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Green finance is set to bloom

Corporate Risk Tools and Technology|Environmental
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By Gavin Newton and Leonardo Chaves | March 23, 2021

To meet the goals of the Paris Agreement, green finance will need to grow considerably.

up to $90 trillion will be needed between 2015 and 2030 to finance the global sustainable development and climate objectives.

As discussed in the renewable energy market review, it has been estimated that up to $90 trillion will be needed between 2015 and 2030 to finance the global sustainable development and climate objectives of the Paris Agreement 1. Investors and financers are increasingly focussing on projects in the following sectors which will help to achieve this:

  • Renewable energy
  • Energy efficiency
  • Clean transportation
  • Coal plant retirement
  • Waste management
  • Bioenergy
  • Climate adaptation and resilience
  • Agriculture and land use

One of the most successful results of this has been the rapid expansion of renewable energy projects. Investment into new renewable power projects has grown from less than $50 billion per year in 2004, to about $300 billion (94% in wind and solar) (2013-2018) 2. By 2018, investment into renewable power projects was 3 times greater than investment into fossil fuel power. Yet despite this growth, renewable investments remain below their potential. Investment in the sector will need to be scaled up to achieve the current climate and development targets. It has been estimated that annual investment in renewable energy power alone will need to double until 2050 to meet these goals.

new renewable power projects has grown from less than $50 billion per year in 2004, to about $300 billion (94% in wind and solar) per year in recent years 2013-2018)

At the same time as green project financing has increased, there has been active moves by global financial institutions to exit projects which are dependent on carbon fuels. In 2013, post-2019 3; this was followed in 2019 by 100 financial institutions (including 40% of the top 40 global banks and 20 globally significant insurers) divesting from thermal coal projects 4. This has been followed up in September 2020 with the announcement by the International Finance Corporation (IFC), the private sector arm of the World Bank Group, that they will no longer make equity investments in financial institutions that do not have a plan to phase out support for coal, as a means to encourage commercial banks in Africa and Asia to reduce their support for coal projects. The World Bank has also announced that it will not be financing upstream oil and gas projects after 2019 5.

Green finance

Although there is no single, agreed definition for green finance, the term is increasingly being used worldwide. The Organisation for Economic Co-operation and Development (OECD) defines it as finance for achieving economic growth while reducing pollution and greenhouse gas emissions, minimising waste and improving efficiency in the use of natural resources. The IFC defines it as the financing of investments that provide environmental benefits in the broader context of sustainable development. The definitions may vary but there are characteristics that are shared:

  • The aim of the finance is to allocate capital towards sustainable, climate resilient purpose.
  • A wider scope of environmental issues needs to be considered, with a focus on environmental benefits or reducing harm to the environment.
  • The project risks will be considered from an environmental standpoint. This will include the physical risks, the risks associated with transition towards a carbon neutral position (including stranded assets).
  • Taking account of sustainable development and/or economic growth.

In most circumstances, the finance products utilised are the same, regardless of the type of project being financed. The difference here is that the proceeds of the finance are directed at a green project, while a further major difference is in the way that the projects are assessed and managed. Financiers have adopted defined principles to ensure that projects are developed in a socially responsible way, reflecting good environmental management practices. A good example of this are the Equator Principles 6, IFC’s benchmark performance standards which have been adopted by over 90 banks and financial institutions (including 32 OECD export credit agencies). Projects seeking to raise finance will need to be aware of the principles that their financier has adopted and make allowance for the environmental focus of the assessment and management processes that will be required. This is a particularly important consideration when multilateral development banks are involved, as they play a key role in mobilizing and scaling up finance for green projects.

The green bond market began over a decade ago with the European Investment Bank’s first issuance of a Climate Awareness Bond in 2007. Since then the market has grown significantly with issuances in 2019 of $ 270 billion.

However, there are now specific green finance products which have been developed. The best known of these are green bonds (historically referred to as climate bonds). These are fixed income instruments, specifically designed to finance climate-related or environmental projects. They usually benefit from tax incentives to enhance their attractiveness to investors. The green bond market began over a decade ago with the European Investment Bank’s first issuance of a Climate Awareness Bond in 2007. Since then the market has grown significantly with issuances in 2019 of $270 billion 7.

