Clean commerce: Finance goes green

Pressure for business to ‘go green’ has been building steadily for much of the past decade. What started in patches from a vocal minority has fast become a corporate imperative, as progressive governments impose both incentives and penalties on businesses, while an increasingly informed consumer base vote with their wallets.

Although the time has come and gone for traditional manufacturers to incorporate sustainability into their corporate ethos and strategy, businesses of all shapes and sizes are now feeling the pressure to follow suit. But one sector slow to rise to the challenge has been finance and financial services, for which the ordinary barriers to green thinking are more pronounced.

‘I think the financial sector, or at least part of it, has acknowledged that the long term is becoming more and more important,’ says Karsten Löffler, co-head of the Frankfurt School – UNEP Collaborating Centre for Climate and Sustainable Energy Finance.

‘What the industry is recognising more and more is that this is something that has been on the agenda for a while. Every financial institution will be faced with how to embrace it, implement it, and make it a tactical component of everyday decision-making.’

Long-Term Investment

A word that comes up often when talking about green finance is ‘long-termism’ – more specifically, the lack of it. In business, there will be few, if any, risks as far (relatively) into the future as climate change. This can make the risk’s incorporation into current models of decision-making difficult.

‘One challenge in particular is that the longevity of what sustainability and being green means actually is not easily translated – at least not by many stakeholders in the financial sector – into everyday decision-making,’ explains Löffler.

But while bringing financial institutions into the sustainability stakes has been slow-going, some institutions have long been on the vanguard.

‘At Santander, we have a very conservative, risk-based approach to how we handle projects, and our long-standing participation in green finance is testament to that,’ explains Timo Spitzer, head of legal global corporate banking Germany, Austria and Switzerland at Santander.

‘The nature of projects that are being financed is changing and continues to do. At Santander in particular, we are seeing an increasing volume of projects involved with financing the construction and operation of projects focused on sustainability – think wind farms, solar plants and thermal facilities. We are specifically targeting projects that are providing positive outcomes for the greater community.’

Myopia is not endemic to the private sector. The ongoing journey towards a sustainable future is littered with stories of governments dipping the proverbial toe into the waters, only to quickly pull it back at the first sign of trouble.

Connecticut has long been seen as an early adopter in the green finance space, with its creation of the Connecticut Green Bank, the first of its kind in the US. The Bank was established in 2011 and quickly became a model, both in the US and globally, for green project finance. It boasts an impressive track record over the course of its seven-year life. According to CEO Bryan Garcia, the Bank has stimulated over USD$900m in private investment in 234 megawatts of clean energy projects, and has reduced carbon dioxide emissions by 3.7 million tonnes.

However, the state budget released in October of last year contained a provision that would strip the Bank of USD$27.5m of ratepayer funding – effectively the entirety of their budget. According to an open letter published by the Bank, ‘not only would a transfer of $27.5m from the Green Bank to the General Fund cause $185m of private investment and over 800 direct jobs (and 1,600 indirect and induced jobs) to be lost in Connecticut, but it would effectively end the Connecticut Green Bank.’

Similarly, the UK’s Green Investment Group (formerly Green Investment Bank) was sold off by the Department for Business, Energy and Industrial Strategy to Australian bank Macquarie earlier this year for £2.3bn. The sale received criticism for being short-sighted, with the UK’s Public Accounts Committee remarking that ‘in making decisions about GIB’s future, the department prioritised reducing public debt and how much money could be gained from the sale over the continued delivery of GIB’s green objective.’

In addition to considering the sale price below expectations, the Committee blasted the Department for repealing legislation protecting the Group’s ‘green purposes’ and for not demanding sufficient guarantees over the future of the organisation: the Department did not require bidders to make specific or legally binding commitments regarding how the Group’s green objectives would continue to be delivered in practice.

This represents a widely criticised handling of a green investment initiative that had been making progress towards its goals. Since its inception in 2012, the Green Investment Group has backed over 100 green infrastructure projects, committing £3.4bn to the UK’s green economy. Now, its future is uncertain.

Public-Private Tension

While a number of businesses have taken up the gauntlet voluntarily, many continue to resist. A report delivered to the UK Prime Minister by Sir Nicholas Stern back in 2006, called climate change the ‘greatest market failure the world has ever seen’. In those terms, this is a failure that needs to be addressed by government. The question then becomes one of approach.

‘There is a debate about whether the public sector should frame regulation in terms of supporting green or penalising brown – for instance, with respect to capital requirements,’ says Löffler.

‘This is an interesting discussion where there is maybe not a single right or wrong answer, but there are certainly different voices to be heard. The benefits of regulating businesses into going green have been touted by many, but there is a risk of unintended side effects that are alien to the system when this is the approach taken.’

Case studies for both the carrot approach and the stick approach can be found around the world.

The use of Energy Efficiency Obligations (EEOs) in the EU have seen increased adoption over the past five years. Their implementation varies from country to country, but EEOs typically set annual energy-saving targets over a long-term period.

A 2016 report published by Norden, the Nordic Council of Ministers, called the Nordic region’s ability to get the right ‘policy mix’ between taxes and subsidies a key contributing factor to its success in the green finance arena.

The EEF, Britain’s manufacturer’s association, released a report in 2015 on Britain’s place on the spectrum. Paul Raynes, then director of policy, said that ‘the current system of energy taxation is too complex and is hurting Britain’s competitiveness,’ adding that ‘instead of simply hitting firms with the big stick of ever-higher carbon taxes and levies, we should be offering them the carrot of tax breaks to invest in potentially very profitable advanced low carbon technologies.’

