FORT LAUDERDALE — The rise of climate change as a global challenge, and the simultaneous need to address its cause by moving away from carbon-intensive sources of commercial energy, is feeding the rapid evolution of sustainable finance.
Socially responsible investing, once the domain of boutique firms such as Trillium Asset Management, First Affirmative Financial Network, Calvert Investments and Walden Asset Management, are now offered by large investment banks and institutional investors, such as public pension and sovereign wealth funds, who is a greater need for community impact beyond a bottom-line return.
The increasing risks of climate change and sea-level rise now join this long-established set of criteria for judging the relevance of environmental, social and governance (ESG) issues when assessing corporate investment. More and more multinational companies are modernizing their investor relations and citizenship and corporate social responsibility disclosures to meet this expanding scope of stakeholder interest and engagement.
Global warming, the conservation of natural capital (soil, air, water, biodiversity) and sustainable human development generally needs an estimated $5-7 trillion a year in overall investment. Currently, less than one percent of global bonds are considered “green”, and the same small percentage of assets held by institutional investors around the world are eco-friendly infrastructure.
This requires a rethinking of not only our economic systems but of the financial sector as well. At a minimum, green finance is understood as the funding investments that provide environmental benefits within the broader context of sustainable development. Reducing air, water and land pollution as well as greenhouse gas emissions are a few examples.
Some obstacles to scaling up green finance include internalizing environmental externalities, asymmetry in investment information, inadequate analytical capacity on the part of financial institutions and the press and a lack of clarity in the terms and definitions being used.
During the last decade, various ways to mobilize the financial sector have emerged globally. Several leading countries have developed voluntary principles for sustainable lending and enhanced environmental disclosure requirements. Collaboration among central banks, finance ministries, regulators and market participants has grown to include strategic policy frameworks for green investment; voluntary principles for green finance; development support for global green bond markets; knowledge sharing for connecting environmental and financial risk as well as metrics for gauging the impact of green financial activities.
European countries such as Germany, Denmark (fossil fuel-free economy by 2050), Sweden (fossil fuel-free economy by 2040), Portugal and in particular, Luxembourg, have established themselves as leaders in green growth. A new Luxembourg-European Investment Bank (EIB) climate finance agreement, for example, will invest more than 30M euros in climate-related projects to mobilize private, third-party investors. In addition, Luxembourg’s new Green Exchange (LGX) will take over $45B worth of green bonds now listed on the Luxembourg Stock Exchange.
But Europe’s not alone. “China’s green finance reforms will be seen as a pivot point in the history of the development of the world’s financial system,” said Philipp Hildebrand, vice chairman of asset management firm Blackrock.
On Aug. 31, the People’s Bank of China (PBoC), Ministry of Finance, National Development and Reform Commission (NDRC), Ministry of Environmental Protection, China Banking Regulatory Commission (CBRC), China, Securities Regulatory Commission (CSRC) and China Insurance Regulatory Commission (CIRC) jointly released new guidelines for establishing a green financial system within the country. The meeting was chaired by President Xi Jinping, whose involvement signaled a personal endorsement of the work led by the Dr Ma Jun.
Key points from Chinese guidelines:
1/ A green financial system is an integral part of supply-side economic reforms;
2/ Unified definitions are needed for financial products, services and investment vehicles;
3/ Standardized assurance by third parties and credit agencies;
4/ Standardized disclosure requirements and penalties; and
5/ Regulatory efficiency and institutional support in the form of indices, data, reporting and compliance standards.
Moreover, the China-backed Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB) founded by the BRICS countries (Brazil, Russia, India, China and South Africa) has also begun to move aggressively through the financing of green development projects throughout East and South Asia.
China’s guidelines fed into the Sept. 5 G-20 statement supporting green finance that was issued at the group’s summit in Hangzhou, China. It welcomed options put forward by the G20 Green Finance Study Group (GFSG) that is developing voluntary proposals for scaling up private capital. This was the first time that G-20 leaders mentioned the importance of green finance.
The GFSG is co-chaired by China and the United Kingdom and administered by the United Nations Environment (UNEP) program.
“The adverse effects of climate change threaten economic resilience, growth and financial stability. Given the scale of the investment capital needed, financial markets are best placed to finance the transition to a low carbon economy. So the work of the GFSG is critical in identifying options to address institutional and market barriers to bringing green finance into the mainstream,” said GFSG co-chair Mark Carney, who is also chief of the Bank of England.
As part of its mission, the GFSG developed “a green finance synthesis report” and submitted it to G20 finance ministers and central bank governors at their most recent meeting in Chengdu.
The report provides ways to overcome three challenges facing the development of a green financial system internationally, including the internalization of environmental externalities (natural capital accounting, carbon & financial transaction taxes), the absence of universal definitions for what constitutes green finance and the lack of adequate environmental information reporting, disclosure and transparency (see Sustainable Stock Exchanges Initiative).
Failure to internalize costs properly leads to under-investment in green activities. Without a proper long-term, cost-benefit analysis of renewable projects that incorporates such factors as reductions in pollution or improvements in the quality of life, the return on investment for renewable projects appears too low to attract sufficient financing, exacerbated by the fact that the assessment of “true environmental risks” is relatively new to most banks and institutional investors. In addition to fiscal and environmental policies, they include such measures as guarantees, concessional loans, demonstration projects, adoption of risk management principles and methods, and green labeling.
Clear definitions and guidelines for what constitutes green finance are essential for investors, companies, and banks. The report suggests that the G20 and country authorities promote an initiative based on China’s leadership in this area. China’s guidelines define green finance as: “Financial services provided for economic activities that are supportive of environment improvement, climate change mitigation and more efficient resource utilization. These economic activities include the financing, operation and risk management for projects in areas such as environmental protection, energy savings, clean energy, green transportation, and green buildings.”
Finally, the report highlights that the lack of disclosure of environmental information by companies, the lack of consistent and reliable “labeling” of green assets, the scattering of data among many government agencies, and financiers’ lack of information about the commercial viability of green technologies are all major barriers to green finance. It recommends that countries, international organizations and the private sector work together to develop, improve, and implement voluntary principles. Once again, China’s guidelines acknowledge the importance of environmental information reporting and transparency and recommend increased disclosure.
To that end, in April 2015, the G20 asked the Financial Stability Board (FSB) to consider risks related to climate change. In December of that same year, FSB launched the industry-led Task Force on Climate-related Financial Disclosures (TCFD).
TCFD will develop a set of recommendations for consistent, comparable, reliable, clear and efficient climate-related disclosures by companies, as requested in the FSB’s proposal. The TCFD has concluded that its recommendations will apply broadly to financial and non-financial firms.
TFCD published its first report in April 2016.
(This post was compiled from various news sources)