Governments have accepted the need for a global shift to low-carbon investment, but the challenge is huge
London's famous black cabs are going green. Last year Transport for London finalised a measure that requires all new cabs to be electric or hybrid vehicles from 1 January 2018. The requirement will extend to all private-hire minicabs from 2023.
Cabbies are being given financial incentives to decommission older black cabs and to replace them with “zero-emissions capable” vehicles. The aim is for rapid transformation, with 9,000 by 2020, out of a total of about 21,000 black cabs in London.
The move has proved a big green investment opportunity. Black cabs are manufactured by the London Taxi Company at a plant in Coventry. To pay for the switch to zero-emission models, the London Taxi Company's owner, China's Zhejiang Geely Holding Group, raised $400m via a green bond issue. The bond was six times oversubscribed, with a final order book of more than $2.3bn.
The bond's success showed that there is demand for the type of investment that is needed if decarbonisation is to succeed. When regulators act decisively to make fossil-fuel intensive ways of doing business more expensive, or to outlaw them completely, money flows to less-polluting alternatives.
For many years, governments showed only limited willingness to put in place such regulations. The first international climate treaty, the Kyoto Protocol, had marginal impact, and attempts to continue it, at the international climate conference in Copenhagen in 2009, failed.
Now, however, there is a “credible narrative around the demise of fossil fuels”, says Seb Beloe, head of research at sustainable investment advisors WHEB.
The Paris Agreement, signed at the end of 2015, seeks to limit global temperature rise to well below 2 degrees Celsius, and to strive for 1.5 degrees C. The agreement is now expected to come into force by the end of this year, after India this month joined 60 other countries that have ratified it. So while the promises governments have made under the Paris Agreement might be insufficient, the direction of travel towards carbon neutrality is clear.
For a successful transition to a decarbonised economy, investment such as that attracted by the London Taxi Company's zero-emission cabs must be dramatically scaled up.
In a 6 September report on adapting investment portfolios to climate change, the Blackrock Investment Institute noted that $90trn is needed for low-carbon investment up to 2030 to avoid the worst effects of global warming, and warned: “The world is spending only half the amount.”
Finding the other half is primarily an issue of creating ripe conditions for money to be redirected from less-sustainable investment. Investment in renewables totalled $286bn in 2015, according to the United Nations Environment Programme. Having typically required government subsidy to compete with traditional power plants, technologies such as solar and wind power now require less and less support to be competitive.
Nevertheless, 2015 also saw about $130bn spent on coal and gas-fired power generation capacity. So though the world's governments have acknowledged the need to decarbonise, money continues to go into the most polluting forms of energy. This is in part because the implications of a switch to green finance, defined as finance that underpins investment that is in step with environmentally sustainable development, have not yet been fully understood.
Even relatively established forms of green finance, such as green bonds, need to be further developed. The value of green bonds outstanding is now at $694bn, according to the Climate Bonds Initiative, up about 16% over 2015. But the value relative to the trillions in green finance that is needed remains “extraordinarily small, albeit growing fast”, says Sean Kidney, CEO of the Climate Bonds Initiative, which tracks developments in low-carbon bond markets.
Better understanding of risk could create space for even more green bonds. But the labelling of some bonds as green – such as those that are financing the zero-emission London taxis – is a “marker” of sustainability rather than a detailed assessment of financial risk, Kidney says.
In addition, there is a huge architecture of established finance that needs to be rethought if green finance is to prevail. WHEB's Seb Beloe says that though there is plenty of capacity for green investment, the major barrier is traditional investment frameworks, where the attitude is that excluding fossil-fuel investments would lead to insufficient diversification.
The need to better understand green finance was highlighted by the G20 summit in Hangzhou, China last month. The post-summit leaders' communiqué said that green finance should be scaled up, but work was needed to tackle “difficulties in internalising environmental externalities, maturity mismatch, lack of clarity in green definitions, information asymmetry and inadequate analytical capacity”.
This conclusion was lifted from a report prepared for the summit by the G20 Green Finance Study Group, a panel of experts formed this year and chaired by China and the United Kingdom, with support from the UN Environment Programme.
