Written by: Afsana Begum
Climate change is an inescapable reality; the planet’s average surface temperature has risen about 1.2°C since the late 19th century, with the majority of warming occurring in the last 40 years[1]. The 2015 Paris Agreement involved 200 countries pledging to control greenhouse gas emissions to limit global warming to 2°C by 2100 from pre-industrial levels. Under this framework, companies and countries alike have accepted that action is needed to combat climate change. Consequently, ‘Green Financing’ is an initiative that many have involved themselves in, in the move towards a greener economy.
What is green financing?
Green financing is defined by the UN Environmental Programme as a means of increasing the level of financial flow (from banking, micro-credit, insurance, and investment) from the public, private, and not-for-profit sectors, to sustainable development priorities[2]. It includes a wide range of financial products and services, with novel financial instruments such as green bonds being established to meet an ever-increasing demand. Green financing has experienced immense growth; in 2012, the sustainable debt market (including green and sustainable bonds and loans, was worth only around $10 billion[3]. Just 6 years later, the market was worth nearly $250 billion.
What are examples of green financing?
In May 2021, Amazon issued a $1 billion sustainability-focused bond to fund new and ongoing sustainability projects. The offering will be directed towards projects in 5 areas which include clean transportation, renewable energy, and affordable housing. These are in line with the company’s commitments to sustainability which include: reaching net zero carbon by 2040; purchasing 100,000 electric delivery vehicles, and supporting affordable housing initiatives.
On a larger scale, as of June 2021, 13.4% of global green bonds were issued by China, raising $26.1 billion[4]. This is partly attributed to a push by Beijing to reach carbon neutrality by 2060.
Banks are also involved in green financing, with HSBC committing to provide between $750 billion and $1 trillion of financing and investment to supporting a movement to lover carbon emissions. Similarly, Lloyds Banking Group provided over £2.3 billion of green finance in Commercial Banking in 2020.
The issuance of green bonds and significant investments into green initiatives inevitably aim to support the fight against climate change. It is also worth noting a likely secondary aim, which is to hallmark the company or country as one that recognizes and is committed to tackling climate issues. This is vital in a time where they are under immense scrutiny to evaluate their practices. However, the efficacy of green financing in tackling climate change is questionable. It may end up shifting the responsibility on external activities while neglecting internal practices.
The limitations of green financing
One of the limitations of green financing is that money is fungible. An individual that purchases a green bond may think they are funding a green initiative but, if the borrowing corporation already has the money to pay for that initiative, they would be freeing its resources to do something else. Green financing may inadvertently be funding less-green activities like oil and gas projects or premises expansions. This is further supported by the fact that expenditure plans are usually very limited at the time of bond purchasing. Comprehensive reporting is time-consuming and expensive and being unable to see the expenditure plan of the borrower can lend itself to this risk.
As of June 2021, there is no global standardized definition or framework for identifying green assets. As an example, China and the European Union have distinct definitions for green finance. The definitions mostly overlap in all descriptions of green finance, however there are some controversial differences. In China, clean coal is treated as a green product and supported by green bonds in China but not in Europe. Clean coal in itself is controversial as some studies have found that it increases the emissions of nitrous oxide, a greenhouse gas with one of the longest atmospheric lifetimes.
Furthermore, greenwashing is an ever-present concern. It’s the process by which an organization spends more time marketing themselves as environmentally-friendly than minimizing their environmental impact, and green financing lends itself well to this. In May 2017, the oil and gas sector’s first green bond was issued by Repsol which raised €500 million. The money was used to upgrade and make its existing fossil fuel refineries more efficient despite its claim that it would support cutting its carbon emissions within 3 years. This again highlights the importance of monitoring how the money is spent and also doing due diligence before investing, in order to ensure that investments really are helping to tackle climate change.
Alongside the funding of green initiatives, corporations have an onus to look at their own practices and reduce their contributions to climate change. Indeed, companies have set their own greenhouse gas reduction targets but this often neglects the emissions associated with the entire life cycle of a corporation’s product[5]. Proctor and Gamble’s (P&G) products in the tissue sector are estimated to generate 17.8 million metric tonnes of greenhouse gas emissions every year, but their greenhouse gas reduction goal only applies to a minute percentage of these emissions. If these aren’t addressed, the vast majority of greenhouse gases attributable to corporations and their products lie outside of their publicized limits and accelerate climate change.
How can green financing better tackle climate change?
There are 3 key areas that should be addressed to help green financing, and the wider impact that corporations have on climate change:
- Green financing practices should be standardized, including a global definition through which to identify green assets.
- Disclosure standards for carbon and other environmental risks should be promoted to enhance the transparency of information associated with green bonds and other financial instruments. This would span the lifetime of the green bond, from expenditure plans to comprehensive reporting on how the money raised by a bond is used.
- A rigorous review of internal practices, alongside the life cycle of the products sold, to ensure that emissions associated with those aren’t neglected when aiming to meet greenhouse gas reduction targets. To support organisations in this endeavour, management consulting firm McKinsey & Company have launched a new practice aimed at helping clients across industries to address issues with sustainability and ESG work.
