Yet at this stage there are still no precise definitions of green or sustainable finance. Broadly speaking, green finance is financing of activities that could be described as being part of the green economy. That might include loans, bonds or other financial instruments to fund renewable energy projects, or venture capital funding of new, low carbon technology, for example. Exactly where to draw the line is still up for debate, but there are two facts about it that seem to be undeniable. First, its importance goes beyond questions of finance and economics. “Green finance is one of the keys to tackling climate change,” says Greg Ford, senior adviser at Finance Watch, a not-for-profit members’ association that promotes the public interest in financial services.
Second, while the value of the green finance sector is still small in the context of global financial markets, it is growing rapidly: 2017 saw $155.5bn of green bonds issued, up from $92.2bn in 2016.
Credit Suisse launched its debut green bond in the first quarter of 2018, proceeds from which will be allocated to sustainable energy and climate action projects in accordance with the Green Bond Principles drafted by the International Capital Market Association (ICMA). “It’s a signal to the market that we’re serious about this,” says Fabian Huwyler, head of green finance at Credit Suisse. “We’re planning a second bond later in the year and then possibly one bond to the market every year.”
Green investments are also producing impressive results: sustainable investments made by 54 FTSE 100 companies over the past five years delivered returns of 10.2% per year, compared to an average return of 9.5% from the FTSE 100 itself, according to a March 2018 study by Royal London Asset Management. As Simon Howard, chief executive of the UK Sustainable Investment Forum, told The Guardian in March, sustainable investment “started driven by values, it’s now definitely [driven] by value”.
One reason why green finance has been gathering momentum is government policy and regulatory change. More policymakers and businesses of all kinds across the globe now seek to support the UN’s Sustainable Development Goals (SDGs). In Europe, March 2018 saw the European Commission unveil its Action Plan on sustainable finance: a roadmap that will enable financial services providers to support sustainable development and to mitigate climate change.
The plan is based on recommendations made by the High-Level Expert Group on sustainable finance (HLEG) in 2017. Elements include the creation of a unified classification system, or taxonomy, for sustainable finance; incorporation of sustainability in prudential requirements for banks; and enhanced transparency in corporate reporting and financial disclosures. “It is hugely positive,” says ICAEW head of sustainability Richard Spencer. “The recommendations they make are pretty substantial and provide the underpinning for a new sustainability economy.”
Michael Wilkins, a managing director at S&P Global Ratings, leads the company’s sustainable finance team, which produces research on risk related to environmental, social and governance (ESG) issues. He also sees policy changes as the most important source of momentum behind the growth of green finance, along with “the general realisation within the financial sector that climate change could pose a real systemic risk”.
Wilkins believes the most significant event driving the growth of green finance has been the negotiation of the Paris Agreement in 2015. Even if the US withdraws from the agreement, most countries in the world have committed to setting policies that aim to restrict carbon and greenhouse gas emissions to the extent that global temperatures rise by no more than two degrees by the end of this century. To meet that target, all industrialised nations will need to transition to a low carbon economy.
“The Paris Agreement really changed views of green finance,” says Huwyler. “Over the months following that announcement we saw important institutional investors asking for climate strategies.”
Companies have also altered the way they disclose corporate information related to climate risks. Many have been guided or influenced by the work of the Taskforce for Climate Related Financial Disclosures (TCFD), which was created by the international Financial Stability Board in 2015. Its members include multinationals Unilever, Tata Steel, Mitsubishi and Dow Chemical; and financial sector companies including Barclays, AXA, JP Morgan Chase, UBS, BlackRock and Swiss Re. The Big Four accountancy firms are also supporting its work.
In 2017 the Taskforce published recommendations for large companies to adopt when disclosing climate change-related risks and opportunities. “The recommendations are based on the financial impact of climate change risk,” says Wilkins. “That might include asset impairment, cashflow deterioration, future liabilities – like buying more carbon permits to offset emissions – or future risks related to changing consumer demands.”
Financial companies have developed more green financial products to meet growing demand from corporates seeking to offset climate risks. As investors ask for more detailed information, the need for a taxonomy becomes clearer.
“Anything can be called a green bond today: there’s no common definition, which makes things difficult for the investor,” says Bjorn Ordell, vice-president, CFO and head of risk and finance at Nordic Investment Bank (NIB). “We need to get the quality of green bonds clearer: if we can get that for green bonds it can be extended to green lending and to equity products.”
