A watershed for the global economy, including the finance sector, occurred in December 2015 with the signing of the Paris Agreement on Climate Change. Article 21 committed the signatories to strengthening the global response to the threat of climate change including the following actions:
Combined with the seventeen Sustainable Development Goals2 adopted by all UN Member States in 2015, a framework has been set for a worldwide commitment to achieving a low carbon future with a shift towards a less carbon intensive and more climate-resilient economy. This has had a significant impact on the financing of infrastructure projects around the world, in terms of the types of projects financed, the development of green finance and the emergence of specialist green banks in response to this agenda.
It has been estimated that up to US$90 trillion will be needed between 2015 and 2030 to finance the global sustainable development and climate objectives3. Investors and financers are increasingly focussing on projects in the following sectors which will help to achieve this:
One of the most successful results of this has been the rapid expansion of renewable energy projects. Investment into new renewable power projects has grown from less than US$50 billion per year in 2004, to about US$300 billion (94% in wind and solar) per year in recent years4, exceeding investments into new fossil fuel power by a factor of three in 2018. Yet despite this, renewable investments remain below their potential; investment in the sector will need to be scaled up to achieve the current climate and development targets. It has been estimated that annual investment in renewable energy power alone will need to double until 2050 to meet these goals.
For example, the United Kingdom government has recently released plans to power every home in the country with offshore wind by 2030, which would require almost £50 billion in investment and the equivalent of one turbine to be installed every weekday for the whole of the next decade5.
At the same time as green project financing has increased, there has been active moves by global financial institutions to exit projects which are dependent on carbon fuels. The World Bank has stopped financing new coal projects; this was followed in 2019 by 100 financial institutions (including 40% of the top 40 global banks and 20 globally significant insurers) divesting from thermal coal projects6. This has been followed up in September 2020 with the announcement by the International Finance Corporation (“IFC”, the private sector arm of the World Bank Group) that they will no longer make equity investments in financial institutions that do not have a plan to phase out support for coal, as a means to encourage commercial banks in Africa and Asia to reduce their support for coal projects7. The World Bank has also announced that it will not be financing upstream oil and gas projects after 20198.
Although there is no single, agreed definition for Green Finance, the term is increasingly being used worldwide. The Organisation for Economic Co-operation and Development (OECD) defines it as finance for achieving economic growth while reducing pollution and greenhouse gas emissions, minimising waste and improving efficiency in the use of natural resources. The IFC defines it as the financing of investments that provide environmental benefits in the broader context of sustainable development. The definitions may vary but there are characteristics that are shared:
In most circumstances, the finance products utilised are the same, regardless of the type of project being financed. The difference here is that the proceeds of the finance are directed at a green project, while a further major difference is in the way that the projects are assessed and managed. Financiers have adopted defined principles to ensure that projects are developed in a socially responsible way, reflecting good environmental management practices. A good example of this are the Equator Principles9, IFC’s benchmark performance standards which have been adopted by over 90 banks and financial institutions (including 32 OECD export credit agencies). Projects seeking to raise finance will need to be aware of the principles that their financier has adopted and make allowance for the environmental focus of the assessment and management processes that will be required. This is a particularly important consideration when multilateral development banks are involved, as they play a key role in mobilizing and scaling up finance for green projects.
However, there are now specific Green Finance products which have been developed. The best known of these are green bonds (historically referred to as climate bonds). These are fixed income instruments, specifically designed to finance climate-related or environmental projects. They usually benefit from tax incentives to enhance their attractiveness to investors. The green bond market began over a decade ago with the European Investment Bank’s first issuance of a Climate Awareness Bond in 2007. Since then the market has grown significantly with issuances in 2019 of US$ 270 billion.10
The cumulative issuance of green bonds are below US$1 trillion; this needs to be measured against the total global bond market which is valued at around US$ 100 trillion, accounting for less than 1% of cumulative global bond issuances. These bonds alone will not provide enough finance to achieve a global shift to the Paris Agreement goals.
