GSF 2023 - Unit 1: An Introduction to Green and Sustainable Finance PDF

20 |Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance INTRODUCTION LEARNING OBJECTIVES Green and sustainable finance is becoming increasingly After reading this chapter, you should...

20 |Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance INTRODUCTION LEARNING OBJECTIVES Green and sustainable finance is becoming increasingly After reading this chapter, you should be able to: mainstream. ‘Net zero’ policy commitments, regulation and market forces are combining to align financial define green and sustainable finance, and distinguish institutions - and their strategies, activities and between these and related terms; operations - with the aims and objectives of the Paris describe a range of approaches to green and Agreement and other sustainability goals. sustainable finance; The most recent comprehensive assessment of climate describe the opportunities and challenges for green science, published by the International Panel on and sustainable finance; Climate Change (IPCC) in August 2021, forecasts that describe the UN Sustainable Development Goals temperatures are likely to rise by more than 1.5o above (SDGs); and pre-industrial levels by 2040 and by more than 2oC outline the development of the green and sustainable later in the century. Dramatic reductions in greenhouse finance sector globally. gas emissions are required to prevent further global warming; the finance sector and finance professionals can play a leading role in tackling climate change and other environmental and social issues. Finance is uniquely positioned to lead the transition to a low-carbon, more sustainable world, as we will explore throughout this study guide. There is a significant commercial opportunity for the finance sector and the banking and finance professions to demonstrate their positive social purpose. In this introductory chapter, we explore the dimensions of green and sustainable finance and provide an overview of green and sustainable finance today. 21 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance 1.1 SUSTAINABLE FINANCE This is the approach we follow throughout this course. These two factors go hand in hand, and it is hard to Other similar approaches include the ‘triple bottom see how individuals and institutions could successfully 1.1.1 Context: line” accounting framework incorporating social, identify and provide finance for sustainable economic, In the aftermath of the Global Financial Crisis of 2008, environmental and financial components (often referred environmental and social objectives without adopting a strong consensus emerged from policymakers, to as ‘people, planet and profit’), and the environmental, sustainable principles and practice within their own regulators, civil society and financial services social and governance components used in ESG organisation. professionals themselves that some (although not investment strategies. all) financial institutions had engaged in too many For the purposes of this study guide, therefore, we define short-term, harmful financial activities without any 1.1.3 Defining ‘sustainable finance’ sustainable finance as: underlying, positive social purpose. It was felt that In the aftermath of 2008, there was a strong focus The inclusion of economic, environmental, and social factors financial institutions, and the finance sector, needed to on making financial institutions themselves more in an organisation’s strategy, management, activities and fundamentally reconsider their strategies, operations, sustainable. More recently still, the emphasis has been operations, combined with the financing of sustainable and activities. They should align with socially purposeful, more on how finance can support sustainable economies economic, environmental and social objectives. longer-term aims to deliver greater economic and and societies in general – including by protecting and social value. Finance, in short, should become more enhancing the natural environment. ‘Sustainable finance’, A term often used in the context of sustainable finance ‘sustainable’. therefore, encompasses both: is “ESG”, which refers to the way organisations take account of and manage environmental (E), social (S) 1.1.2 Defining ‘sustainability’ making the activities and operations of banks, asset and governance (G) factors in their operations and While definitions vary, ‘sustainable’ and related terms, managers, insurers and other financial institutions activities (and, in the case of financial institutions, in their including ‘sustainable development’, ‘sustainability’ and more sustainable, including but not limited to lending and investment decisions). As we will explore ‘sustainable development’, generally refer to: “ … meeting considering broader economic, environmental and further below and elsewhere in this study guide, ESG the needs of current generations without compromising social factors (e.g. reducing a firm’s carbon footprint, focuses on how organisations incorporate these three the ability of future generations to meet their needs”. implementing responsible lending policies, adopting an factors. A broader sustainability/sustainable finance This definition was first coined in the Report of the inclusive approach to recruitment, treating suppliers approach also considers the economic, environmental World Commission on Environment and Development, fairly) in an organisation’s strategy and management; and societal impacts – both positive and negative – of commonly known as the “Brundtland Report”. The report and an organisation’s activities, operations and lending and has been widely cited since it was published in 19871. financing sustainable economic, environmental investment decisions. Whilst many use the terms “ESG” and social objectives, often those set out in the UN and “sustainable” interchangeably, there is an important ‘Needs’ may be wide and varied, but many approaches to Sustainable Development Goals (introduced later in difference between them as, ultimately, it is the impacts sustainability focus on three key aspects, often described this unit). we need to measure in order to monitor what progress as a “three-legged stool”: is being made towards a more sustainable, low-carbon 1. economy, world. 