With the clock steadily ticking towards 2030, when the bulk of the reduction in carbon emissions must be achieved if the world is to reach its objective of net-zero status by 2050, the focus is turning to how the carbon transition will be financed
The world’s objective of reaching net-zero status by 2050 may seem a long way off, but many believe – especially in the wake of the IPCC’s recent report on the climate crisis – that the bulk of the actions required will need to be taken by 2030.
Dubbed ‘the decade of action’, the reality is that the vast majority of steps that need to be taken are not 30 years away but just over eight.
That tees up some huge challenges for the investment world – as it seeks to play its part in supporting government initiatives and financing the changes required to decarbonise the planet.
Both the public and private sectors have a part to play in providing transition finance. And the COP26 meeting of the world’s climate leaders in Glasgow in November is expected to be a huge catalyst for placing a greater focus on the financing process – from the public, private and third sectors.
The role of governments will be to encourage and incentivise investment by promoting the right landscape, while business will turn its expertise to garnering capital through innovative new investment opportunities, in part driven by climate-conscious investors.
Bill Prew, CEO of INDOS Financial, a JTC Group company, says: “Our view is that net zero will ultimately be financed by consumers and the capital markets, as it is simply too big a thing to be financed by governments alone.
“However, the role of governments and supranational bodies in creating the right environment will be crucial, and that will include regulation and legislation.”
UK leads the way
The UK is a world leader in committing to net-zero targets and will play a significant part in the transition, according to Mark Cleary, Interim MD Guernsey Funds and Director in Jersey at Zedra.
He points to the June launch of the UK Infrastructure Bank in Leeds, tasked with accelerating investment into ambitious infrastructure projects in support of regional economic growth and net-zero ambitions.
It will issue £10bn of government guarantees to help unlock more than £40bn of overall investment.
“What the bank may do is take the first tranche of risk and this will ‘crowd’ private capital into new projects,” says Cleary.
“By being innovative enough to create this bank, the UK will encourage private companies to invest alongside it and to increase the amount of capital that’s going to be invested in the sustainable infrastructure that will be needed.
“Banks will support this by providing loans at lower interest rates, perhaps linked to a decrease in carbon or some other sustainable outcome. Lower interest rates result in higher financial returns, too, so there’s a win-win here.”
Indeed, there’s some justification for the financial services industry to be proactive about the transition process, beyond pure self-interest, adds Sally Rochester, Director, Risk and Regulation, at Deloitte Guernsey.
Culpable City
Rochester cites a report released in May 2021 by Greenpeace UK and the World Wildlife Fund UK, which concluded that UK banks and asset managers were responsible for financing 805 million tonnes of CO2 in 2019 – 1.8 times the UK’s net annual emissions. This would make the City of London the ninth biggest emitter of CO2 in the world if it were a country.
Aiming for net-zero targets does not have to be at the expense of profitability, however, and many businesses are adopting a strategic approach.
Cleary says: “You’ve got to ask what incentivises private markets to invest in sustainable infrastructure or other net-zero products? There’s been quite a lot of evidence that you don’t necessarily give up returns by pursuing any ESG-related investment thesis.”
Ian Corder, Director of Standards and Operations at ESI Monitor, agrees – and sees no conflict for environmentally aligned businesses.
“For businesses using renewables, net-zero targets and profitability are absolutely on the same page. They will be able to corner the market, create new products and new markets – unlike those stuck on pathways that use polluting fossil fuels,” he says.
Alongside governments and financial institutions, investors are having a huge influence on business, and it is incumbent on financial institutions to demonstrate that their strategies support decarbonisation. Disclosure is becoming increasingly important in this area.
Hitting the target
Bradley Davidson, ESG lead at RBS International, says: “Over the past few years, we have seen a massive increase in investor requirements regarding ESG policy – for investment funds to demonstrate a clear net-zero target and how they are delivering on that target has a direct financial impact.
Prew supports this view. “It’s quickly becoming a virtuous circle of supply and demand, but our experience so far has been that investor demand is the initial driver, then financial institutions respond to meet that demand,” he says.