China has been active in launching new initiatives to promote green investment, and its various approaches have fallen all along the ‘carrot-stick’ spectrum. For instance, when assessing the suitability of advancement for its public officials, China is now implementing a new system whereby progress towards environmental objectives is rewarded over GDP growth, the more traditional metric. On the other side of the coin, China has introduced mandatory environmental pollution liability insurance for ‘brown’ investment projects. Reducing the environmental risk means a reduction in the added cost – a win for the environment.

Singapore’s hybrid ‘carrot-and-stick’ approach has been praised, particularly in the context of water efficiency. The country’s National Water Agency (PUB) offers the free replacement of old, inefficient nine-litre water closets with efficient, four-and-a-half-litre models for low-income households. At the same time, larger water users in the industrial sector are required to install private water metres and then submit the collected data to PUB for at least three consecutive years. It has also established the Water Efficient Building certification, encouraging businesses, industries, schools and buildings to adopt water-efficient measures in their premises and processes.

‘Progressive governments are pushing forward with this, but there’s no one-size-fits-all policy, or a right way and a wrong way,’ says Löffler. ‘This had to be an ideal embedded in the national standing, tradition, and methodology of policy-making.’

Eurocentric Approach

In March, the European Commission revealed its Action Plan for Financing Sustainable Growth. The roadmap was drafted following a report published by an EU-appointed High Level Expert Group on sustainable finance in 2016. The plan asserts that the financial system has a key role to play in the push towards a sustainable future for our planet and economy.

There are three broad aims of the roadmap: reorient capital flows toward sustainable investment, manage financial risks stemming from climate change, and foster transparency and ‘long-termism’ in financial and economic activity.

‘The roadmap has the opportunity to be a catalyst – and at the very least have a significant impact – towards promoting methodologies for the financial sector to deal with the issue of green and sustainable finance,’ says Löffler.

The Plan spells eight priority action points for the European Commission that will shape the EU’s efforts in the sustainable finance arena going forward:

• Introduce a common sustainable finance taxonomy;
• Elucidate investor duties to extend the time-frame of investment and prioritise environmental, social and governance issues;
• Tighten disclosure rules to make sustainability opportunities and risks fully transparent;
• Connect the general public with sustainable finance opportunities;
• Develop official European sustainable finance standards with green bonds as a priority;
• Establish a ‘Sustainable Infrastructure Europe’ to improve and expand the current pipeline of sustainable assets;
• Reform governance and leadership of companies to build sustainable finance competencies;
• Enlarge the role and capabilities of the European Supervisory Authorities to promote sustainable finance as part of their mandates.

That the taxonomy point is listed first is no accident: it’s something that thought-leaders in this area have been asking for since the start of the movement.

Löffler expands: ‘We will first get most certainly a taxonomy on what “green” actually means. That might change the regulators’ perspective in terms of coming to terms with and supporting the financial institutions to be better able to report on what they are doing. This is now what I see coming first. Maybe it’s not disruptive, but certainly it adds quite some substance to the overall discussion.’

The need to facilitate and ameliorate discussion in this area feeds into another salient thrust of the Plan: increased transparency. In the words of the Plan, ‘Transparency of market participants’ activities is essential to a well-functioning financial system’ and ‘A central focus of the sustainability agenda is to reduce the undue pressure for short-term performance in financial and economic decision-making, notably by increased transparency,so that investors, whether corporate or retail, can take better-informed and more responsible investment decisions.’

‘Because transparency means “extra workload”, sometimes there is resistance to that, even though it might add to the decision-making, and more information regarding the risk of climate change might add to the quality of investment decisions,’ explains Löffler.

If the Action Plan is to be taken at its word, this move towards added transparency is a serious one. Recent years have seen a rise in sustainability index providers, but without full disclosure of their methodologies, these will be of limited use. To address this, the Commission aims to, by Q2 2018, propose an initiative for harmonising benchmarks comprising low-carbon issuers, based on a sound methodology to calculate their carbon impact, to be put into place once the climate taxonomy is implemented.

Conspicuously missing from the Plan is substantive word on the ever-evolving fintech sector. Given demonstrated initiatives to produce clearer pictures of an organisations ‘green’ make-up (and the implications for transparency), the omission (apart from a few brief references) is a surprise.

The (Clean) Road Ahead

The fact remains that there is still a gap between the public and the private sector when it comes to pulling in one direction.

‘At this stage, a number of private-sector stakeholders are not in the position to embrace the long-term objectives entirely, primarily because those long-term objectives and the business’s objectives don’t align’ says Löffler.

No-one would argue that the private sector should be left to its own devices, but the balance of responsibilities is yet to be agreed upon. Market forces – competition and the damage that can come from bad press – might be enough to kick the private sector into gear in some cases, but it can’t be relied upon in every case, or even most cases. Instead, the public sector will need to play the leader.

Where there are gaps in terms of profitability, for example, compared to traditional models of investing or lending, then this is an area where the public could make a real difference to address it. It could be that the public sector can make a difference by assuming some of the risk on certain projects or areas, such as technologies that are perhaps a bit younger and their risk profiles less certain. It’s often these types of technologies that can be impactful, but financial institutions can find it difficult to justify these investments under existing risk models.’

Governments need to be proactive about filling this gap – either through carrots, sticks, or a combination of both.