In the third chapter of its global financial stability report that was released on Monday, the IMF said that these investments would need to be oriented away from the fossil fuels sector and towards renewables as well as towards low-emissions solutions within sectors by switching to green investments, which are essential and urgent to facilitate the transition into a green economy.

Additionally, the report stressed that the sustainable investment funds sector can be a key driver of the global transition into a green economy, however, it is too limited in size and scope to have a major impact and faces challenges related to greenwashing.

In this respect, the report noted that despite their small size globally, the total assets under management of sustainable investment funds have grown rapidly over the past four years to record $3.6 trillion in 2020, with $130 billion out of this total constituting climate-oriented funds.

It added that a successful green transition requires a deep economic transformation alongside mobilisation of private finances on a large scale.

It also underpinned that shifting towards sustainable investment funds can support the transformation of economies through two main channels.

“First, investors make portfolio decisions based on their preferences for sustainability and their assessment of risks and opportunities, and these decisions create inflows into sustainable funds that increase the supply of capital available to firms supporting the transition. This in turn reduces their cost of capital and encourages transition-aligned investments geared towards emissions reductions,” read the report.

“Second, sustainable funds can influence firms’ strategies through stewardship, supporting the move towards more transition-aligned corporate policies.”

Moreover, the investment funds sector could also curb the impact of sudden transition shocks on financial stability.

The transition to a green economy could be a source of financial stability risk for firms adversely affected by the accompanying economic transformation as well as for financial institutions that hold claims on these firms, according to the report.

“Sudden and larger-than-expected transition shocks — such as a delayed and abrupt tightening in carbon policy — could be amplified by vulnerabilities in the investment funds sector and have a meaningful impact on financial stability. In such a scenario, investors would reassess risks, likely triggering outflows from funds with high exposure to transition risk, potentially leading to runs on these funds and fire sales and causing a further fall in asset values,” the report explained.

It also highlighted a number of challenges these kinds of funds in the field of green transition are experiencing, including data gaps, risk of corporate greenwashing, multiple disclosure standards, and a lack of globally accepted taxonomies.

The report also suggested that the upcoming 26th United Nations Climate Change Conference of the Parties may be a pivotal opportunity to scale up the transition to a low-greenhouse-gas economy and avoid climate change’s catastrophic impacts.