2. environment 3. society. 22 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance Since the Paris Agreement on Climate Change in 2015, policymakers, regulators and financial services practitioners have focused on environmental QUICK QUESTION: WHAT ARE SOME OF THE KEY SOCIAL sustainability and addressing the causes and impacts of climate change. This has included significantly increasing ISSUES FACING THE COUNTRY WHERE YOU LIVE AND/OR the financing of new technologies and activities designed WORK? TO WHAT EXTENT ARE THESE CURRENTLY BEING to reduce greenhouse gas emissions (‘climate change ADDRESSED BY THE FINANCE SECTOR? mitigation’) and/or support climate-resilient development (‘climate change adaptation’), as well as identifying and Write your answer here before reading on. disclosing climate-related and other environmental risks. More recently, in response to the greater prominence of social issues (e.g. the ’Black Lives Matter” movement) and demands to ‘build back better’ (i.e. more equitably) following the COVID-19 pandemic, social sustainability issues have attracted greater focus, as have a wider range of environmental issues beyond climate change, such as addressing biodiversity loss on land and in the oceans. 23 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance 1.2 GREEN FINANCE job losses among those working in the plants, in the coal support of communities and societies impacted by mines supplying fuel, and in a wide range of supporting climate change and the projects and activities developed 1.2.1 Context sectors. If that employment is concentrated in a relatively to tackle it. We should think, therefore, of green and All green investments must be genuinely environmentally small region, this could have a substantial economic and sustainable finance being highly interrelated, with green sustainable to be accurately described as such, otherwise social impact on current and future generations. The finance being a major and integral element of sustainable this would be ‘greenwashing’ – a term defined and investment might not, therefore, be considered fully finance overall. This is the approach we adopt throughout explored later in this chapter. For example, it is clearly not sustainable because current and future generations, at this study guide, and we generally refer to ‘green and environmentally sustainable to continue to extract and least in the region in question, are likely to be significantly sustainable finance’ except where the context specifically burn fossil fuels at the rate we currently do, since at the disadvantaged, albeit for what many might argue is a requires the use of a single term. very least this means there will be insufficient resources greater overall good. in the future, and in some scenarios large parts of the Green and sustainable finance is one of several terms planet will be rendered uninhabitable due to global The impact of a transition such as this could be used to label activities related to the interaction temperature rises (we explore the science and impacts of mitigated by investing in training and development to between the economy, environment, society and greenhouse gas emissions and global warming in Chapter enable workers to reskill and find new employment finance. Related terms include ‘Responsible Banking’, 2). Nor could an economic activity be described as in the renewable energy and supporting sectors. ‘Responsible Investment’, ‘Environmental, Social and sustainable if it resulted in significant benefits today, but Incentives might be deployed to encourage clean Governance’ (‘ESG’), ‘Sustainable Finance’, and ‘Climate led to substantial detriment to future generations. energy companies and others to establish themselves Finance’. These are often treated synonymously, but as in a region traditionally reliant on fossil fuel extraction described previously, there are important differences ‘Sustainable’ is often used synonymously, or in and production. Supporting workers and communities between “ESG” and “sustainability”/”sustainable finance”, conjunction with ‘green’, as in the title of this study guide. negatively impacted by the transition to a sustainable, with the latter focusing more on impacts. There are There are important differences, however. In practice, low-carbon world, and helping current and future also differences in their scope, particularly in terms of the great majority of green investments – particularly generations benefit from this, is known as the ‘just whether they focus on climate and environmental issues those that support climate-resilient development and transition’ – ensuring that the switch from a high to a or incorporate a wider range of social and governance other climate change adaptation activities – may also be low-carbon economy is fair for current as well as future issues. The United Nations Environment Programme described as sustainable. For