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2021 Stewardship Sustainability

It's Time to Take Action on Climate Finance

Anyone who questions the essential and salutary role the financial system plays in society need only look at the way participants in financial markets are responding to the planet's single most pressing existential imperative – transitioning to a low-carbon economy.

There is an enormous amount of activity these days on the part of governments and NGOs, regulators, philanthropists, investors, and financial services providers around gearing up to support emerging climate-aligned finance initiatives. 

In the first week of March alone:

  • The U.S. Securities and Exchange Commission (SEC) announced the formation of a Climate and ESG Task Force and said its 2021 examination priorities will "reflect the complicated, diverse and evolving nature of risks to investors and the markets, including climate and ESG."
  • The Securities Industry and Financial Markets Association (SIFMA), a trade group, announced its support for "mandatory disclosure of corporate-specific, financially material, decision-relevant data relating to climate risks and opportunities." 
  • The House Financial Services Committee Capital Markets Subcommittee held hearings on "Climate Change and Social Responsibility: Helping Corporate Boards and Investors Make Decisions for a Sustainable World."
  • Federal Reserve Bank Governor Lael Brainard delivered a speech at the Institute for International Finance 2021 U.S. Climate Finance Summit on "The Role of Financial Institutions in Tackling the Challenge of Climate Change."

Despite this extraordinary energy around the topic, the scale of the climate finance challenge is massive. According to a December 2020 report by Boston Consulting Group (BCG) and the Global Financial Markets Association (GFMA), the aggregate investment required to keep global temperatures from rising more than 2 degrees centigrade from pre-industrial levels (the ambition contained in the Paris Agreement) is $100-150 trillion, or $3-5 trillion annually. This compares to an estimated current investment of $600 billion annually. It also dwarfs the $4 trillion in aggregate spending President Biden is signaling he will propose later this year for "Build Back Better" investments in infrastructure and strategic industries, with only a portion targeted at climate-related business sectors like renewable energy and electric vehicles. 

This will require nothing short of an overhaul of financial markets structure to accommodate an unprecedented increase in financing that enables decarbonization and other forms of climate change mitigation. 

The following chart (courtesy, again of BCG and GFMA) affords a picture of who and what will need to be involved to make this happen.

Defining climate finance market structure (CFMS)

Source: Climate Finance Markets and the Real Economy: Sizing the Global Need and Defining the Market Structure to Mobilize Capital. Published by Boston Consulting Group (BCG) and Global Financial Markets Association (GFMA) in December 2020. Used with permission. 

This goes far beyond earlier efforts, like so-called "green bonds," which seem quaint by comparison. Mobilizing capital to prevent a species-threatening environmental crisis will involve a broad range of asset classes – including not just equity, bonds and bank loans, but also structured financings and sustainability-linked instruments. 

Old-school instruments like municipal bonds should not be overlooked. Commentator Chris Hamel points out in a recent Bond Buyer article that municipal market in any given year is responsible for about 75% of the new money spend on infrastructure and calls for allowing private activity bonds to be used to finance things like a national system of charging stations for electric vehicles. 

What will also be necessary are innovations in financial products that help reduce and allocate the risk inherent in replacing fossil fuel-based power with renewable power, particularly in areas of the world (namely Asia) where the need is greatest and political and currency risks elevated. This kind of risk mitigation will require new derivative tools and strategies (yes, the same derivatives Warren Buffett once called "financial weapons of mass destruction"). This effort will also require a lot of blended public/private/not-for-profit financial partnerships. Public and philanthropic capital – also known as "concessionary capital" – will be needed to entice much more significant amounts of capital from private investors out along the risk continuum. 

Critically important will be identifying and deploying patient capital, so-called "green equity." "We need to reenergize financing for all of this," Microsoft founder Bill Gates, recently told the Harvard Business Review. "We need to tap... capital for the super-long-term nature of the products we need." In that same interview and others, Gates has said that if we are able to successfully mitigate the disastrous impact of climate change, it will be the most amazing thing humanity has ever done. Finance has an important role to play in that effort. 

For more on climate finance, its evolution and related news, I suggest exploring SIFMA's suite of videos and articles on the topic. 

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