Development and Global Sustainability: The Case for ‘Corporate Climate Finance’

Climate change is as much an economic issue as an environmental and ethical one. Increasing climate resilience in developing nations and moving to a low-carbon economy globally will require significant capital outside of normal government channels and beyond business as usual. While the roles of multilateral public finance actors such as the World Bank and the newly created Green Climate Fund have received broad attention, this article argues the case for engaging transnational private finance sector actors (such as insurers, institutional investors, banks) as key providers of and conduits for ‘corporate climate finance’ in developing nations.

Introduction

Climate change is as much an economic issue as an environmental and ethical one. The imperative of climate change mitigation is to urgently cap global warming at two degrees Celsius (2°C) in order to prevent catastrophic global change. In order to do this, global GHG emissions must level by 2020 and then reduce by half by 2050 (European Commission 2013).   Yet scientists nearly unanimously predict that without urgent policy and multi-sectoral action the world will warm by 4°C above the preindustrial climate by the end of the century (World Bank 2012). Such a rise would instigate unprecedented heat waves, droughts, flooding, cyclones and wildfires in many of the world’s poorest regions (IPCC 2014) with serious impacts on infrastructure, ecosystems and human services that are likely to undermine development efforts and global development goals (World Bank 2012). To date, most attention has been directed at multilateral arrangements for mitigation and adaptation provided by developed to developing nation states, which is consistent with the common but differentiated responsibilities and respective capabilities of Parties to the United Nations Framework Convention on Climate Change (UNFCCC).  Less consideration has been given to the role of financial intermediary actors. This is a curious oversight because mitigating greenhouse gas (GHG) emissions and adapting to inevitable climate impacts will not only require behavioral and technological change; it will also require lots of money.

Massive financial mobilization in the order of US$15.2 trillion of additional costs for both developed and developing nations will be required for global GHG emissions mitigation, which is an exponential increase on the current annual investment of US$160 billion (Green Climate Fund 2013). In order to assist adaptation in developing nations, trillions of dollars will be required to upgrade and expand energy and transport infrastructure (World Bank 2010); and additional annual investment of nearly US$800 billion will be required for electricity expansion, modern cooking fuels, energy efficiency, and renewable energy (World Bank 2013).

In short, moving to a low-carbon global economy and increasing climate resilience in developing nations will require significant capital outside of normal government channels and beyond business as usual. Indeed it will involve one of the largest market and economic transitions in modern global society.

Given this reality, the finance sector has a key role to play in helping address climate change in terms of assisting developing countries with adaptation. Public finance actors, such as the World Bank and the newly created Green Climate Fund, tend to take the spotlight here. Far less attention has been given to the potential of and processes for directly engaging private finance sector actors as positive societal change-agents. Specifically, transnational private sector financial actors that are headquartered in developed countries are global economic gatekeepers and financial intermediaries, making them critical actors in the transition to a low-carbon global economy. They comprise insurers (especially re-insurers), institutional investors (especially pension funds) and banks. The potential of these private finance actors to assist climate change adaptation in developing nations and also the shift to a low-carbon economy globally has been largely unnoticed by scholars and policy-makers. The purpose of this article is to demonstrate that we need to start paying attention now.

Public Climate Finance

The role of financial capital in addressing climate change becomes clear by examining its relevance to sustainable development and ‘the environment’ more generally. Financial support for projects and technological innovation will almost always have environmental effects of some kind whether adverse or beneficial. Wholesale decisions regarding future development often arise in the finance sector; so this is where future pressures on the environment begin. As Richardson notes: “[i]f sustainable development is understood to imply, among other things, maintenance of natural and human-made capital for posterity, the role of capital markets must be recognized as pivotal to this goal.” (2006:309)