the most part, they seek to generations, and that the transition is truly sustainable in (UNEP) describes those issues as2: preserve (or enhance) the environment for the benefit of the broadest sense. current and future generations, and may deliver a range Environmental issues: the quality and functioning of economic, environmental and social benefits – or, at In practice it seems difficult, if not impossible, for of the natural environment and natural systems, least, mitigate the economic, environmental and social any genuinely sustainable approach to finance not to including: biodiversity loss; greenhouse gas emissions, harm caused by climate change. incorporate environmental factors, particularly those renewable energy, energy efficiency, natural resource relating to climate change mitigation and adaptation, depletion or pollution; waste management; ozone It is possible, however, for an investment (or activity) climate-related risks, and biodiversity. It seems equally depletion; changes in land use; ocean acidification and labelled ‘green’ not to be considered by some as difficult for green finance to avoid considering the changes to the nitrogen and phosphorus cycles. ‘sustainable’ in certain respects. Investment in renewable broader aspects of sustainability, including economic energy combined with the closure of thermal coal power and social costs. To succeed, climate change mitigation generation plants, for example, could lead to significant and adaptation projects and activities require the active 24 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance Social issues: the rights, well-being and interests of in both high-income and low-income countries, and 1.2.2 Defining ‘Green Finance’ people and communities, including: human rights, the need to improve standards of living and reduce Although the term ‘green finance’ is now used regularly by labour standards, health and safety, relations with inequality cannot be separated from the need to protect governments, central banks, regulators, financial services local communities, activities in conflict zones, health our environment. In 2015, the United Nations defined firms, NGOs, academics, finance professionals and and access to medicine, consumer protection, and and adopted its Sustainable Development Goals (SDGs) others, there is no universal definition of the term. It can controversial weapons. to encourage governments, business and civil society to refer to some or all of: Economic issues: investee impacts on economic tackle these wider issues of sustainability. The SDGs are conditions at the local, national, and global levels, explained in more detail in section 1.6, and we will return The role of finance in allocating capital for wider, more including: direct financial performance and risk, and to them throughout this study guide sustainable purposes; in particular, aligning financial indirect impacts such as through employment, supply institutions’ strategies and activities with the Paris Where the concern is only with preventing or responding Agreement; chains, and the provision of infrastructure. to climate change, the term ‘climate finance’ may be Governance issues: the management of investee used. Climate finance is also used specifically to refer to Finance sector initiatives to tackle climate change and entities, including: board structure, size, diversity, skills the UN climate change negotiations (the United Nations promote environmental sustainability; and independence; executive pay; shareholder rights; Framework Convention on Climate Change – UNFCCC) An emerging sector of financial institutions focused on stakeholder interaction; disclosure of information; and the provision of finance from developed countries environmental objectives; business ethics; bribery and corruption; internal to developing countries to help with climate change A focus on the use of lending and investment to either controls and risk management; and, in general, issues mitigation and climate adaptation. The Paris Agreement, benefit the environment or reduce environmental dealing with the relationship between a company’s part of the UNFCCC process, aims to limit increases in the harm; management, its board, its shareholders and its other global average temperature to below 2 °C above pre- stakeholders. industrial levels, and ideally below 1.5 °C. We will explore Managing environmental and climate-related risks; climate science, and the most recent assessment of this The products, services, sectors, and projects that may Approaches which embrace the full range of these issues by the International Panel on Climate Change (IPCC) in be supported by green and sustainable finance; and seek to assess impacts are more likely to be termed Chapter 2. ‘sustainable finance’, whereas those that focus mainly on Policy, regulatory and market initiatives, instruments, environmental issues are more likely to be termed ‘green One of three objectives set out in Article 2 of the Paris standards and frameworks. finance’. Agreement - Article 2.1(c) - commits signatories to This list is not exhaustive. As green and sustainable making financial flows consistent with a pathway towards Advocates for a sustainable finance approach argue finance becomes more mainstream, many more activities low greenhouse gas emissions and climate-resilient that it is not possible to separate the environment from are being promoted as ‘green’ and/or ‘sustainable’. development. The recognition of the key role of finance society: society depends on the environment for its Assessing the extent to which activities are