The Case for Green Finance

Commentary: ESG investing has suffered a series of blows to its reputation. But green financial instruments are showing signs of having genuine, rather than theoretical positive impact.

The outlook on green finance in 2022 tells a pessimistic story.

ESG investing has recently taken many blows to its reputation. Take Larry Fink, CEO of the world’s largest asset manager, BlackRock, for example. In January 2022, he reiterated the paramountcy of sustainability in his 2022 letter to CEOs. Yet by May 2022, BlackRock backtracked from this position, announcing that it would vote against more climate resolutions.

In 2021, the former chief sustainability officer at Deutsche Bank’s asset management arm, Desiree Fixler, revealed an ugly underbelly of ‘green’ investments that continued to support unsustainable business practices. Even the global head of responsible investing at HSBC, Stuart Kirk, was recently suspended for his off-tune remarks about climate change being “irrelevant” to regulators and financial investors.

While not ideal, the failure of the financial sector to live up to its climate rhetoric is understandable. As it stands, financial systems are in a difficult position when asked to pivot to environmentally-friendly practices. Among other reasons are the structural inability of the financial system to account for the long-term, the tendency for profit-making to correlate with higher carbon emissions (though decoupling efforts are being made), the comparative ease with which “greenwashing” marketing campaigns can substitute for actual transformative change, and the reality that fossil fuels are still a lucrative industry. The list goes on. 

For all these reasons, critics are right to point out that green finance is, at present, a deeply flawed actor in the fight against the climate crisis. However, a meaningful discussion about  market forces requires a deeper interrogation of the mutability of financial systems. Rather than writing off the financial sector as a one-dimensional antagonist in the climate crisis narrative, what if banks, regulators, and investors had a redeeming character arc?

Why Green Finance?

Despite ESG’s muddied reputation and difficulties in changing financial behaviour, green finance should not be forsaken. 

Firstly, green finance is a way of accounting for climate change, rather than leaving it as a costly externality. The truth of the matter is that climate change will directly impact financial activity. “The Dasgupta Review”, a comprehensive global review commissioned by the UK government, concluded that the economy is dependent on biodiversity and ecological health. Keystone species such as mangroves, perform crucial ecological functions such as flood protection and erosion prevention.

The massive scale and speed of biodiversity loss we face today is an existential threat to nature, people, prosperity and security.

These functions, otherwise known as “ecosystem services”, are extremely costly and sometimes impossible to replace with technology. Reinsurance group Swiss Re valued the total estimated cost of ecosystem services at $33 trillion a year. As the G7 climate ministers put it, this makes the massive scale and speed of biodiversity loss we face today an “existential threat to nature, people, prosperity and security”. 

This means that the financial sector will ultimately pay a higher price if they ignore climate change, rather than confront it head-on. Mark Carney put it succinctly in his seminal speech in 2015 – climate change imposes three distinct costs: physical risks, such as ecological disasters causing direct damage to physical assets, liability risks, which arise from people seeking compensation for losses suffered from climate change, and transition risks, resulting from the transition to a low carbon economy, all of which have a financial cost to them. 

Green finance has the potential to empower companies  and investors alike to stay ahead of the curve. The Asian Development Bank has called on investors to embrace long-term investing, which entails mobilising capital on an institutional level to support investment opportunities that are geared towards a sustainable future. 

“Today’s savvy investors – and the financial industry as a whole – need to look ahead, beyond today’s market prices and policies to the market prices and policies of the future,” the bank wrote in a 2019 report.

Plainly speaking, if past actions cannot be undone, green finance is a way to set the future path straight for financial actors...As a matter of self-preservation and ethical responsibility, financial accountability for climate change at a systemic level is necessary if we wish to mitigate the threats of climate change.

Secondly, green finance, when properly executed, is a way to ensure that capital flows do not enable environmentally destructive economic activities. The fossil fuel industry is one such sector which has been a source of massive economic profit, but is also  a major contributor of emissions. The drastic global warming and worsening environmental conditions caused by the use of fossil fuels have led to the displacement of climate refugees from their homes in vulnerable third world countries. 

Truly “green” funds would ideally no longer support such “brown” activities. This would take the form of divestment from environmentally harmful activity, redirecting investments into green technologies such as renewable energy, and even investing in ways to help the fossil fuel industry pivot away from tapping oil and gas. Plainly speaking, if past actions cannot be undone, green finance is a way to set the future path straight for financial actors. Until green finance decouples itself from emission intensive sectors, it cannot be considered truly “green”. This would require tightening ESG standards and enacting punitive legislation to stem the flow of investments towards environmentally destructive activities. 

It is clear that as a matter of self-preservation and ethical responsibility, financial accountability for climate change at a systemic level is necessary if we wish to mitigate the threats of climate change.

Hope for Green Finance

Luckily, green financial instruments are showing signs of possessing real, rather than theoretical positive environmental impact. Yes, there has been ongoing debate as to whether green bonds are truly making any substantial positive impact given how hard it is to measure tangible environmental impact caused directly by financial activity. 

Though it is difficult to discern which investments are truly impact-generating, the process of doing so has gotten easier with the increasing wealth of research on green financial instruments and the development of taxonomies.

Here, it might be useful to draw attention to the subtle difference between impact-aligned, and impact-generating investments. While impact-aligned investments are claimed based on already-realised environmental benefits, the latter label requires an investment to make further impact than what has already been achieved.     

Environmentally-minded investors should aim for the latter, which moves the needle on tackling climate change, where the former does not. Though it is difficult to discern which investments are truly impact-generating, the process of doing so has gotten easier with the increasing wealth of research on green financial instruments and the development of taxonomies.

For instance, more recent studies show that issuers of green bonds have a “pronounced, significant and long-lasting” decrease in their assets’ carbon intensity. Essentially, this means that lower Scope 1 (or direct) carbon emissions have been observed from issuers who borrow on green bonds rather than non-green bonds.

Moreover, the size of the green asset market is bound to increase as regulators and financiers grow more concerned with greening finance. The push for financial institutions to invest in assets with higher ESG ratings has grown considerably in the last year. In light of this, ensuring that assets are accurately labelled as “green” will be critical. The European Union, in particular, has just pushed out new standards on climate risk disclosure through the Green Taxonomy, a piece of European legislation which outlines activities which are considered sustainable, starting in 2023. Singapore is following suit, leading the APAC region with its own green taxonomy coming out in late 2022. 

In theory, these regulations should help to redirect financial flows from dirty assets to the clean investments necessary for a green transition. Though their efficacy remains to be seen, the introduction of these regulations signals a much stronger hand from regulatory institutions in enforcing sustainable standards in the finance sector.

Though the current state of green finance is bleak, not all hope in financial mechanisms as a means of enacting environmental change should be lost. Green finance has both the moral and financial impetus behind it to become an empowering tool in the fight against the climate crisis. With the right changes to institutions and individuals to shift the finance sector away from purely profit-driven motives, the mountain of challenges that seem to loom ahead will be surmountable. 

This insight piece was authored by Leanne Chee, and first published as a commentary article titled “Don't dismiss green finance just yet” on Eco-Business. Leanne is part of the research team at the Green Swan Initiative.