Since the 2007 Bali Action Plan, international action on climate finance has centered on the provision of financial aid by developed countries to developing countries via public (usually multilateral or bilateral) institutions to build their resilience against climate variability (e.g. Chaum et al. 2011; Brahmbhatt 2011; Fankhauser and Burton 2011) and facilitate mitigation. For example, Climate Investment Funds are managed by the World Bank and implemented jointly with regional developing banks, which can leverage support from developed countries and buy-down the costs of low-carbon technologies in developing countries. Another option is the Green Climate Fund (GCF), a new multilateral fund that was agreed by Parties at the 2010 UNFCCC conference as an operating entity of the UNFCCC’s financial mechanism. The GCF’s purpose “is to promote, within the context of sustainable development, the paradigm shift towards low-emission and climate-resilient development pathways by providing support to developing countries to help limit or reduce their greenhouse gas emissions and to adapt to the unavoidable impacts of climate change.” (Green Climate Fund 2014). It will do this by allocating funds pledged by developed nations – US$100 billion per year by 2020 – to both mitigation and adaptation activities in developing nations, especially the most vulnerable (Cancun Agreements, Decision 1, CP16). The GCF is still under construction; its Board will aim to decide essential matters of how the GCF will receive, manage, programme and disburse funds in May 2014 (Green Climate Fund 2014).

There is no doubt that multilateral efforts are vital. In particular, the GCF is a most welcome and timely global initiative; however, there are at least two initial concerns. First, looking at the sums of money cited in the Introduction, US$100 billion is insufficient to meet the task at hand. Due to the limited availability of public funds, investments at scale will also require private sector funding. To this end, the GCF employs a Private Sector Facility (PSF) to promote the participation of private sector actors in developing countries, particularly “small and medium-sized enterprises and local financial intermediaries.” (Green Climate Fund 2013:1). Private sector entities (like Google or Coca Cola) can provide funds through the GCF’s External Affairs division, alongside public contributions. This raises the second concern: that a vital opportunity to directly engage the private finance sector will be missed under these arrangements. Neither the PSF nor the External Affairs (donations) division will capture or engage multinational and transnational financial intermediaries, such as a large U.S. pension fund or a European bank.

Why does this matter? Private finance sector actors are economic gatekeepers with access to large and multiple pools of money and the innate ability to move it around. Their raison d’être is to make intermediating decisions about where money (as an asset, debt or equity) comes from and where it flows to (via sourcing, allocation and advisory processes). In short, they have a central role to play in climate change efforts because, as noted by Lord Stern, “reducing emissions and adjusting to climate change involves investment and risk” (UNEPFI 2007:2).

The Case for ‘Corporate Climate Finance’

Accordingly, we need to be thinking about how best to directly engage private finance actors to facilitate the capital required for global mitigation and adaptation measures. And we need to consider these actors separately to the broader ‘private sector’ due to their unique financial functions and abilities.

Specifically, there are two main groupings of private finance actor relevant to facilitating mitigation and adaptation measures. First, transnational banks that engage in project finance, corporate lending and asset management. These actions are important by sheer weight of numbers: global markets can be more valuable and affluent than some developed nations. Commercial and investment banks have unique ability to access those markets in ways that can address climate change. For example, from January 2007 to July 2013, , private green investment totaled US$5.2 trillion, of which nearly US$2.4 trillion was invested in renewable energy alone (Ethical Markets 2013).

The second grouping is institutional investors that invest through debt or equity. Institutional investors comprise asset/investment managers such as banks, asset owners such as pension funds, and insurance companies. Indeed, in Australia and New Zealand alone, the Investor Group on Climate Change (IGCC) represents institutional investors with approximately AU$900 billion of funds under management (IGCC 2012). These funds invest in several markets and assets for which adaptation investment will be required, namely: property (residential and commercial), transport infrastructure (roads, bridges, airports), social infrastructure (hospitals, prisons), utilities and network infrastructure, and agriculture (IGCC 2011). Equivalent coalitions reside in most developed nations; for example, the European Institutional Investors Group on Climate Change is based in the U.K. and currently represents assets of around €7.5 trillion; the North American Investor Network on Climate Risk supports 100 institutional investors with assets exceeding US$10 trillion (Ceres 2013).

Private finance actors are key players in mitigation and adaptation efforts because their raison d’être is to facilitate and channel finance, in very large amounts, around the world. This is not an ad hoc process reliant on the charitable disposition of the corporate actors involved. It is driven by business case logic, which in its simplest terms can be summarized as the desire to make money and to not lose money.

