Green finance is a rapidly evolving area of finance that seeks to incorporate environmental and social considerations into investment decisions.
While climate change continues to be debated, the financial industry has begun a transformation to incorporate environmental and climate changes into financial decisions. Green finance represents money issued or raised in the equity or debt capital markets designed to impact the planet positively. More specifically, green finance can take the form of sustainability-linked bonds in the fixed-income markets or environmentally friendly stocks in the equities markets. It also extends to big and small investors as well as consumers.
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Environmental, social, and governance (ESG) themes are nothing new. However, in recent years banks have been thrust into the spotlight for decarbonization. Sustainable finance is a movement to use the influence of the finance sector to help the global economy pivot off dirty fossil fuels and toward renewable sources of energy. In fact, without the banking industry’s support, or climate fintech, climate adaption and transitioning the economy toward decarbonization would only be a pipe dream.
To achieve this shift, it will require $1.5 trillion in financing, or 5% of the world’s GDP, to reach the UN’s net zero emissions target by 2050. The one common denominator in green finance is banks, which underwrite the financing of corporate America or other global economies. They also provide lending to consumers and manage the wealth of high-net-worth individuals.
However, green finance is not an island unto itself and will require an overhaul of many sectors of the economy, including energy systems, transportation, agriculture, etc. As a result, it will command the cooperation of industries across the economy to be the most effective.
In addition, banks can view green finance as an opportunity to strengthen their client relationships. However, it’s also creating challenges in which industry groups hold bankers’ feet to the fire to meet stringent requirements.
This is partly because as much as green finance involves, equally important is what it is not. Green finance is the absence of banking activity in sectors of the economy that are deemed to contribute to climate change instead of working toward a solution. Some banks, like JPMorgan, are looking to strike a balance in this regard, with CEO Jamie Dimon reportedly stating recently,
“We should focus on climate. The problem with that is that because of high oil and gas prices, the world is turning back on their coal plants. It is dirtier. Why can’t we get it through our thick skulls that if you want to solve climate [change], it is not against climate [change] for America to boost more oil and gas?”
Nevertheless, banks are certainly feeling the heat to distance themselves from companies operating in sectors like fossil fuels that contribute to global warming.
According to the Global Sustainable Investment Alliance, there was a 15% jump in sustainable and responsible investments (SRI) in the two years leading up to 2020 to $35.3 trillion across Europe, the United States, Canada, Australasia, and Japan. So, it’s safe to say the number of assets in sustainable investments is rising globally.
At the latest UN Climate Conference, US President Joe Biden unveiled a series of initiatives designed to bring the United States closer to a clean energy future. The US has already been moving in this direction, with $17 trillion in sustainable AUM comprising 33% of the industry’s $51 trillion in total assets overseen, as per a 2020 US SIF Foundation report.
Meanwhile, assets linked to ESG standards overseen by US institutional investors have been rising for the past decade and a half, reaching $6.2 trillion in 2020. Public pension funds represent 54% of those investments, the report reveals.
The World Bank issued the industry’s maiden green bond in 2008 to support financing projects with sustainable social goals. Since then, the trend has only gained momentum, and banks are demonstrating their support for green finance in myriad ways.
In particular, there is a growing demand for sustainable investments in fixed-income markets. Increasingly, companies and, in some cases, nations opt to raise capital for their projects in the debt capital markets via sustainable bonds. Green bonds are a type of debt whose proceeds are directed toward renewable energy projects such as solar, wind, or ag-tech.
Among the high-profile companies to have issued sustainable bonds is iPhone maker Apple. The billions of dollars in proceeds from the bonds have helped the company to develop what it describes as low-carbon manufacturing and recycling technologies.
One of the reasons companies are looking to launch sustainable bonds is in response to investor demand. Deloitte says that in the UK, three out of every five banking clients would like to see their financial institutions “create a positive, social and environmental impact.”
Complicating things, not just any issue, fits the bill as a sustainable bond. It must meet specific criteria, the parameters that have been a challenge for the market. Banks and corporations are working together to determine the standards for green bonds and the projects that qualify for funds raised for this purpose.
It is not unusual for investor demand for sustainable bonds to outpace supply, giving the bond issuers (the borrowers) more leverage. In this case, they can harness the strong interest to lower the interest rate on the security, resulting in savings for them. As a result, green bond issuers generally see savings of 0.05%-0.1% in interest, thanks to the supply/demand dynamic.
Sustainable bonds raked in $479 billion in funds in 2021, setting a fresh record. And investment bankers are expecting that was only the tip of the iceberg.
Banks have been upping the ante on their green finance commitments lately. This is one way in which green finance is changing the financial landscape.
- UK-based Barclays 2022 reportedly bolstered its sustainable finance target to $1 trillion in the next seven years to speed up the pivot to a decarbonized economy.
- HSBC plans to direct as much as $1 trillion to support companies transitioning to a low-carbon economy.
- JPMorgan is targeting $2.5 trillion in sustainable funding by the next decade.
- The Glasgow Financial Alliance for Net Zero (GFANZ) is a global coalition of more than 500 banks across trillions in assets whose mission is to slash their carbon emissions and that of their clients to net zero by 2050. The ultimate goal is to cap global warming at 1.5 degrees. The group got its start at the UN Climate Change Conference (COP26) in Glasgow, Scotland, in November 2021.
- Some European banks use what are known as bid-data-fueled carbon calculators to determine the size of the carbon footprints of their clients. Elsewhere, banks have begun issuing payment cards that are comprised of recycled materials.
- On the consumer side, homebuyers might receive a more attractive mortgage interest rate if they construct homes with environmentally friendly features.
The role of banks in transitioning toward climate adaptation and decarbonization is vital, like climate fintech, but it will not happen overnight. In addition to pursuing sustainable financing deals, banks also must reflect similar values in their company culture. This requires the participation of bank management teams as well as the involvement of regulators.
In the meantime, as the principles for green finance and ESG investing continue to be written, one thing is clear: banks are key to helping companies, individuals, and the world move closer to sustainability goals.
In conclusion, green finance is a movement aimed at incorporating environmental and climate changes into financial decisions. The global economy needs $1.5 trillion in financing to reach the UN’s net zero emissions target by 2050, and banks are the key players in providing the underwriting of financing.
Green finance is not just limited to big and small investors or consumers, but it extends to various sectors of the economy. Sustainable bonds and green investing are two important components of green finance that are gaining momentum. Despite the challenges in determining the standards for green bonds and the projects that qualify for funds, the demand for sustainable bonds is outpacing supply, leading to potential savings for the bond issuers.
The financial industry is under pressure to distance itself from companies that operate in sectors contributing to global warming, and the cooperation of industries across the economy is crucial for the success of green finance.