There are innumerable projects and initiatives to fight climate change that need to be matched with appropriate funding sources. Investors, governments and the insurance industry need to work together to make this a smooth process.
The Paris Agreement has set clear greenhouse gas emission goals for 2030 and 2050. In 2020 estimates indicated that to achieve the 10-year goal set forth would require over $1.3 trillion in investments exclusively dedicated to climate change projects over the decade. Some experts believe it could be much more than that.
Since climate change gained momentum over 25 years ago, advances towards renewable and sustainable industries have generated numerous ground-breaking technologies and solutions that are now well established. Among them are wind and solar energy farms, as well as hybrid and electric vehicles. However, we are still far from reaching the goals of the Paris Agreement, not least because the pandemic required a diversion of capabilities to stabilise economies. We need to step up our efforts.
Climate change is a public and private responsibility
While governments (re-) negotiate global emissions reduction targets and translate them into rules and regulations, the solutions to reach the targets will mainly come from private enterprises to ensure that they are developed and implemented in the most efficient and effective way.
The business environment has taken note of the situation and is increasing its efforts to address the climate change threat and develop the required capabilities. More and more companies are driving towards becoming carbon neutral and are dedicating time and money to sustainable products and services. Investment funds and global industries around the world are increasing their participation in “green funding” either driven by conviction, regulatory mandates or simply by a changed consumer perception and preference.
A public/private approach broadens the scope of opportunities for these desperately needed projects as they are likely to need to tap several funding sources on their journey before they can reach market success and help taking society closer to reaching the Paris Agreement goals.
Green investors can be categorised in several groups:
1. Government initiatives
Government authorities around the world offer either funding programmes, subsidies or incentives at several levels (national, state or province, municipal and even cities or towns) aimed towards innovations, ecological or sustainability projects. In general, they are insufficient for actually launching a new project, but they can serve as a facilitator if profit margins are tight and market conditions challenging.
2. Multilateral agencies
The Green Climate Fund (GCF), World Bank, Inter-American Development Bank (IDB), European Bank for Reconstruction and Development (EBRD), European Investment Fund (EIB) and almost every other multilateral financing agency has in the recent years included “green project investments” in their portfolios of public and private lending. The interest rates for green projects are usually subsidized and subject to government approval although some of these programmes are managed by private domestic banks.
3. Public/private investment funds
Private investment funds and public entities are joining forces to create new alternative funding sources that combine private funding for climate projects with government participation and subsidized interest rates. Examples include the recently created Global Sub-national Climate Fund (SnCF) that aggregates the capabilities of the Pegasus Capital Advisors (Pegasus), a private equity firm, the International Union for Conservation of Nature (IUCN), a membership union composed of both government and civil society organisations, BNP Paribas, a bank, Gold Standard, a WWF founded best practice standard setting agency, and R20 – Regions of Climate Action, an non-profit environmental organisation.
4. Private funds, institutional and corporate investment
Most private funds have either taken the decision autonomously, received a mandate from investors, or instructions from their regulators, that a portion of their investments must be directed to sustainable projects. Furthermore, institutional investors and corporations are directly investing in green projects.
5. Angel investors
Angel investors are establishing private foundations or “seed” investment funds as part of their philanthropic initiatives. The number of wealthy individuals supporting climate change initiatives financially is rising. In many cases these are famous actors or former politicians using their celebrity status to raise funds.
The challenges of funding climate change solutions
Regardless of all the new funding sources there are still many aspects related to climate financing that need to be addressed in order to accelerate the process and get closer to achieving the 2030/2050 Paris Agreement goals.
An agreement between a project and investors needs to address some uncertainties if the deal and the project are to go ahead.
Traditional funds usually aim at projects that have sound and proven technological background and clear market feasibility. Most climate change related projects include the development of new technologies and sustainability concepts that may require years of testing before they are “marketable” from an investor’s point of view. Before reaching this stage, a business needs to successfully test the technology and make sure that it is scalable, a process that also needs financing. Developers do not only have to show that their products are effective but also economically viable as they would otherwise depend 100% on government subsidies.
Another significant hurdle relates to the risks associated with start-up projects in general. More than two-thirds of start-ups never deliver a positive return to investors. Start-ups may fail for several reasons, including running out of cash, no market need, being outcompeted, flawed business model or regulatory/legal challenges. Fund managers know this all too well and need to place their bets cautiously.
An important player that has yet to take a significant role in the promotion of climate change funding is the insurance market. Traditional insurers will normally require that new technologies have a track record of performance before being “insurable”. Most insurers simply do not have a decision-making team to consider non-traditional risks and there is currently little risk-capital directed to innovative business concepts.
There is an opportunity for insurers to bridge the gap between new innovative climate change projects and the available financing through non-traditional insurance products. These can provide the levels of protection that investors need on low return lending. Underwriting risks without historical information is difficult, but insurance is the cheapest risk capital available provided it is only contingent capital based on actuarial evaluations. It was extremely difficult to place insurance for power-generating windmills in the 90’s and this has become substantially easier thanks to power generating corporations, financiers and insurers working together and administrating their individual and combined exposures to suit their risk appetite.
Investors, governments and the insurance industry have important roles to play in accelerating the deployment of climate change solutions and need to treat this as an urgent matter.