truly green in tackling climate change has made a major contribution existence, and human society has a major impact on the and sustainable, and avoiding ‘greenwashing’, are major to the growth of green finance, and we will return to this environment. Understanding and measuring the positive themes of this study guide. throughout this study guide. The UNFCCC and the Paris and negative impacts of finance on the environment and Agreement are explored in more detail in Chapters 2 and society are key to aligning finance and sustainability. Many 3. of today’s most pressing environmental issues impact disproportionately on those with the fewest resources, 25 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance A helpful way to consider the scope of green finance is to Green finance, therefore, is: think of it in terms of both ‘financing green’ and ‘greening finance’: “Any financial initiative, strategy, product or service designed to protect the natural environment and support the transition Financing green refers to increasing flows of finance to a sustainable, low-carbon world, and/or to manage to support green and sustainable development climate-related and other environmental risks impacting objectives. This includes aligning lending and finance and investment”. investment portfolios with climate and environmentally positive assets and investments, including those This is a broad definition. It acknowledges the different supporting the transition to a more sustainable, low- aspects of green finance, with an overarching focus carbon world and shifting finance away from financing on protecting and enhancing the natural environment firms and sectors that are not transitioning, or not and managing current and future environmental risks transitioning rapidly enough, to more sustainable – particularly, but not exclusively, climate change. It business models. highlights and recognises the two-way nature of the relationship. Finance and investment can help or harm Greening finance refers to integrating sustainability the environment and society, while the environment within financial institutions’ strategies and activities, and society can also positively or negatively impact the and across financial services as a whole. This includes performance of investments and financial services firms. identifying and disclosing climate-related financial risks - and, increasingly, broader environmental and sustainability risks, at both firm and sector levels. “Financing green” and “greening finance” are not opposing goals - they reinforce each other. For this study guide, we have developed a general definition of ‘green finance’ that combines aspects of the above. For the Chartered Banker Institute, green finance encompasses the finance sector’s strategic approach to meeting the challenges of climate change and the transition to a more sustainable, low-carbon world, incorporating both ‘financing green’ and ‘greening finance’. 26 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance 1.2.3 Different shades of green To support the growth of green finance, at the most basic QUICK QUESTION: WE HAVE JUST DEFINED ‘GREEN level policymakers, regulators, financial services firms, FINANCE’. BUT WHAT, IN YOUR VIEW, DOES ‘GREEN’ clients and customers must agree on which products, services and activities are ‘green’, i.e. environmentally ITSELF MEAN? HOW DO WE KNOW WHEN A PRODUCT, sustainable. And, equally importantly, which are SERVICE OR ACTIVITY IS – OR IS NOT - GREEN? not (these are sometimes referred to as ‘brown’, i.e. unsustainable). For example: Write your answer here before reading on. Are electric vehicles genuinely ‘green’ if produced in factories dependent on fossil fuels for power generation and other aspects of manufacturing, and if the minerals required for their batteries are extracted at significant cost to the environment? Is a shift from coal-fired power generation to gas-fired generation ‘green’, since greenhouse gas emissions will be reduced, but not eliminated? These are not academic, theoretical debates, and issues such as these are debated at length by policymakers, regulators and financial services practitioners developing taxonomies and other tools that try to define what is ‘green’. As we will explore throughout this study guide, agreeing what is ‘green’ (and what isn’t) is key in determining what can be financed using, for example, green bonds and green loans, or included in green and sustainable investment funds. 27 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance Part of the difficulty is that ‘green’ is not a case of one- size-fits-all. Different regions, countries, sectors and firms READING: “50 SHADES OF GREEN” will require different approaches and (possibly) slightly different definitions to ensure a successful transition Financial markets increasingly recognise that sustainable investment is the new horizon that can bring enormous to a sustainable, low-carbon world. It is as important to opportunities, ranging from transforming energy to reinventing protein. recognise and support the transition to green as it is to recognize and finance firms, projects and activities that For sustainable investment to go truly mainstream, it needs to do more than exclude incorrigibly brown industries are green. This is often referred to as ‘transition finance’, and finance new, deep green technologies. Sustainable investment must catalyse and support all companies that and is another key theme of this study guide. are working to transition from brown to green. As firms and sectors transition from high- to low-carbon Such “tilt” investment strategies, which overweigh high environmental, social and governance (ESG) stocks and means of production and distribution, they will not “momentum” investment strategies, and which focus on companies that have improved their ESG rating, have usually become ‘green’ overnight. The transition takes outperformed global benchmarks for close to a decade. The mainstreaming of such strategies and the tools to time, although ideally it should be aligned with the goals pursue them are essential. and timescales of the Paris Agreement. The finance At present, one of the biggest hurdles to doing this is the inconsistent measurement of ESG. We need a common sector needs to provide transition finance to support taxonomy to help financial markets rigorously identify environmental outperformance and to direct investment those making the transition – and must recognise that accordingly. the extent and pace of transition will vary between firms and sectors, and across geographies. Green and The EU’s Green Taxonomy and the Green Bond Standard are good starts, but they are binary (dark green or sustainable finance is not, therefore, purely focused on brown). Mainstreaming sustainable investing will require a richer taxonomy – “50 shades of green”. financing those economic activities that are 100% green and sustainable (often referred to as “bright green” One promising option is to develop transition indices composed of corporations in high-carbon sectors that have or “deep green”). Rather, it needs to consider a wide adopted low-carbon strategies. spectrum of shades of green, as captured in the reading opposite. Such approaches are essential for citizens to make sure their money is invested in line with their values. Source: Mark Carney: Remarks given during the UN Secretary General’s Climate Action Summit 2019. Available at: https://www.bankofengland. co.uk/-/media/boe/files/speech/2019/remarks-given-during-the-un-secretary-generals-climate-actions-summit-2019-mark-carney.pdf [Accessed: 13 January 2023] 28 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance As referenced in the Reading previously, a number of China and the EU are working on a “Common Ground” Climate change mitigation seeks to address the causes countries and regions, including China, the EU and the project to align their respective taxonomies, and it of climate change, and in particular focuses on reducing UK, have developed (or are developing) taxonomies. seems likely that, over time, many other countries will or eliminating greenhouse gas emissions. In terms of These are classification systems that define (ideally using align and harmonize their approach with that of the green and sustainable finance, investing in renewable science-based criteria) whether an economic activity can EU, though some differences between definitions may energy, clean transport or energy-efficient buildings are be described as environmentally sustainable. Lending, remain – especially in terms how gas and nuclear power all examples of climate change mitigation, as they aim investment and other financial activities can then be generation are treated. Harmonization would be a very to reduce or eliminate emissions. Similarly, countries’, regarded as green (or not) depending on their alignment significant step forward in terms of defining what is or is sectors’ and firms’ net-zero transition plans are also with the taxonomy. not ‘green’, but, as discussed previously, we also need to examples of climate change mitigation. consider the transition of firms, sectors and economic The most significant development in this area was the activities to ‘green’. Climate change adaptation seeks to address the impacts of publication and adoption of the EU Sustainable Finance climate change, including the impacts of extreme weather Taxonomy in 20203, explored in more detail in Chapter 1.2.4 Green and Sustainable Finance and the Climate events (e.g. floods and droughts), rising sea levels and 3. For now, it is sufficient to understand that the EU Transition rising surface temperatures. Adaptation aims to make Taxonomy lists sustainable economic activities that We explore the science of climate change and its impacts countries, communities, businesses and individuals make a substantial contribution to at least one of the in Chapter 2. In brief, however, the UN Intergovernmental more resilient to the effects of global warming. In terms six environmental objectives set out below, without Panel on Climate Change (IPCC) has shown that global of green finance, investing in flood and sea defences are detracting from any of the others: greenhouse gas emissions during the decade 2010- obvious examples of climate change adaptation, but so 2019 were higher than at any previous time in human are less obvious financial products and services, such as 1. Climate change mitigation making climate insurance available to smallholders and history, and continue to rise despite efforts to reduce 2. Climate change adaptation them - although the rate of increase is slowing. Global farmers. 3. The sustainable use and protection of water and marine CO2 emissions would have to peak by 2025 to limit global resources warming to 1.5oC above pre-industrial levels by 2050, but achieving this seems highly unlikely at present4. 