Climate Finance: Financing the Future
By Brianna Baily, Executive Editor
Fair Trade. 99% Natural. Responsibly Sourced. If you’ve been to a retail store in the past few years, chances are you’ve seen these words slapped on a package. While some of these claims are nothing more than lightly-regulated marketing tools, they signal a growing trend. More and more, consumers care about the practices and stories behind the products they purchase, and desire a side of sustainability with their grocery bill (and car payment, mortgage, etc.). It’s no surprise, then, that consumers also care about the environmental impact of their stock portfolios and 401(k)s.
In fact, consumers are the driving force behind Socially Responsible Investing, commonly called Impact Investing, a practice where investors put money into funds or companies which follow certain socially, ethically, or environmentally responsible guidelines. Unsurprisingly, the environment is a primary beneficiary of SRI. Recognizing this consumer demand, many financial institutions have begun offering green financial products. In fact, 14% of 401(k) plans have now added socially responsible funds to their investment menus, and over three dozen dedicated green portfolios, including both mutual funds and ETFs, exist.
“[…] 14% of 401(k) plans how now added socially responsible funds to their investment menus, and over three dozen dedicated green portfolios exist.”
In a sort of trickle-up effect, many activists have taken the eco-friendly demand to the boardroom, advocating for greener practices in corporations such as Exxon Mobil and Equity Residential. In 2013, 92 companies faced shareholder resolutions relating to climate change issues, asking for an explanation of the environmental impact of the company’s practices.
The demand for this social and environmental responsibility fits neatly within a more global push toward sustainability. Governments across the globe continue to enforce increasingly strict emissions standards, and public and private entities have made tremendous strides in improving the efficiency of certain renewable energy sources.
As environmental regulation becomes more robust, governments are turning to private actors for support in furthering these initiatives. Climate finance has exploded recently, with an estimated $359 billion a year in global climate finance flows. Many “green” financial products are being marketed to private investors. One such product is the green bond. Capitalizing on the multi-trillion dollar bond market, the World Bank issued its first green bond in 2008, and has since issued more than $6.7 billion in green bonds in 17 currencies, with the International Finance Corporation issuing $3.6 billion. These bonds operate the same as any other debt-based instrument, except that they solely support sustainability efforts.
“Capitalizing on the multi-trillion dollar bond market, the World Bank issued its first green bond in 2008, and has since issued more than $6.7 billion in green bonds…”
Green financial products are proving attractive; the private sector invested 62% of climate finance in 2012. While climate finance is clearly growing, some of the largest players are not yet on board. Institutional investors, who manage an asset base of over $70 trillion, are hesitant to dive in to this relatively new space. Institutions have repeatedly endorsed the exciting new opportunities that come with this renewable energy space, but in practice, the risks associated with this type of investment appear to be holding back these institutions. Not only is the renewable energy market still young, the developing countries which most require climate finance aid are prone to sudden policy shifts, and tend to have immature financial markets.
Many solutions have been proposed to make investment in climate finance more attractive for institutions. Suggestions include modifying financial regulations which affect renewable energy investment, better treatment of illiquid assets, and the removal of policy barriers which may discourage institutions from investing. It’s also possible that the simplest, and most natural solution is a proven market. As climate finance grows, market-based risks such as illiquidity are reduced. Additionally, investor confidence in renewables is improving. Regardless of the method of inducement, it is clear that institutional investors are a key component in the continued success and growth of climate finance.
“Many solutions have been proposed to make investment in climate finance more attractive to institutions, including modifying financial regulations which affect renewable energy investment, better treatment of illiquid assets, and the removal of policy barriers…”
Despite the popularity of social responsible investing, some investors at the consumer level still hesitate to apply their eco-friendly practices to their choices of mutual funds and ETFs, for legitimate reasons. Avoiding a fund containing tobacco or oil company shares, both of which are traditionally high performing long-term stocks, may put a consumer’s portfolio at a disadvantage. Volatility in certain sectors and lack of diversification in funds is also a concern. However, with risk comes reward, and the plethora of low-cost buy-in opportunities in renewable energy might make investing early in green funds a worthwhile endeavor. And for environmentally-conscious consumers, using their finances to support the future of our environment (and economy) may prove to be all the upside they need.