Huwyler also predicts healthy growth in the use of green asset-backed securities (ABS), a market that is already growing rapidly in the US and Asia and is likely to be boosted in Europe by the actions of European regulators and policymakers.
Investors are showing more interest in green funds. Andy Howard, head of sustainable research at Schroders, says many more clients are factoring climate change into investment decisions. “The agreement global leaders reached in Paris marked a real shift from general interest to clear priority for a lot of our clients,” he says. “Green labelled investment products have clearly benefitted, but the bigger question is how climate change will affect economies, industries and portfolios. We have focused on finding better ways to measure and manage investment risks and opportunities across all sectors and funds.”
In 2017 Schroders launched its Climate Progress Dashboard, updated quarterly, which monitors the progress governments are making towards meeting the two-degree target. Schroders has also developed the Carbon Value at Risk (Carbon VAR) model, which assesses the risks that higher carbon prices would pose for companies and investors.
Finance Watch, the thinktank Z/Yen and conservation foundation MAVA have launched the Global Green Finance Index (GGFI), which surveys individuals working in green finance to rank financial centres according to the quality and depth of their green finance offerings and to help green financial centres and companies to share best practice.
“We want to encourage discussion about what makes a financial centre able to describe itself as ‘green’,” says Ford. “We also want to promote a race to the top. The green finance phenomenon should not be seen as some sort of gold rush, like derivatives in the 80s. It’s about switching legacy finance to low carbon activity, not about building a new pile of green assets on top of a brown economy.”
The inaugural edition of the GGFI, published in March 2018, showed green financial centres in western Europe performing particularly well (although it should be noted that 21 of the 47 centres surveyed are in western Europe). The top five rankings for green finance penetration went to London, Luxembourg, Copenhagen, Amsterdam and Paris. The top five for quality were London, Amsterdam, Brussels, Hamburg and Paris.
The leading green financial centres for other regions of the world were identified as San Francisco, Shanghai and Shenzhen, Johannesburg and Cape Town, Mexico City; and Moscow. Paris, Frankfurt and New York were cited as the centres most likely to become more significant. And some centres may be starting to specialise in key areas of green finance to differentiate themselves.
But, says James Vaccaro, director of corporate strategy at Triodos Bank green finance alone cannot guarantee that the ambitious targets for reducing carbon emissions set out in the Paris Agreement will be met. “If you pull away some of the froth around green climate bonds you find that actually some things just aren’t happening fast enough,” he says. “Emerging solutions in energy efficiency storage or grid infrastructure are not getting the investment needed for them to scale up. There is also still high carbon lending going on. Major banks that have made commitments to transition away from fossil fuels are still increasing their lending to it. We need to start getting carbon out of the system.”
He cites the work of the Platform for Carbon Accounting Financials (PCAF), created by a group of financial institutions active in the Netherlands, including Triodos Bank. PCAF members seek to measure and disclose the carbon footprints of their investments and loans and to develop more effective strategies to reduce them. The PCAF has created transparent methodologies for setting carbon emission reduction targets in relation to listed equities, project finance, government bonds, mortgages, corporate finance and real estate – all of which could be adopted by other investors.
In addition, as ICAEW’s Spencer points out, the accountancy profession can help businesses implement new rules on disclosures and reporting; and bring considerations of natural capital into business decisions. He highlights the work of the Natural Capital Finance Alliance (NCFA), of which ICAEW is a supporter. The NCFA aims to integrate natural capital considerations into financial decisionmaking; and to develop tools to help financial institutions to understand risks and opportunities related to natural capital.
Another change we may see in the longer term would be the establishment of a “real” price for carbon. French president Emmanuel Macron put the case for a carbon price floor set at EU level during a speech in Brussels in March 2018, arguing that it will be needed to drive more investment in clean technologies. Implementation of a carbon price would present significant challenges to financial companies and other businesses, but some believe it is inevitable.
The rise of green finance may help to encourage a transition to a low carbon economy, but while that process may be necessary for the good of humanity, it will create further difficulties. “Some people may get caught up in the negative consequences of that transition,” says Wilkins. “How do we make sure the transition is done in a socially responsible way?”
As green finance and the sustainability agenda move firmly into the mainstream, answering that question may represent the next major challenge that policymakers, financial services companies, businesses and their advisers will need to consider in the decades ahead.