4. The transition to a circular economy Restricting global warming to below 2oC will require very 5. Pollution prevention and control substantial reductions in fossil fuel use, and the use of negative emissions technologies that remove CO2 from 6. The protection and restoration of biodiversity and the atmosphere and store it on land, underground and in ecosystems the oceans. The EU Taxonomy provides a foundation for many of In addressing the causes and impacts of climate the EU’s activities and policies to promote sustainable change, two key concepts for all finance professionals finance. It underpins the EU’s Sustainable Finance to understand, and two of the most important Disclosure Regulation and Green Bond Standard. For environmental objectives identified in the EU Taxonomy example, it defines what activities and investments can/ introduced previously, are climate change mitigation and cannot be defined as or financed by a bond classified as adaptation. These are defined as follows: ‘green’. 29 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance It is difficult to obtain accurate figures for the total size Whilst these are substantial amounts, green and sustainable finance still represents a small, but growing, part of finance of the global green and sustainable finance market, for overall. Cumulative green bond issuance of $1.5 trillion accounts for merely 1.25% of the total global bond market (2021), reasons including the challenge of defining whether and annual issuance of $520 billion is just a fraction of the investment estimated to be needed to achieve global climate financial instruments and investments are genuinely and other sustainability goals. Estimates of the investment needed to achieve different (and sometimes overlapping) “green”, as discussed previously. Different bodies green and broader sustainability objectives vary, but all are substantial, as set out in the table below: and organisations track different indicators, making comparisons difficult, but we can say with confidence FINANCING NEEDS TO ACHIEVE SUSTAINABILITY GOALS that green and sustainable finance is growing rapidly. For example: FINANCE NEED GLOBAL INVESTMENT REQUIRED SOURCE The Climate Bonds Initiative (CBI) reports that green bond issuance has increased from just over $100 New Climate Economy: Global To achieve global sustainable billion in 2015 to nearly $520 billion in 2021, with $6 trillion per year / $90 trillion by 2030 Commission on the Economy and Climate development and climate objectives cumulative green bond issuance now more than $1.5 (2014 – 2018)9 trillion. van Vuuren, D.P., van der Wijst, KI., The CBI also reports a nearly 350% increase in social Median estimates to meet the 2oC and Marsman, S. et al. “The costs of achieving $15 trillion and $30 trillion respectively and sustainability bonds of various types (see Chapter 1.5oC Paris Agreement targets climate targets and the sources of 7 for more details), from $98 billion in 2019 to nearly uncertainty”, Nature Climate Change (2020) $650 billion in 20215. Approximately Euro 28 trillion in clean For the EU to achieve net zero by 2050 McKinsey (2020)10 technologies and techniques According to the Global Sustainable Investment Alliance (GSIA), using a very broad definition of the 6th Carbon Budget: UK Committee on For the UK to achieve net zero by 2050 Approximately £50 billion per year term, global sustainable investment in major markets Climate Change (2020)11 totalled $35.3 trillion in 2020, an increase of 15% over To achieve the UN Sustainable the two-year period since 20186. $5 to $7 trillion per year World Bank (2020)12 Development Goals (SDGs) The UNFCCC Standing Committee on Finance (see To achieve energy transition consistent $1.7 trillion per year between 2020 and Chapter 4) reports that global climate finance flows IPCC (2018)13 with 2oC of warming 2030-2035 were 16% higher in 2017-2018 than in the previous 2-year period (2015-2016), reaching an annual average To achieve energy transition consistent $2.4 trillion per year between 2020 and IPCC (2018)14 of $775 billion7. with 1.5oC of warming 2030-2035 The Climate Policy Initiative (CPI) finds some $632 International Energy Agency (2021): “Net Approximately $5 trillion per year in billion was invested globally in the area of climate To achieve Net Zero by 2050 Zero by 2050: A Roadmap for the Global energy transition investments by 2030 finance in 2019/20 (the figure is an average across both Energy Sector”15 years), an increase of nearly $200 billion since the Paris Agreement was signed in 20158. 30 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance Throughout this study guide, we will use the $6 trillion per finance professionals also play a vital role. As we will The 2022 “Banking on Climate Chaos” report found year/$90 trillion over 15 years estimated by the Global explore in Chapter 12, change is ultimately led by that bank lending and underwriting to the fossil fuel Commission on the Economy and Climate/New Climate individuals, and the changes needed to embed and sector increased each year following the signing of the Economy, which seems consistent with the more recent mainstream green and sustainable finance principles Paris Agreement in 2015 to $824 billion in 2019, before World Bank estimate of $5-$7 trillion per year to achieve and practice within financial services require finance falling back slightly to $750 billion in 2020, and $742 the UN SDGs by 2030. The scale of investment required professionals who have the relevant knowledge and skills billion in 202119; means that public funds alone will not be sufficient. The to be able to develop and deploy products, services and The same report also found that 60 of the largest financial services sector therefore has a key role to play tools that can mobilise capital to support the transition. global banks had provided a total of some $4.6 trillion