The reality of climate change and the imperative to cut greenhouse gas (GHG) emissions globally is requiring leaders in business, government, and civil society to consider what will be required to have a competitive economy with much lower GHG emissions. Green investment capital and financing need to be mobilized to address climate change, support transformation toward an economy with much lower or no net GHG emissions and sustain robust economic performance. Finance is not going to solve climate change, but it has a central role to play in making the transition happen.
How much financing and investment is needed? At a global level, a recent Morgan Stanley study estimates that a staggering $73 trillion in global investment is required over the next three decades to transition to a global energy system with no GHG emissions.[1] Of that amount, $16.6 trillion (USD 2013) would be invested in China, about $7.8 trillion in the U.S., and about $6.2 trillion in Europe. This investment would include power generation with no GHG emissions (hydro, wind, solar and nuclear), transmission and local distribution, and expanded and enhanced use of electricity by consumers, businesses, and governments.
Who will provide the required investment capital and financing? Green finance has been treated as a marginal activity to now, but that is quickly changing. Larry Fink, the chair of Blackrock Capital, a market-leading global investor and asset manager, just released a letter stating that climate change has become a defining factor in companies’ long-term prospects. In his view, we are on the edge of a fundamental reshaping of finance. Climate risk is investment risk and needs to be taken fully into account.
Pools of capital, institutions and expertise in the private sector will ultimately deliver the bulk of sustainable financing. National and sub-national governments the world over have recognized the opportunity to manage new climate risks and accelerate the low-carbon transition, while at the same time spurring economic development. Traditional and emerging financial centers are beginning to show ambitions to become global hubs in green finance. Indeed, Momentus (Formerly IFCL) has recently worked with economic development organizations to define strategies to position their jurisdiction as a sustainable finance centre in an increasingly competitive environment.
More broadly, private sector financial institutions are beginning to build green finance lines of business. They are earmarking portions of investment capital for green purposes, through equity investment, debt financing and insurance and other risk management products. Markets are developing for green bonds and specialized instruments like catastrophic bonds, and internal centres of expertise are being created.
What specific areas will require green investment capital and financing? These include:
The energy sector: Huge amounts of capital will be required to finance transformation to energy sources with low or no GHG emissions. Power utilities will need to expand and deepen their access to capital markets and may require additional equity investment from their owners. Firms in the oil and gas sector will be expected to reduce and capture GHG emissions and improve operating efficiency If they are to continue accessing capital.
Innovation in low-emissions technology and services: There is considerable activity in developing innovative technology and services that can help to reduce GHG emissions. Providing financing for low-emissions technology, start-ups and demonstration projects has become a priority for many governments.
Transition by consumers: Residential energy transformation and efficiency measures, choices on personal transportation, and other major consumption decisions can reduce GHG emission reductions and generate energy cost savings for consumers. Innovative access to consumer credit in all these areas could facilitate the transition.
Adaptation by existing firms: Many existing firms are developing ways to reduce their GHG footprint, which can both reduce operating costs and help to market their business. Sources of financing and insurance will look for business advantages from specific investment activities, notably reducing energy consumption and related emissions.
Infrastructure investment: Enhanced investment in existing and new infrastructure will be needed to increase its resilience to climate change, to meet future demand, and to reduce future GHG emissions.
The built environment: The built environment will need renovations and retrofits of existing buildings to reduce energy consumption and operating costs, and new structures that use efficient low-emissions energy and adopt state-of-the-art design, physical positioning, and materials.
International trade and investment, and international development: Low-carbon economic activity extends beyond national borders – there will be a need for financing and risk management to facilitate exports of low-emissions products, technology, and services.
In addition to the private sector, government-backed financial institutions can play a valuable role in addressing green finance and investment market gaps and needs, ideally working in a complementary fashion with the private sector to build overall market capacity. Many export credit agencies (ECAs) and national development banks (NDBs) already have aspects of green finance in their mandates to facilitate export sales, help emerging businesses, and support national development priorities. Existing ECAs and NDBs that are not already active in green finance and investment will need to develop strategies and instruments to become players.
There is also an opportunity to create new targeted “green banks”, which already exist in a number of jurisdictions. They could be established at the sub-national, national or regional level to help mobilize capital and provide financial capacity for aspects of low-emissions economic development. New green banks could be created, capitalized by governments and other partners, and given a mandate to provide green financing and investment to clients and transactions while building core expertise in the low-emissions economy. They could also work closely with existing financial institutions and power utilities, aiming to expand overall green finance market capacity. The question of whether governments should seek to establish a new green bank or ‘green’ an existing one was addressed by our firm in a recent paper for the Inter-American Development Bank.
A green bank could help fill several expected financial market gaps.
— Owners of commercial, institutional and residential buildings will require access to credit in order to reduce their GHG footprint by cutting and transforming energy consumption and by improving operating efficiency.
— Consumers will need innovative access to credit in order to undertake residential energy retrofits and efficiency measures, and to finance major consumption decisions that would reduce GHG emissions. Here, green banks could work closely with other lenders, insurers and utilities that already have a business relationship with consumers.
— Enhanced investment in existing and new public infrastructure will be needed in order to increase its resilience to climate change, to meet future demand, and to reduce future GHG emissions.
— Start-up development funding and investment in innovative low-emissions technology and services could also be part of a green bank’s mandate, either on its own account or by delivering government-backed initiatives.
In short, expanding access to green investment and financing will be a key part of a successful low-emissions economy. The game is changing and there is a clear opportunity for nimble financial institutions to position themselves as leaders in this space, including ECAs, NDBs and green banks. They will need the right technical expertise and innovative capacity to help build national, regional or even global capacity in market segments.
[1] Equivalent to almost half the value of 2020 global GDP at PPP.