“Crucially it is their behaviour that has a knock-on effect on the wider economy and the behaviour of companies that need access to global capital.”
However, simply setting targets is not enough, as investors are also looking for evidence that those targets are achievable.
“It’s investor-driven,” Davidson says. “Investors are increasingly choosing entities that have robust ESG pathways. Over the next year, that will be a crucial difference.
“At the moment, it might be okay to have a target; but over the next year we’ll need to outline the plan to get there too, as investors recognise the benefits of investing in Paris-aligned investments. Investment institutions are having to play catch-up.”
There are, however, some stand-out examples setting a benchmark, as Rochester points out.
“Financial institutions in some cases have led the charge. Organisations such as Aviva and BlackRock have been agents for change and have been championing the cause for a number of years.
“The UNPRI [United Nations Principles for Responsible Investment] and various other groups are encouraging and supporting transition through these principles. The Task Force on Climate-Related Financial Disclosures [TCFD] is developing as the international standard so that investors can make an informed choice about which companies they invest in.”
Davidson highlights the need for compliance and regulation. “One of the most important differences between today and the future is this idea of sustainability reporting. In a net-zero economy it will be part of how a business operates, it won’t just be a nice-to-have.
“Regulations are catching up with where business is going. We will see entities being held to carbon dependency in a more scrutinised way.”
“I rarely go into meetings now where I don’t hear ESG mentioned at least five times,” adds Cleary. “A lot of that is propelled by the younger generation and the demand is also recognised by managers and general partners. They have to change their ways or they are not going to be a player. There’s a groundswell coming from different sources.”
So, what will the net-zero economy of the future look like? Corder highlights some key differences. “We need a clear picture of what the net-zero economy could be and how to get there,” he says.
“If we are heading for it by the year 2100, we are really missing the point. If we are saying it remains part of the 21st century, certainly there will need to be incredibly high levels of renewables and electrification.
"If 90% of electricity is renewable by 2050, the view is that almost all of that will need to be provided by solar and wind – and requires a big change in how power is stored and distributed at larger scales than currently.
“Storage is really important – making sure it’s available when people press the switch – and by 2040 most new vehicles on the road will need to be electric.”
Greenification
While disinvesting is the answer for some, Davidson argues that it might not be the best solution.
“It’s a difficult conversation and over-nuanced, but if you are an investor and in a position where you are starting to tilt towards ESG, excluding brown entities is simply walking away from the problem. If an entity does not want to change, it’s a more difficult conversation.”
Corder goes further, saying: “Greening existing companies is essential, probably more important than encouraging new start-ups. There’s a great incentive for existing companies still to be there in 20 to 40 years.”
A challenge for the investment community is the mismatch between traditional fund lifecycles, particularly in the private equity space, and patient equity.
Prew is pragmatic: “If, for example, investors expect returns after just a few years for equities, or five to seven years for private equity, then asking them to focus on patient equity can be hard.
“However, there have always been long-term plays and, ultimately, if the best returns come from patient equity strategies, the market will move in that direction.”
The challenge is not insurmountable for Davidson. “Fund lifecycles are relatively short – five to 10 years,” he points out.
“Usually, there’s a period of a one- to three-year financing cycle, which clearly does not align with the long-term goals we are looking for.
“That gap is definitely identified, but it’s not a reason not to do it. You may be operating for five to 10 years, but there’s lots you can do even if you are not reaching out to 2050 transition financing and innovative solutions.
“There could be partnerships between governments and financial institutions to set out that the capital is going to the right place at the right time.”
Rochester believes Jersey and Guernsey can punch well above their weight when it comes to transition finance and tackling climate change.
“The islands have the opportunity to demonstrate action, both in relation to nature and climate change, and show the difference that can make to the environment and the wellbeing of our local population. What we do, or don’t do, will be looked at on the world stage.
“If we are brave enough to take the lead on some well-thought-out projects, we can be a global role model for what’s the most defining issue of our time.
“It takes risk and it takes bravery. There are people on the islands who can make this happen and I would hate us to miss the opportunity.”