The Role of Disclosure in Green Finance

In this article, we study the design features of disclosure regulations that seek to trigger the green transition of the global economy and ask whether such interventions are likely to bring about sufficient market discipline to achieve socially optimal climate targets. Transparency obligations stipulated in green finance regulation can be categorized as either compelling the standardized disclosure of raw data, or providing quality labels that signal desirable green characteristics of investment products based on a uniform methodology. Both categories of transparency requirements can be imposed at activity, issuer, and portfolio level. Finance theory and empirical evidence suggest that investors may prefer 'green' over 'dirty' assets for both financial and non-financial reasons and may thus demand higher returns from environmentally harmful investment opportunities. Investor-led market discipline can benefit from mandatory transparency requirements and their rigid (public) enforcement, because these requirements prevent an underproduction of standardized high-quality information. However, many forces and frictions may also steer market outcomes away from socially optimal equilibria aligned with climate targets. Disclosure-centred green finance legislation is a second best to more direct forms of regulatory intervention (eg global emissions trading), but can play a supporting role in the sustainable transition, especially while first-best solutions remain politically unavailable.