisation goals. Emerging markets and developing economies (EMDEs) face additional hurdles, such as high capital costs, currency risks, and the lack of investment-grade ratings for many projects. Private capital flows to these regions need to increase fifteen-fold by 2050, with an estimated USD 850 billion required annually for the energy transition.

How to make it work within constraints of risk/return profiles

The framework advocates for a multi-asset class strategy to address decarbonisation challenges while balancing risk and return. Different asset classes are suited to different stages of technological development, with venture capital supporting early-stage innovation and fixed-income targeting long-term, stable projects. Collaboration with stakeholders, including multilateral development banks, is key to scaling climate finance in difficult sectors.