 The Importance of Business Case Logic

Unlike public finance entities or philanthropic public companies, the private finance sector has never been known for an ‘international ethics’, ‘societal benefit’ or otherwise charitable approach to doing business. In one of the first qualitative studies on corporate climate finance published recently in the Stanford Journal of Law, Business & Finance, I addressed the question of what drives early-moving banks in market economies to ‘go green’ (Bowman 2014). I found that they are driven by business case logic, which comprises profit increase (directly via fee generation and indirectly via competitive edge) and risk mitigation (financial, regulatory, and reputational). Crucial to these findings was a deeper understanding of ‘corporate reputation’ in business practice: it comprises not only the well-established ‘social reputation’ or social license of a firm but also a reputation for good business sense and delivering excellent service that helps large corporate clients to flourish. I termed this phenomenon ‘client service reputation’, and it was a prime motivator for climate-related products, services and new market entry. Banks are fighting for a fixed universe of clients and there is a fixed size of the purse. So by helping corporate clients to survive and thrive in an increasingly carbon-constrained world, banks help themselves by enhancing their competitive advantage and thus fee generation. Under the impetus of client service reputation, banks could be agnostic about climate change; their ‘green’ driver was the greenback not a desire to save the world.

Importantly, interplay between reputation and regulatory context became apparent when examining banks’ perspectives of climate change as a risk or an opportunity. In large part, their perspective was jurisdiction-specific and shaped by regulatory context. The regulatory context included not only government interventions – namely a carbon price, financial incentives for renewables, a GHG reduction target, or even direct coercive social regulation such as the U.S. Community Reinvestment Act of 1977 (12 U.S.C. 2901) – but also social pressure from non-government organizations (NGOs) and civil society. The more sophisticated and stable the state interventions, the more that banks saw climate change as an opportunity, and leveraged regulatory incentives to enhance their client service reputation, social reputation, and profits. The weaker or less certain the state interventions, then: (a) the more important NGO activity and voluntary industry standards became to mobilize better corporate behavior; and (b) the more likely that banks saw climate change as a risk. In such a regulatory context banks focused on strategies for downside prevention, particularly for protecting their social reputation. In other words, banks that were primarily driven by risk mitigation were reactive, particularly to social pressure, and their aim was to keep ‘business as usual’ running as smoothly as possible. They were less likely to be proactive and innovative in addressing climate-related issues.

 The Role of Policy

Based on that earlier study, it is clear that government policy has an important role in shaping the behavior of private finance actors. A strong policy framework will incentivize proactive and innovative approaches by private finance actors in addressing climate change through their lending, financing, investing and shareholding practices. Specifically, policy that modifies risks and returns for investors and also “the information and processes they use in investment decisions” will influence whether and to what extent private sector finance flows to adaptation and low-carbon initiatives (Pierpont 2011:3). The key is to leverage and deploy resources at the necessary scale. To this end, public policy for private finance plays a crucial role: it can establish the incentive frameworks needed to catalyze high levels of private investment in mitigation and adaptation activities.

Given the heterogeneity of projects, investors, and climate risks, there is no one-size-fits-all prescription for designing effective climate finance policy; precise solutions will vary from country to country. Nonetheless, we now know that private finance actors make decisions based on business case logic, which comprises a cost/benefit analysis of projected returns and potential risks inherent in an investment or project. Accordingly, existing and new government policies for mitigation and adaptation need to be measured against this generic benchmark: ‘how do they support the business case for private investment and financing?’

Overall, a federal regulatory mix in both developed and developing countries is required to encourage, leverage and procure private financial resources for mitigation and adaptation at the necessary scale.  Details of exactly what policy measures will work and in what circumstances, particularly accounting for heterogeneity, requires lengthy analysis and is beyond the scope and intent of this article. Suffice to say here that rrecommended instruments include: public-private co-financing arrangements, concessional loans, payments for environmental services, improved resource pricing, charges and subsidies, risk sharing and transfer mechanisms (IPCC 2014); creative use of insurance products such as parametric insurance to fund increased insurance premiums for wild weather-related disasters (Swiss Re 2011); and the use of market policy mechanisms such as tax credits, feed-in-tariffs, grants and climate bonds (Bowman 2014).