The study group's conclusions mean that environmental as well as financial returns need to be factored into any investment – making much fossil-fuel investment unprofitable – while finance needs to be sufficiently long-term and there needs to be a clearer idea of what, for example, a green bond is, to make it easier to account for such investments.
In addition, companies must disclose more information about their environmental performance, while banks and investors need to better understand this information. Maximising opportunities for green finance will also be about understanding the risks of non-green finance – for example, the carbon-intensive investment that could become stranded as controls on carbon emissions get tighter. Judgements will have to be made about the winners and losers from decarbonisation.
For London taxis, for example, while suppliers of battery technology might benefit from the switch to zero emission capable cabs, petrol suppliers and companies that provide combustion-engine technology stand to lose out, even if they provide state of the art, highly efficient combustion-engine technology.
Andrew Voysey, director of finance sector platforms at the Cambridge Institute for Sustainability Leadership, who advised the G20 Green Finance Study Group, says that it is necessary to “fully sensitise the financial system to environmental risk” and to align the financial system with the direction of travel towards decarbonisation.
The adoption by the G20 of the Green Finance Study Group's conclusions is a significant step forward, Voysey says. “It's the first time the G20 has considered green finance specifically.”
Companies should therefore be wary. If there are environmental risks inherent in their operations, product or supply chains, they could find it harder to attract investment. An early casualty was US-based Peabody Energy, the world's largest private coal company, which filed for bankruptcy in April 2016 amid massive falls in its stock price, a pile-up of debt, concern about how it would meet environmental liability costs and declining coal use.
If the environmental costs do start to be factored in, some companies might also find their assets being dramatically re-valued. Beloe says the most exposed sectors, such as coal producers, have arguably already seen the impact of the shift. But many indirectly exposed companies might not even be aware of the extent of the risk they represent.
This issue was highlighted by Bank of England governor Mark Carney in a speech in Berlin last month. “The combined market capitalisation of the top four US coal producers has fallen by over 99% since the end of 2010,” he observed.
Carney heads the Task Force on Climate-related Financial Disclosures (FSB), which is working on how companies can measure and disclose the climate-related financial risks they face, to help investors make greener decisions.
He added: “The more we invest with foresight; the less we will regret in hindsight. Financial stability risks will be minimised if the transition begins early and follows a predictable path, thereby helping the market anticipate the transition to a two-degree world.”
But it is unclear how early that transition will take place. Voysey says the G20 statement on green finance was a “unique moment”; others are less sure.
John Kirton, co-director of the University of Toronto's G20 Research Group, says that the G20 statement used cautious language, saying only that it was “necessary” to scale up, and that G20 leaders “believe efforts could be made to provide clear strategic policy signals”. Such language is not a commitment, Kirton says.
In addition, the G20 continues to sidestep any concrete promise to phase out fossil-fuel subsidies. Shelagh Whitley of UK think tank the Overseas Development Institute noted in a blog post that the Hangzhou summit was the “eighth time in as many years” that the G20 had repeated a stock phrase on a “medium-term commitment to rationalise and phase out inefficient fossil fuel subsidies”.
While there might be a clear rationale for green finance, there is also pushback. On fossil-fuel subsidies, Kirton blames India, Russia and Saudi Arabia for having “basically vetoed any end date”.
Kidney acknowledges that “moving a supertanker is tough” but there are now substantive discussions about green finance. If the scaling-up of green finance can be achieved, coupled with innovation in green technologies, the economic transformation of the next 20 years “could be quite exciting”. If, on the other hand, decarbonisation is stalled, he says. “the risks are very, very severe for all of us”.
Mark Carney told his hosts in Berlin that Germany had the power to push green finance even higher up the agenda when it takes over the presidency of the G20 from China in December: “Over the past year, the focus of G20 leaders and the aegis of the FSB have spurred important progress. The upcoming German presidency of the G20 now has a historic chance to mainstream climate finance and turn risk into opportunity.”
There is now a 'credible narrative around the demise of fossil fuels'
For a decarbonised economy, investment, such as that in London cabs, must be dramatically scaled up
Maximising opportunities for green finance will be about understanding the risks of non-green finance
The G20 continues to sidestep any concrete promise to phase out fossil-fuel subsidies
Moving a supertanker is tough but there are now substantive discussions about green finance