Helping the financial world prepare for climate change and net zero
From intense droughts to extreme flooding and wildfires — we’re already seeing the devastating impacts of climate change on people’s lives and livelihoods around the world.
But global warming doesn’t just affect individuals. It poses risks to financial institutions too. Extreme weather can decimate businesses and supply chains, while up to 44 trillion pounds of the world’s economy is dependent on biodiversity and nature.
We need healthy ecosystems to grow food and access clean water. The impact that dwindling population of bees and other pollinators would have on the agricultural industry for example could be huge. If businesses around the world were to start defaulting on their loans and going bankrupt due to climate change, financial institutions will be in trouble too.
But it isn’t just climate change itself that poses a risk, our response to it also comes with risks.
In 2019 the UK government made a legal commitment to reduce Britain’s carbon emissions to ‘net zero’ by 2050.
To reach this goal our entire economy will need to be restructured and turned on its head. We need to change how we manufacture our goods, how we transport them, and how we consume them. Change is needed in just about every sector of industry. That change, it turns out, comes with risks of its own.
“The transition to a green economy will create winners and losers”, explains Dr Ben Caldecott, the Lombard Odier Associate Professor of Sustainable Finance at the University of Oxford.
‘’For instance, while electric car companies like Tesla are employing lots of people and creating lots of jobs, at the same time you have also got incumbents struggling to adapt and survive in this new world.”
“In the energy sector you have coal fired power stations closing, and if you have loans associated with those companies then that will affect you as a financial institution.”
It’s vital, therefore, that in this rapidly changing landscape financial institutions invest their money wisely.
To help them do this, Dr Caldecott heads up the new UK Centre for Greening Finance and Investment (CGFI). The centre aims to provide financial institutions with access to the best environmental science to help them make decisions about how to manage risk and invest their money in the right places.
“Over the last few decades there has been tens of billions of dollars invested into environmental science,” says Caldecott.
“As a result, we now have powerful climate models that can predict the effects of climate change, we have state of the art satellite observation platforms, and extremely large data sets. But what proportion of that currently finds its way into financial decision making? The answer is not very much.”
CGFI will change this. The Centre will ultimately allow financial institutions to access and use climate and environmental data at any point on Earth, at any point in time, and for every major sector.
The centre will work with finance professions, such as the Chartered Bankers Institute and Chartered Financial Analysts UK, to ensure that every professional financial decision takes climate change into account.
This means that no matter how turbulent the changes are, the financial system will still be robust, people will still be able to access markets, and the chance of another financial crisis occurring will be minimised.
Financing the green revolution
Having access to environmental data and being able to accurately assess risk will also make financial institutions feel more confident about investing in sectors and companies that have a smaller environmental footprint.
This has never been more important as the transition to net zero through the replacement of entire technologies, supply chains and infrastructures within extremely short timescales takes shape.
How we finance such monumental changes is pivotal. The government has invested in green and low carbon technologies and infrastructure, and private sector investment is just as important for realising the dream of a green economy.
It is estimated that $125 trillion of investment is required just to tackle climate change, of which $37 trillion is needed this decade.
“The transition to net zero requires a huge amount of investment”, says Dr Ben Caldecott.
“With fossil fuel power stations, the cost of building the stations is comparatively low, and it is buying the coal, oil or gas and burning it that is expensive and is a much larger proportion of lifetime costs. But in this new world we are entering the opposite is true. Whether you are talking about an electric car or a windfarm, there is a really high upfront capital cost but then the operational cost is very low.”
Around the world scientists and innovators are working on ingenious solutions that will help us transition to a green economy — from powerful batteries that will power the next generation of electric cars, to ammonia or hydrogen fuel that could propel cargo ships.
But that is not enough. We need a global financial system that will support and fund these solutions.
One company that specialises in providing loans to green companies is Charm Impact. The business was set up to connect entrepreneurs working in Africa and Asia with everyday people wishing to invest their money in green causes. Entrepreneurs working in emerging economies often find it incredibly difficult to secure the finance they need through traditional banks and lenders. The idea is that the loans provided by Charm Impact generate both a financial, social and environmental return.
Charm Impact has funded 55 solar-powered home systems and 20 solar-powered sewing machines for rural communities in India. In West Africa meanwhile, Charm Impact loans have supported a manufacturer and distributor of solar-powered refrigeration units and enabled the construction of a solar-powered micro-grid that will provide electricity to 155 homes and 25 businesses.
However, if we’re going to reach net zero we need to encourage more lenders and investors to embrace green finance.
The Investing in the Future programme, is looking into what changes in policy and finance are needed to unlock new forms of investment for building low-carbon infrastructure.
As humans we are often programmed to prioritise short term wins over longer-term gains. Unfortunately, the same is true of banks, investors and lenders. However, this attitude can get us in trouble. Speculative, short-term investment was one of the main causes of the global financial crisis.
This myopic habit of ours is totally at odds with a transition to a low-carbon economy. The transition will require huge sums of investment, and many of the rewards will take decades to realise.
The Investing in the Future programme aims to change this preoccupation with short term gains by re-defining finance and investment in terms of a meaningful ‘commitment to the future’.
So far findings suggest that it is a lack of confidence, rather than capital, that is preventing investors from throwing their money behind green technology. Creating policies that make investment in low carbon energy generation infrastructure attractive to private investors is one solution
If we’re going to reach net zero it’s vital that our financial sector has the tools and information it needs to get behind the transition.
“We need to mobilise a huge amount of capital into environmental solutions and to do that we need a financial system that’s fit for purpose,” says Caldecott.
“A vital part of that is to ensure financial institutions are properly measuring, pricing and managing the risks that are associated with climate change.”
Want to know more?
If you’re a UK taxpayer, your contributions helped fund this work, via UK Research and Innovation — the funding body that allocates government funds for research — and the nine research councils.
The UK Centre for Greening Finance and Investment is the UK national centre established to accelerate the adoption and use of climate and environmental data and analytics by financial institutions. The Centre is funded through the Climate and Environmental Risk for Resilient Finance programme launched by the Natural Environment Research Council (NERC) and Innovate UK in February 2020.
Charm Impact is supported by Innovate UK. The Investing in the Future programme is funded through the ESRC Centre for the Understanding of Sustainable Prosperity (CUSP).
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