The cumulative issuance of green bonds are below $1 trillion; this needs to be measured against the total global bond market which is valued at around $100 trillion, accounting for less than 1% of cumulative global bond issuances. These bonds alone will not provide enough finance to achieve a global shift to the Paris Agreement goals.

Green investment funds are mutual funds or investment vehicles which only invest in environmentally responsible companies.

Other examples of green finance products are green tagged loans, green investment funds and climate risk insurance. Green tagging is a systematic process which identifies the environmental attributes of the loans and the underlying assets to allow easier access to the green bond market and better tracking of green loan performance. Green investment funds are mutual funds or investment vehicles which only invest in environmentally responsible companies. Climate risk insurance is designed to mitigate the financial consequences and other risks associated with climate change.

Green banks

As the shift to a sustainable future has accelerated, many countries have set up or promoted the establishment of green banks to increase the level of low carbon, climate resilient and sustainable development. These banks have usually been capitalised through state investment. A recent report identified nearly 30 existing green banks with $24.5 billion capital invested in green projects attracting $45.4 billion of private co-investment (7).

a recent report identified nearly 30 existing green banks with $24.5 billion capital invested in green projects attracting $45.4 billion of private co investment.

Public Green Banks and other dedicated green investment entities have been established at a national level in Australia, Japan, Malaysia, Switzerland and United Kingdom, at a state and county level in the United States (California, Connecticut, Hawaii, New Jersey, New York, Rhode Island and Montgomery County, Maryland) and at city level in the United Arab Emirates (Masdar).

With specific mandates to invest in low-carbon, climate-resilient projects, these banks’ primary functions are to:

  • Encourage co-financing for green projects
  • Build pipelines of financeable projects
  • Address the risks associated with these projects
  • Provide green experts with local market knowledge

Conclusion: green finance is here to stay

The shift needed to achieve the Paris Agreement goals is driving significant changes in the types of projects being financed, the way that the financing is approached and the emergence of new finance providers and tools. These changes have resulted in new risk exposures and increased the complexity of the technologies employed. This means that financiers have an increased focus on the assessment, management and transfer of the risks arising from green projects and will seek to ensure that any collateral they have is fully protected. Companies seeking to raise finance need to be aware of their financiers’ concern and to allow for the costs and time to allow for full technical, legal and insurance assessment of the project risks.

Given the size of the investment that will be needed, together with the rapid development of new technologies to manage and adapt to climate change, the availability and importance of green finance is only likely to increase in years to come.

Footnotes

1 “Financing Climate Futures: Rethinking infrastructure,” OECD, accessed March 22, 2021. https://www.oecd.org/environment/cc/climate-futures/policy-highlights-financing-climate-futures.pdf

2 “Finance and investment.” Irena, accessed March 22, 2021, https://www.irena.org/financeinvestment

3 Tim Buckley, “Over 100 Global Financial Institutions Are Exiting Coal, With More to Come,” Institute for Energy Economics and Financial Analysis, February 27, 2019, http://ieefa.org/wp-content/uploads/2019/02/IEEFA-Report_100-and-counting_Coal-Exit_Feb-2019.pdf

4 Matthew Green, “World Bank's IFC adopts new climate rules to deter lenders from backing coal,” Reuters, September 24, 2020, https://www.reuters.com/article/climate-change-coal-idUSKCN26F06Y

5 “World Bank's IFC adopts new climate rules to deter lenders from backing coal,” The World Bank, accessed March 22, 2021, https://www.worldbank.org/en/news/press-release/2017/12/12/world-bank-group-announcements-at-one-planet-summit

6 “The Equator Principles,” Equator Principles, accessed March 22, 2021. https://equator-principles.com/wp-content/uploads/2020/05/The-Equator-Principles-July-2020-v2.pdf

7 Angela Whitney, Tamara Grbusic, Julia Meisel, Adriana Becerra Cid, Douglass Sims, Paul Bodnar, "State of Green Banks 2020," Rocky Mountain Institute, 2020, https://rmi.org/insight/state-of-green-banks-2020/

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