In this way I advocate taking the IPCC (2014) suggestion of overlap between mitigation and adaptation activities and extending it to climate finance. Indeed, I see significant overlap between (a) financial mechanisms for adaptation that protect both physical and fiscal assets from the risks of climate change, and (b) financial mechanisms for mitigation that assist the transition to a low-carbon economy. For example, fund managers need to invest in low-carbon options in order to protect pension funds, which are a long-term fiscal asset, from the adverse impacts of climate change. Such impacts include decreased returns on investments in climate-vulnerable or carbon-intensive industries. It is this overlap that makes corporate climate finance for adaptation a unique beast.

Yet, there will be challenges in moving forward. For example, possible conflicts of interest may exist between the goals of nation-states and those of transnational corporations given their different constituencies. Importantly, community benefits or ‘social returns’ on infrastructure investments do not feature in a conventional commercial business case. This means that finance actors are less likely to make major infrastructure investments in developing nations that yield high social returns – such as improving the climate resilience of electricity or water utilities – if there is not high enough economic return to outweigh the risks. Conversely, private financiers can (and do) support lucrative projects that concomitantly produce deleterious socio-environmental outcomes. This is where policy becomes so important: climate bonds; proactive insurance; and co-financing arrangements (where the federal government provides part or concessional finance) can harness private finance for public good. By covering upfront costs and mitigating project risks, policy can leverage private finance in the public interest, directing it to where it might not otherwise flow and away from where it otherwise might.

Another  challenge is more technical than socio-political: improving the availability and quality of information for investors. Improved information resources are crucial for private finance actors to manage climate-related risks and make long-term investment decisions, otherwise private sector actors “will fail to develop economically efficient responses for climate change adaptation and risk management” (UNEPFI and SBI 2011: 19). Specifically, financial actors require ‘applied’ research and tailored information, such as sectorial analyses, regional scenarios, databases of adaptation and clean tech projects, and extreme weather events both historical and predicted (UNEPFI and SBI 2011; Economics of Climate Adaptation Working Group 2009).

Private finance actors can supply a solution here – to the benefit of the broader private sector and public agencies. Leading insurers and other financial service providers have developed statistics and competencies in these areas, including extreme weather and loss databases and catastrophe models. Moreover, finance actors desire collaboration with research institutes and other partners to help develop information services and formats (UNEPFI and SBI 2011). Thus, a further role for policy-makers in both developed and developing nations is to encourage co-operation between private finance actors and government agencies and/or universities to exchange and enhance experience and knowledge ‘on the ground.’

Conclusion

At the World Economic Forum in Davos earlier this year, World Bank President Jim Yong Kim said “In 20 years, all of us will be asked the question, ‘What did you do to fight climate change?’” He highlighted that leaders “both from the private sector and from governments, have in their power to act in substantive ways.” (World Bank 2014). This article has argued the case for engaging the private finance sector as a separate species of private sector actor with the innate albeit unlikely ability to act in a substantive way through the provision of ‘corporate climate finance’. The raison d’être of financial actors is to facilitate and channel finance from the private sector around the world using business case logic, which includes exploiting opportunities where the policy settings are conducive to doing so. Public policy that targets private finance can establish the incentive frameworks needed to catalyze high levels of private investment in mitigation and adaptation activities at scale. In this way, the goals of climate change adaptation in developing nations and also the global transition to a low-carbon economy may be more expeditiously realized.

Dr. Megan Bowman is a Research Fellow in the Centre for Law, Markets and Regulation, Faculty of Law, UNSW Australia, Sydney. She has previously participated in the Stanford/Harvard International Junior Faculty Fora and written widely on environmental law and business strategy. This article is part of her broader study of climate finance. Dr. Bowman can be contacted at: megan.bowman@unsw.edu.au

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