Climate finance in trees

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While progress is being made in the world’s mission to preserve the climate, a big boost in annual finance and improved standards are necessary to stay on track. Philippa Nuttall reports.

More transition finance and an increase in standards and consistency will help generate the considerable amounts of cash necessary to finance a rapid shift away from fossil fuels and towards a low-carbon economy.

That was the message from Daniel Stevens, a senior partner with McKinsey in Washington, on November 29.

Mr Stevens made his comments during a webinar organised by UK think tank Chatham House held in response to the Sharm el-Sheikh Implementation Plan agreed at COP27, which indicated that the low-carbon transition will require “a transformation of the financial system”.

This wording was the first time a COP decision had made explicit the need to overhaul the global financial system to scale up climate finance. “Governments, central banks, commercial banks, institutional investors and other financial actors” will all need to engage to transform the system’s “structures and processes”, it said. 

The call came after ministers and campaigners at COP27 had consistently underlined the significant shortfall in investment to fund renewable energy infrastructure and to help countries cope with the impacts of climate change, in particular in lower-income countries.

Developing countries are estimated to need $5.8tn to $5.9tn between now and 2030 to implement the plans set out in their nationally determined contributions, highlighted by the Sharm el-Sheikh plan. 

Global climate finance flows to developing countries in 2019-20 were estimated to be $803bn, the plan said. That figure is well below what is needed to keep the global temperature rise below 1.5 degrees or even 2 degrees and “below what would be expected in the light of the investment opportunities identified and the cost of failure to meet climate stabilisation targets”.

Poor distribution of wealth

The big problem, as Chatham House’s Lilia Caiado Couto highlighted when opening last week’s webinar, is that climate flows are not global, with 90% of private climate finance being spent domestically, mainly in richer nations. 

While “energy investments today in emerging and developing economies rely heavily on public sources of finance”, as a 2021 report from the International Energy Agency stated, an estimated 70% of finance for the clean energy transition globally will need to come from the private sector by 2030.

Despite investment shortfalls, McKinsey’s Mr Stevens suggested the climate finance glass is more half-full than half-empty. “Growth of the market has been phenomenal,” he said. “If we were five years ago, we would be surprised by how well it has gone”. Annual climate finance flows are worth around $2trn today, he explained, and this figure “needs to be $9tn on average between now and 2050”. That $2tn out of $9tn “isn’t trivial”, continued Mr Stevens. “We’ve already got a big chunk turned on.”

Nonetheless, he agreed that this investment is happening “almost exclusively in the developed world” and most of it is flowing into “utility-scale renewable energy and electric vehicles”. 

Finance transition

Banks need to help push more finance into lower-income countries, but also into projects and technologies that will help decarbonise high-emitting sectors, said Mr Stevens.

We need a new asset class that goes beyond green

Daniel Stevens

He sees a shift from “reducing financed emissions, to financing reduced emissions”, estimating that renewables finance must grow “five times on an annual basis”, while finance going to the developing world must increase “by 10 to 100 times”. Capital spent on decarbonisation, he said, such as renewable fuels or the maritime sector, should expand by an order of magnitude of one to two.

Scaling up transition finance would help boost investment in “things that are heavy emitting and make them less heavy emitting”, said Mr Stevens. “We need a new asset class that goes beyond green. Transition bonds, for example, are fairly under-developed.” 

The ratio between transition and green bonds should be about 1.5:1, suggested Mr Stevens. Today, investment is massively skewed towards green bonds at a ratio of about 70:1, he added.

Improving standards

A lack of credible standards is one reason why the transition asset class is less developed, with financial institutions concerned about reputational impacts if they invest in decarbonisation, rather than renewables projects, said Mr Stevens. “Folks have received criticism for coal retirement deals and that would be a big part of what that asset class would need to include,” he commented.

Mr Stevens and Ms Couto both underlined the need overall for more and better standards around net zero. “Depending on the country, net-zero alignment can mean one thing or it cannot mean anything at all, as regulations and standards are not in place,” said Ms Couto. “Central banks and international regulators can do a lot more; we need uniform standards and metrics so the portfolio alignment with net-zero commitments is defined consistently.”

Change in the finance sector is happening, but fast enough, said Mr Stevens. While banks bear some responsibility, “more real economy demand” for renewables and decarbonisation is also needed, he insisted, underlining that financial institutions will not fund projects and technologies without government and industry engagement.


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