Other examples of green finance products are green tagged loans, green investment funds and climate risk insurance. Green tagging is a systematic process which banks the environmental attributes of the loans and the underlying assets to allow easier access to the green bond market and better tracking of green loan performance. Green investment funds are mutual funds or investment vehicles which only invest in environmentally responsible companies. Climate risk insurances are designed to mitigate the financial consequences and other risks associated with climate change.
As the shift to a sustainable future has accelerated, many countries have set up or promoted the establishment of green banks to increase the level of low carbon, climate resilient and sustainable development. These banks have usually been capitalised through state investment; a recent report identified nearly 30 existing green banks with US$24.5 billion capital invested in green projects attracting US$45.4 billion of private co investment11.
Public Green Banks and other dedicated green investment entities have been established at a national level in Australia, Japan, Malaysia, Switzerland & United Kingdom, at a state and county level in the United States (California, Connecticut, Hawaii, New Jersey, New York, Rhode Island and Montgomery County, Maryland) and at city level in the United Arab Emirates (Masdar).
With specific mandates to invest in low carbon, climate resilient projects, these banks’ primary functions are to encourage co-financing for green projects, build pipelines of financeable projects, address the risks associated with these projects and provide green experts with local market knowledge.
The shift needed to achieve the Paris Agreement goals is driving significant changes in the types of projects being financed, the way that the financing is approached and the emergence of new finance providers and tools. These changes have resulted in new risk exposures and increased the complexity of the technologies employed.
This means that financiers have an increased focus on the assessment, management and transfer of the risks arising from green projects and will seek to ensure that any collateral they have is fully protected. Companies seeking to raise finance need to be aware of their financiers’ concern and to allow for the costs and time to allow for full technical, legal and insurance assessment of the project risks.
Given the size of the investment that will be needed, together with the rapid development of new technologies to manage and adapt to climate change, the availability and importance of Green Finance is only likely to increase in years to come.
Gavin Newton is Executive Director, Lenders’ Insurance Advisory Practice, Willis Limited. gavin.newton@willistowerswatson.com
Leonardo Chaves is Global Head, Lenders’ Insurance Advisory Practice, Willis Towers Watson. leo.chaves@willistowerswatson.com
1 https://unfccc.int/sites/default/files/english_paris_agreement.pdf 2 https://www.un.org/sustainabledevelopment/ 3 The Global Commission on the Economy and Climate (2014) The New Climate Economy Report: Better Growth Better Climate https://newclimateeconomy.report/2016/wp-content/uploads/sites/2/2014/08/NCE-Global-Report_web.pdf 4 https://www.fs-unep-centre.org/global-trends-in-renewable-energy-investment-2020/ 5 https://www.theguardian.com/environment/2020/oct/06/powering-all-uk-homes-via-offshore-wind-by-2030-would-cost-50bn 6 http://ieefa.org/wp-content/uploads/2019/02/IEEFA-Report_100-and-counting_Coal-Exit_Feb-2019.pdf 7 https://www.reuters.com/article/climate-change-coal-idUSKCN26F06Y 8 https://www.worldbank.org/en/news/press-release/2017/12/12/world-bank-group-announcements-at-one-planet-summit 9 https://equator-principles.com/wp-content/uploads/2020/05/The-Equator-Principles-July-2020-v2.pdf
10 https://irena.org/newsroom/articles/2020/Feb/Financing-the-Global-Energy-Transformation-Green-Bonds#:~:text=Renewable%20energy%20finance%3A%20Green%20bonds,energy%20and%20other%20green%20assets.&text=Like%20conventional%20bonds%2C%20green%20bonds,specific%20projects%20or%20ongoing%20business 11 https://www.greenfinanceinstitute.co.uk/wp-content/uploads/2020/11/state-green-banks-2020-report.pdf
