Climate Action

Finding the Clean Trillion

Whatever the outcome of the Paris Conference, huge investments will be needed to create a sustainable world. Estimates vary, but the investor group Ceres calls for a ‘Clean Trillion’ or US$1 trillion every year between now and 2050. And most of that money will have to come from the private sector.

  • 03 December 2015
  • William Brittlebank

That is the challenge, and it may seem daunting. Yet the run-up to this conference has witnessed extraordinary support from the global finance industry. The world’s largest investors promise that money will flow if a robust and fair deal is struck. Meanwhile, banks are finding ways to promote and channel tens of billions towards green investment.

But finance does not flow in a vacuum. How incentives are struck, and the finance that follows, are closely related. We need to focus on the efficiency of the finance industry in helping channel people’s savings into investments that will generate both short-term returns and long-term sustainability.

Development cannot take place unless the finance industry does its job. People need a place to keep money safe and a way to conduct transactions with each other. If people are to adapt to climate change, many will need the insurance industry to help them defray catastrophic risk. But most critically, if we are to create a sustainable and prosperous world, we need to find the Clean Trillion.

Development cannot take place unless the finance industry does its job

The finance industry must find a way to fulfil these demands, and to do so profitably. If bad financial institutions make more money from unsustainable projects than the good ones that fund sustainable projects, they will drive the good ones out of business. So if financial markets are going, at scale, to bring cash from where it is to where it is needed, good investments need to make a return.


Set the incentives to make the money flow

The good news is that the financial world has ample savings to invest. Some US$225 trillion is represented in our capital markets; a little more than half from the banks, the rest from insurance, pension and investment companies. Against that sum, the Clean Trillion looks quite modest. But market forces still haven’t got enough money flowing. Indeed, less than half of the Clean Trillion is being invested each year.

The good news is that the financial world has ample savings to invest

How can that be? Investment institutions are indeed seeking sustainable investment opportunities. They are doing so on behalf of hundreds of millions of savers, who want, at some time in the future, returns from those investments to pay for pensions and other contingencies. If we don’t control the world’s climate, we put at risk not just environmental viability, but financial and economic viability as well. If that happens, we cannot fulfil the pension promise. So why isn’t the money flowing already?

One reason is that the private incentives are just not strong enough. Investment institutions cannot turn a blind eye when a dirty investment gives a greater return than a clean one. That is why over 300 institutions, representing US$24 trillion of investment, are urging world leaders to reach an agreement in Paris. They are happy to pay a price for carbon if it makes sustainable investment relatively more attractive, but they cannot do that individually. Once carbon is ‘priced into the market’, it can generate potentially huge economic rewards. But if we don’t control climate change, long-term financial returns are also at risk.


Sustainability is the prerequisite

The largest investors, insurance and pension funds in the world are asking governments at the Paris Conference to:

  • Provide stable, reliable and economically meaningful carbon pricing that helps redirect investment
  • Strengthen support for energy efficiency and renewable energy
  • Support innovation in and deployment of low carbon technologies
  • Develop plans to phase out subsidies for fossil fuels
  • Ensure that national adaptation strategies are structured to deliver investment.

These institutions have not suddenly become green activists. They are simply saying that unless the climate is stable, the world economy in which they invest is at risk. Those who think sustainability hinders economic growth in the long term are misunderstanding the nature of the issue. Without sustainability, there can be no economic growth.


Money is beginning to flow

Some might argue, and not without justification, that actions speak louder than words. They are still waiting to see enough money flow towards green investment projects. But there has been huge progress. The Chinese, for example, with their Green Credit Policy, are leading the world in finding ways to use the financial system to support sustainable investment and to reverse unsustainable activity.

The Chinese, for example, with their Green Credit Policy, are leading the world in finding ways to use the financial system to support sustainable investment

In developed market economies, governments are less willing to direct investment flows. Nevertheless, there have also been huge steps forward. For example, the ‘green bond’ market, where countries and companies borrow for sustainable investment projects, has taken off. Some US$60 billion of green bonds will be issued this year as investors look for ways to invest sustainably. Only four years ago, it was less than one-tenth of the size.

Groups of investors are getting together to ‘decarbonise’ their investment. Launched less than a year ago, the Portfolio Decarbonisation Coalition has signed up over US$50 billion of funds. They are finding ways to sell out of their brown investments and reinvest in green ones. Many banks have banned lending to certain projects; HSBC, for example, is refusing to finance dirty power.


