It is estimated that over the next 15 years, $93 trillion of investment will be required to build a low-carbon infrastructure across the world. This is an eye-watering sum, given that the CIA estimates the entire total of money currently in existence to be $80 trillion.
Ahead of the inaugural SustainableFinance.Live Co-Creation Workshop, hosted by Finextra Research and ResponsibleRisk, we spoke to Richard Conway, CEO of Elastacloud who references this staggering figure about the work needed to stimulate and grow investment in transitioning to a low carbon economy. Richard Conway is also a Finextra Sustainable advisory board member.
Mobilising for a low-carbon future
Moving to net zero carbon emissions by 2050 requires huge advances in the reliability and affordability of low-carbon technologies. The financial world has been contributing to this aim, with promotion of sustainable investment and a focus on the ESG performance of companies and industries. However, it will take a different approach in order to build on this process.
Conway highlights that “low-carbon technologies are increasingly cost-competitive, but innovations must find ways around their current limitations. Innovation is not only about improving goods and services that currently exist, but also about replacing them with new models of production and consumption.”
An example of this is the service economy, where companies can reduce energy and raw material consumption by selling the use of goods, rather than the goods themselves.
Innovation is increasingly found at smaller companies in comparison to established players, thanks to the former’s business models that are suited to low-carbon technologies. Conway argues that investors and financial institutions (FIs) may have to rethink their policies and adapt to new business models that accompany disruptive technologies.
In order to meet the global commitment to net zero carbon emissions, governments need to set out a clear vision of the transformation of business and energy infrastructures and provide effective policy frameworks, both at a national and international level.
Meanwhile, the finance sector will need to continue its work in maintaining a stable economic environment to ensure that sustainability remains at the top of the agenda. “Success would mean mobilising more private capital behind public goals, delivering economic growth and putting us on the path to a net-zero emissions global economy,” Conway sums up.
Risk mitigation and portfolio diversification
Investment through financial instruments directed towards climate-related causes has soared in recent years. Financial services company Moody’s found that in Q2 2019 debt issuers brought $66.6 billion in green bonds to the global market. This total is predicted to exceed $200 billion by the end of the year.
Green bonds are, according to Conway: “multi-sector, diversified and high quality. They are very much in line with an aggregate fixed income type exposure, which means it can fit neatly into a core bond portfolio - to invest sustainably within the core.
“Yield and duration are in line with the aggregate, so investors can shift part of their core bond allocation to green bonds with very little impact from that perspective, while also getting sector diversification.”
Investors are using green bonds as a cushion against risk, just as they may use government bonds or gold as a hedge against volatility in equity markets. In times of uncertainty, investment in green bonds could indeed be regarded as a necessity in terms of diversifying. Conway regards them as a “cheap or free hedge against climate risk.”
Supply and demand of green bonds
The increased demand for sustainable investment vehicles is one of the legacies of the 2008 crisis. Institutions and corporations look for means of defining a sustainable identity and fulfil the desire of investors to make a difference and take responsibility for the world’s challenges.
Climate risk however is not understood in the same way as risk related to liquidity, credit or inflation, and therefore is not as commonly priced in by the market.
An example of companies with high climate risk could be those who are reliant on underground oil reserves. Similarly, businesses with large presences in coastal areas of low-lying countries may be more vulnerable to rising sea levels.
At present, the market is not pricing such factors in, so those exposed to them are not distinguished from those that are less so.
“When the market begins to price in climate risk, we would expect these issuers to underperform versus issuers who have taken steps to mitigate their climate risk,” Conway says.
This poses the question if the growth in demand for green bonds is driven by social attitudes or by strategic solutions to the evolving demands of clients. “The answer is that both of these drivers are working in tandem, leveraging upon one another,” Conway says.
Despite its rapid growth, Conway believes the green bond market is still a fraction of what it could grow to, describing the current levels as a “tiny segment” of the fixed-income market.
“Issuance of green bonds is much exceeded by demand for them, therefore ‘pricing’ is currently not providing for a buyer's market, reflecting on the demand, which is much higher than supply.”