Markets In Your Community

Can Capital Markets Help the Environment?

Not every problem can be solved with more money. But in the case of repairing and restoring the environment, targeted investments in climate initiatives may be just what the doctor ordered.

That’s the essential argument behind “green finance,” a category of social impact investing that focuses on steering private financing toward sustainability initiatives, with the goals of protecting the environment and countering climate change.

That may include investments like the development of cleaner renewable energy technologies, such as solar and wind power; sustainable land use and construction projects; debt financing for climate initiatives through green bonds; equity financing through green IPOs; and more. Such investments will go a long way toward building a more sustainable economy, while sparking economic growth and creating new classes of jobs.

Proponents say this growing area is a promising application of financial innovation that will help counter adverse environmental trends around the globe-while bringing profits for investors at the same time. With last year’s acceptance of the Paris Agreement on Climate Change by 195 nations, green finance is expected to play a larger role in building a sustainable economy in the coming years.

Who’s driving the growth of green finance?

According to the “Global Landscape of Climate Finance 2015” report published by the Climate Policy Initiative (CPI), the market for green finance is rapidly growing. The total “amount of climate finance invested around the world in 2014 increased by 18%, from $331 billion to $391 billion.” That total represents investment from both public and private sources.

If you think government and non-profit spending constitute the largest part of this growing market, CPI’s findings may surprise you. With investors focusing on new opportunities in green finance, private investment in this area grew by 26% in 2014, CPI reports.

At $243 billion worldwide, private investment represents nearly two-thirds of the global market for green finance, according to the report. That represents investment from commercial financial institutions, private equity and venture capital funds, institutional investors, corporate actors and individual households.

To address environmental challenges, the CPI report emphasizes, funding from both public and private sector sources is critical.

Public sector green finance investment, the report notes, helps “drive the global climate finance system by reducing the costs and risks of climate investments, strengthening knowledge and technical capacity, and building the track record needed to enhance confidence in such investments.

Private finance, building upon the foundation of this public investment, can then make the decisive difference as it opens up development to larger pools of funding through the capital markets-just as it did in earlier areas like transportation, telecommunications and computing.

“These markets are new, and they’re being developed in terms of the sell-side and the buy-side,” Kenneth E. Bentsen, president and CEO of the Securities Industry and Financial Market Association (SIFMA), explains in a recent CNBC interview. “So it’s important for industry leaders to get together with our public policy leaders to see how we can make this work.”

Capitalism is saving the climate

In a 2014 article for The Daily Beast, journalist Daniel Gross makes the case that “capitalism is saving the climate.” While initial government investment is essential to get green initiatives up and running, he writes, the next wave of private investment and financial innovation would allow for a more “rapid scaling up” to build a more mature market.

“Rolling out carbon-free energy, whether it is a rooftop solar system, or a giant wind farm, involves complex financial calculations,” Gross writes.  “Developers need to take advantage of tax breaks and credits, figure out how to reduce upfront costs, and match up willing capital with viable projects. That means that financial innovation is now as important to scaling up renewable energy as engineering innovation.”

There’s some evidence that the positive dynamic described by Gross may already be developing, as various industries focus on adopting green technologies within their own purviews.

A recent Wall Street Journal article detailed how several major corporate players in the U.S. economy-General Electric, Wal-Mart, Intel, Whole Foods and others-are taking advantage of declining costs in the green energy space to incorporate solar and wind energy sources into their own business operations.

As more companies embrace renewable energy solutions, that may drive further innovation and adoption among industry and consumers-opening up further opportunities for investment and finance.

“It’s a combination of social pressure on large, visible corporations to do good for the world, and the fact that today you can sign deals that are attractive economically,” Mr. Herve Touati, research director of a clean energy think tank, the Rocky Mountain Institute, tells the WSJ.

The flow of green investing dollars may also serve to strengthen global relationships between the U.S. and other nations. For example, Mark Schwarz, vice-chairman of Goldman Sachs and chairman of the investment bank’s Asia-Pacific region, writes in The Financial Times about the Chinese government’s embrace of green finance to suggest that the environment could be the issue that “binds the two giants of the global economy together.”

“The opening of China’s green market can bring significant private sector investment to meet this shortfall,” Schwartz writes. “Investors are interested: Goldman Sachs estimates that ‘green services’ is a $1 trillion potential market over the next five years. Clean energy is another significant market opportunity. Harnessing market principles and innovative financial structures such as securitizations and yield vehicles can catalyze access to deep liquid public capital markets.”

Green finance can help combat environmental challenges, while bringing the west and China closer together to solve problems.

Not a passing fad

Since green finance represents a relatively new market, expect to see a lot of experimentation. Not all of these experiments will bear fruit-but even the failures will likely mean lessons learned for investors and entrepreneurs that will be beneficial in the future.

Challenges remain to be addressed within the emerging world of green finance. One issue is the need for clearer information and standards to determine precisely what types of investment count as “green” and what does not. Those judgments are not always as clear as you might assume. Establishing workable standards will help increase investor confidence and ensure funding is steered toward worthy projects.

The realm of green finance and sustainable investing is still relatively new. If you’re interested in exploring how to make green investing part of your own balanced portfolio, it’s a good idea to talk to a financial professional who can offer you sound advice about risk and opportunity.

Most observers agree that changing the trajectory of climate change and other environmental risks is going to require more than simply additional regulations, mandates and intergovernmental agreements. The private sector can and must play a role, and green financing is creating the mechanisms through which that participation will occur.

As reported in International Business Times, “sustainable investing is not a passing fad,” wrote the researchers from BlackRock, whose $5 trillion in assets makes it the largest asset management company in the world. “This is not just about doing or feeling good.”