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The Interesting Role Of Finance In Saving The Climate


Background:  The ideas in this article were significantly sharpened by a panel on sustainability held by Florida Polytechnic University’s Executive Leadership Initiative (ELI). Special thanks to my co panelists Sean Kidney (Climatebonds.com) and Michael Hawes (Fulbright) for a very interesting discussion.

Climate change is the main issue of the day.  The most visibility activity on the issue has been in the political realm with the gyrations around the Paris accords. “Accelerating Technology Adoption is the Key to Solving Climate Change”  argues that underneath the froth of politics are deep technology shifts which may well be more material to solving the climate problem.  Another tectonic shift happening below the radar comes from the world of finance. 

Financial markets are the oxygen which drive the overall economy and their structure drives development patterns in areas ranging from transportation to high technology.  A key driver of financial markets are long term investors such as pension, sovereign, or insurance funds. These fund managers must provide stability as well as return with trillions of dollars of assets. How do they accomplish this task ?    They access risk and hedge their bets.  Traditionally, this has involved hedging across a spectrum of investment instruments such as bonds, stocks, private equity, venture capital, hedge funds, and more.  

What kind of risks are introduced by climate change ?   

  1. Development near the ocean maybe impacted
  2. Carbon heavily industries may face regulatory risk
  3. Certain regions may face political conflicts
  4. etc.

Like any other risk, long term investors seek to hedge their risks for climate change, and new financial instruments called green bonds and ESG targets for stocks have been invented. From an investor point-of-view, these financial instruments provide a method to hedge risk. 

What is the maturity of this market ?

“In 2020, green bond issuances passed one trillion dollars. Further, the German government has made a commitment to provide green bonds at all the standard denominations, and corporate entities such as Mercedes or Verizon
VZ
are increasingly using this financial instrument. In fact, currently, the demand outstrips supply, so this is also a rate advantage for green bonds, “  says Sean Kidney, CEO of Climate Bonds, an NGO which provides certification services for green bonds. 

On the equity side, large fund managers such as Blackstone
BX
have declared that ESG metrics will be the key component for their investment decisions. In terms of maturity, ESG targets are not as mature as green bonds.  Most companies walk through a progression of looking through their own waste products (do no harm), examine methods for adding efficiency(minimize carbon footprint), and in rare situations, drive changes through their supplier chain. There are often goals presented on dates/times to be carbon neutral and associated investments in planting trees (sequestration). Currently, there is no independent assessment of ESG metrics as compared to traditional audited financial statements. 

In summary, the world of finance is moving quickly such that the fundamental hedging strategy used by long term investors is now increasingly including financial instruments around sustainability. This means the literally trillions of dollars (at low interest rates) can be made available for battling the sustainability problem.  

Today, green projects are defined to be projects connected directly to climate and environmental projects. However, is this too limited a point-of-view ?   Some examples to consider:

  1. 5G Buildout or Data Center:   Are 5G or data center investments “green.”  One can make the case that to the degree these technologies virtualize critical aspects of the economy (online education, work-at-home, telemedicine, ecommerce, streaming entertainment), they reduce demand for energy in a nonlinear manner.
  2. Scaled Online Training:  Driving a nonlinear change for carbon climate change will drive highly disruptive changes through the labor markets. In order to manage these changes, a nonlinear investment in retraining will be required.
  3. Transitioning Climate unfriendly assets:  Safely turning off carbon unfriendly assets (coal plants, old cars, etc) requires investment, and in fact, retiring these assets makes the world greener. 

This and many other examples beg the question.   What exactly makes something green, who decides, and how is it assessed ?   To mature to the next level,  a combination of economists and scientists will likely have to build a broader quantitative framework for answering these questions.  As an example, leading scientific institutions such as Woods Hole Oceanographic Institute might be in the best position to build a protocol for accessing green (blue) bonds connected with the ocean projects. Economists can connect these protocols to economic processes which connect to financial instruments.  

Overall, political theatre often dominates the media and public consciousness, and certainly a political discussion has its role.  However, underneath this political discussion are deep tectonic movements driven by technology advancement and financial hedging which are building powerful tools to solve the climate change problem.

Related Articles:

  1. Forget Politics, The US Will Lead In Sustainability Because Of Its Entrepreneurs
  2. Rethinking ESG Targets For Companies Like Amazon, Apple And Analog Device



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