Financing for a Greener Future

Apr 25, 2023 | Articles

Written by Andrew Cormack, Senior Climate Change Consultant, ESG Advisory

The debate is over, we know that to achieve a net-zero future, financial institutions (FIs) must view their role in driving the transition as a short and medium-term challenge. The Energy Transition Commission recently released a report estimating that approximately $3.5 trillion per year is needed for investments in low-carbon infrastructure,  primarily in power generation, transmission, and distribution, and FIs have a crucial role in ensuring that this investment is made. All segments of the financial industry must contribute, and the net zero transformation will need to occur simultaneously in the real-economy, the financial sector, and the regulatory space.

My focus at SLR Consulting is on creating climate related disclosures that provide decision-useful information for investors. By disclosing better information about risks, opportunities and response options, we help our clients demonstrate resilience and ambition, improve reputation, attract investment, and meet regulatory requirements. I recently attended The Economist’s ‘Financing a Greener Future’ event which brought together leading figures in green finance to discuss the transformation of financial systems to support the transition to a net-zero future. The event was moderated by Greg Clark, Chair of 3Ci, and included James Alexander, CEO of UK SIF, Rhian Mari Thomas, CEO of the Green Finance Institute, and Adair Turner, Chair of the Energy Transitions Commission. It was a fascinating discussion and my take-aways are set out below:

Adapting Financial Systems for Net-Zero Future

First-mover disadvantages in the real economy are a key issue slowing the transition. Regulators must help to remove these first-mover disadvantages and the panel pointed to the USA’s Inflation Reduction Act as a key example of this. The Inflation Reduction Act provides very large subsidies, rebates, grants and loan guarantee programmes for clean energy technologies and climate solutions. When regulation removes these first mover disadvantages, businesses in the real economy will be incentivized to undertake ambitious decarbonization projects, and financial institutions will be more likely to fund them, as they are more likely to be profitable. The panel also indicated it was likely that the EU and UK will follow suit with subsidy-based regulations of their own.

Financial institutions must also engage early with businesses that are considering ambitious decarbonization projects. They should participate actively in the transition planning process, collaborating with industries, academics, and policymakers to design feasible and financeable strategies. FIs must also find ways to support ambitious projects that may face initial profitability challenges due to first-mover disadvantages.

 Priorities for Financial Institutions

The panel also discussed how Financial Institutions must operationalize their own net-zero commitments. They suggested the following:

Setting clear financing criteria: Financial institutions must establish their stance on funding for oil and gas. As the International Energy Agency has stated that in order to keep the 1.5 target alive there can be no more investments in new fossil fuel supply beyond that committed in 2021, institutions must question their involvement in any oil and gas projects of this type. Soon they must begin drawing clear ‘red lines’ about what they will refuse to finance.

Developing climate-oriented metrics: Financial institutions should focus on two key metrics: ‘financed emissions’ (both direct and indirect) and the ‘new to old ratio’, which is the ratio of investments made in assets that support the transition against total investments in the power and industrial sectors. The transparency and consistency of these metrics rely on the creation of trusted standards, and perhaps also the implementation of a regulatory body, which may at first be voluntary.

How we can help

If you work at a financial institution, we can help you estimate and report metrics such as your financed emissions and your ratio of investments that support the transition and those which do not. We can help you decide how exactly to meet your net zero commitments and where to draw your red lines.

If you work at a business that wants to take ambitious action but is hesitant due to first-mover disadvantages, we would encourage you to explain this in your climate-related disclosures and engage with your financing partners early on to discuss options for obtaining investment. You may find your financing partners more receptive to ambitious decarbonisation plans than you thought – they are coming under increasing pressure to find ways to fund the transition, and many of them are very motivated to help tackle climate change.

Contact Sam Gill, Director of Climate Resilience, ESG Advisory if you have any questions, would like to discuss a project or would like to learn more about how we can help with your sustainability needs.