Getting companies to ‘go green’

Companies, rather than financial institutions, make most of the private sector investment. And most times they do not need to come to their bankers and capital providers for each investment. Rather, they pay for it with retained profits. So investment institutions are being strongly encouraged to push the companies they own into ‘going green’.

It makes good sense for them to do so. Evidence suggests there is already more fossil fuel discovered in the ground than it will be possible to burn. So why would energy companies waste capital expenditure on finding more? That is why progressive financial institutions are asking companies to review their capital expenditure.

There are different approaches to make the business case. Signatories to the Principles for Responsible Investment, now representing over US$50 trillion of investors, take a ‘gentle’ path of persuasion. Others, like the US$300 billion CalPERS, a progressive pension fund, issue a more focused demand to desist from wasteful expenditure. Either way, the message to companies is clear: go green.


A sustainable financial system

So plenty of activity is taking place. But it is still not enough. We are still a long way from the Clean Trillion.

One reason for the gap is because the finance system itself is not well structured to promote sustainable investment. Quite the reverse. Right now, there are flaws in the way the financial system operates. Many of these problems are quite technical, but, taken together, mitigate against sustainability. In fact, Bloomberg New Energy Finance describes the way capital markets work as being ‘institutionally fossilist’, in other words they inadvertently give preference to unsustainable over sustainable investment.

Bloomberg New Energy Finance describes the way capital markets work as being ‘institutionally fossilist’

For example, credit rating agencies, which determine whether a bond is ‘investible’, do not consider risk beyond three years. So a bond backed by an unsustainable dirty coal plant that will need to close can receive the same rating as a solar plant. The same is true for accounting standards; despite their claims to be prudent, they do not question the value of ‘stranded assets’.

By their nature, the risk measures used to manage banks are backward-looking, and ill adapted to foresee catastrophic climate impact that could lie ahead. Investment institutions, which owe a fiduciary duty of care, nevertheless often ignore the effect of investment decisions on their customers. Indeed, some still claim that fiduciary duty demands such myopia.


Setting the direction

There are many more such examples of ‘institutional fossilism’. But rather than dwelling on the detail, we first need to set the direction. Savers, citizens and policy-makers alike should ask operators to commit to managing the financial system so that it is fit for purpose, that is, designed to support sustainable development.

When world leaders meet in Paris, the thought will be in everyone’s mind: “Where is the money coming from to finance sustainability?” And of course we don’t know; private sector money needs an incentive to flow. Those in the developing world will doubtless be thinking, “Shouldn’t those who have caused pollution over generations pay up?” But of course there is no way that pointing fingers will raise the Clean Trillion.

As one response, world leaders could ask those responsible for the regulation of our financial services industry, particularly those regulators with global responsibilities, to make a real commitment. The industry could ensure their activities support an efficient and stable finance system, in support of sustainable development or a sustainable economy.

The Dutch financial system is one of the best in the world at finding and investing in profitable sustainable projects

Some institutions, such as the Dutch Central Bank, have already done so. Not surprisingly, the Dutch financial system is one of the best in the world at finding and investing in profitable sustainable projects. If every national regulator – those global organisations that oversee banks, insurance, securities markets, accounting, audit and actuarial standards, and overall financial stability – were to do likewise, it would be a huge step forward.

We could also ask for specific commitments from the private sector to respond to these challenges ahead of regulation.

Credit rating agencies, for example, could do the following:

  • Offer ratings that look to the long term and incorporate sustainability
  • Get companies to report openly on their environmental standards and agree to declare their improvement plans
  • Create standards of reporting for all companies that raise money through public stock exchanges
  • Get banks and investment institutions to manage and minimise value ‘at risk through climate change’, making them safer, and steering them away from unsustainable activity.

Trustees of investment funds could be encouraged to accept fiduciary responsibility.

Equity investors could integrate climate considerations into their engagement with companies and voting for boards.

Insurance companies could help identify and create climate-resilient and safe standards for green bonds and similar sustainable financial products.

Each of these is the first of many small steps. But taken together they would put the world on a very different course towards sustainability and development.


Will Paris do the job?

At the time of writing, we do not know the outcome of the Paris Conference. But the best result will still require world leaders, regulators, bankers, investors, insurers, auditors, credit rating agencies, stock exchanges and many more to play their part to raise that Clean Trillion. We need to get on with it.

And if you need advice on how your financial institution can get together with others and help solve the world’s biggest problem, join with us in the UN Environment Programme’s Finance Initiative.