The coronavirus pandemic has dramatically changed our way of life and how we work. As restrictions force people to spend more time at home, there has been increased demand, especially in pandemic-stricken countries, for larger homes with outdoor space.
For corporations, there is a shift away from business models that focus primarily on financial returns; for policymakers, discussions about how to rebuild the economy in a more sustainable way have become commonplace.
Even before the pandemic, there were efforts to build a more liveable and greener environment, but these have now taken on more urgency based on science-based evidence. The Paris Agreement – an international treaty that aims to cap global temperature increase to no more than 1.5 degrees Celsius compared to pre-industrial levels – was adopted in 2015.
To achieve this goal, signatory countries will have to undertake ambitious efforts to reduce their carbon footprint. Several have already put into legislation the commitment to achieve net-zero greenhouse gas emissions by 2050. In a September speech to the United Nations, President Xi Jinping pledged that China would become carbon neutral by 2060.
The World Bank estimates that the world will need US$90 trillion, equivalent to the annual world economic output, in climate-friendly investment by 2030 in order to meet the Paris goals. To turbocharge investment of such a scale, green finance will play a pivotal role. Simply put, green finance, a welcome joint effort between environmentalism and capitalism, directs money from savers to projects which produce a better environmental outcome and help the transition to a world without fossil fuels.
Green bonds, first issued by the European Investment Bank in 2007, are arguably the poster child for green finance. In 2020, the global issuance of green bonds reached a record high of US$290 billion, representing an average annual growth of 36% over the past five years, according to the Climate Bonds Initiative, a London-based non-profit organisation. On a cumulative basis, more than US$1 trillion worth of bonds have been issued since their inception in 2007. The United States, China and France are the three major issuers of green bonds, accounting for a combined 45% of the global total.
There are a number of reasons why green projects are increasingly favoured by investors. In a world that is becoming more socially conscious, impact investment is growing fast. A term first coined in 2007, impact investments are defined as purposeful investments that deliver societal as well as financial returns.
By putting money towards investments committed to environmental, social and governance (ESG) principles and away from fossil fuel-related projects, investors are in a better position to manage and minimise political, regulatory and financial risks, which take the form of higher climate-related taxes, lawsuits and pushback from activist groups. For institutional investors, reputational risks and pressure from clients are additional considerations.
Despite its increasing popularity, green finance’s ability to gain further traction will depend on the resolution of what may appear to be intractable issues. First of all, what is classified as “green” is highly debatable. Unfortunately, the lack of unified green financing standards is hindering investors’ decision-making when comparing projects, especially across jurisdictions. Secondly, there are concerns about the use of green funds to invest in projects which are not as environmentally friendly as promised – a phenomenon that is dubbed greenwashing.
A comprehensive taxonomy to define “green” investments, combined with increased reporting and verification requirements, should help avoid greenwashing and prevent good intentions from changing into a box-ticking process.
The European Union is at the forefront of this initiative with the launch of its Sustainable Finance Disclosure Regulation in March. There are also other global organisations that have come up with guidelines and frameworks on green finance standards. This is no easy task, however, as a purely scientific approach could be too rigid, thereby excluding meaningful investments that fall a little short of the mark. On the other hand, too much compromise could undermine global efforts to tackle climate change.
A common phrase used by world leaders to emphasize the urgent need for collaboration in vaccine distribution to combat the pandemic is that “no one is safe, until everyone is.” As with the current Covid crisis, a global and coherent approach is needed to deal with climate change. Likewise, the success of green finance will be very much dependent on establishing a set of harmonised international standards. Some good news on this front recently was an announcement by Yi Gang, the governor of the People’s Bank of China, of a potential cooperation between China and the E.U. to converge green investment taxonomies in the two markets.
The design of green finance products can also help ensure that the whole topic does not just become hot air. Some green bonds tie interest payments to a project’s sustainability performance based on such metrics as the ability to meet emission targets or share of renewable energy generated. Not only does this incentivize the issuer to strive for green-related objectives, it also provides some kind of protection to investors as they can earn higher interest should the project fail to deliver its promise in producing green outcomes.
Amid cynicism about capitalism and the useful role that it can play in fostering a better world to live in, it would appear that marrying finance with ESG causes could help redeem the image and perception of market-based economies. In a post-pandemic world, conscious capitalism has the potential to reposition businesses to create financial, social, physical and ecological wealth for all their stakeholders. We cannot afford to waste this chance.
Wilson Chong, email@example.com