in mobilising and directing private capital to support This study guide will equip you with the knowledge and of fossil fuel financing between 2016 and 2021. Four the transition to a sustainable, low-carbon world; it is tools you need to begin to apply green and sustainable US banks accounted for approximately 25% of the estimated that up to 80% of the funds required will need finance principles in your professional practice, thereby banking sector’s fossil fuel financing in the six years to come from private sources. playing an active role in the transition to a more following the signing of the Paris Agreement. sustainable, low-carbon world and creating prosperity for This is not only a commercial opportunity for the current and future generations. Some of the discrepancy between commitments and financial services sector, however. By playing an active action can be explained by factors such as the length role in protecting and improving our planet, financial There is still a long way to go before green and (tenor) of lending and investment agreements, which in services can do more than profit financially. Our sector sustainable finance achieves the mainstream scale the case of power generation and extractive industries can demonstrate our positive social purpose by playing and effectiveness necessary to address our greatest can often exceed 10 years. Whilst these may not be a key role in the transition to net zero and a more environmental and societal challenges, though. There renewed, existing financing agreements will usually be sustainable world. By supporting activities, organisations are still many barriers and challenges to overcome honoured. In addition, taking a broader sustainability and industries that can mitigate climate change, helping until, in the words of UN Special Envoy (and former lens, lenders and investors may be considering the individuals and communities adapt to the effects of Governor of the Bank of England) Mark Carney, “every impacts of a rapid withdrawal of funding on jobs and climate change, and supporting long-term social and professional financial decision takes climate change into communities. In some cases, though, financial institutions sustainable development goals, financial services account”17. Today, banks and investors are still funding may be guilty of (at best) inadvertent greenwashing, organisations can help solve some of the world’s, and environmentally destructive activities that contribute to a concept we explore in the next section. Greater local communities’, greatest challenges. According to the climate change and cause substantial and long-lasting disclosure and transparency of environmental and IPCC, this makes economic sense too, as its most recent environmental and social harm. For example: broader sustainability impacts will, as we will see in later report (AR6) finds that – with medium confidence – the units, help avoid such greenwashing in the future. global economic benefits of limiting global warming to 2oC Speaking to the UK House of Commons Treasury above pre-industrial levels will exceed the costs of climate Select Committee in October 2019, Governor of change mitigation activities16. the Bank of England Mark Carney told Committee members that global markets were currently holding International and national institutions, and financial portfolios consistent with 3 to 3.75 degrees Celsius of services firms large and small, have key roles to play warming, and possibly more than 4 degrees Celsius of in addressing these challenges and supporting the warming18; transition to a sustainable, low-carbon world. Individual 31 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance Public disquiet at the environmentally detrimental activities of financial institutions, combined with rising consumer and retail investor demand for sustainable QUICK QUESTION: TO WHAT EXTENT ARE YOUR SAVINGS, financial products and services, has led to a number of high profile campaigns, including ‘Make My Money INVESTMENTS AND PENSIONS INVESTED IN A GREEN AND Matter’ (see short case study in Chapter 9) and ‘Stop SUSTAINABLE MANNER? CAN YOU EASILY FIND OUT? the Money Pipeline’. Such campaigns encourage retail Write your answer here before reading on. savers and investors to act by, for example, lobbying against certain financial institutions and moving savings, investments and pensions to alternative, more sustainable providers. In the long-term, heightened reputational risk may damage financial institutions’ brands and franchises. 32 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance To date, the majority of funding and investment in For the purposes of this course, we define greenwashing There have been many high-profile cases of green and sustainable finance has tended to support as: “… inadvertently or deliberately misleading others about greenwashing and purpose-washing, including climate change mitigation projects and activities, rather the environmental or broader sustainability benefits of an Volkswagen in Germany 2015, H&M Norway in 2019, than adaptation. The UNFCCC’s Fourth (2020) Biennial activity, project, product or service.” and Boohoo in the UK in 2020. We explore the different Assessment 20, which we examine in more detail in dimensions of greenwashing, and its implications for the Chapter 4, estimates that public mitigation finance is There are many different types of greenwashing, for finance sector and finance professionals, in subsequent some 2-3 times greater than adaptation finance. This instance: chapters. For now, though, it is sufficient to note that it is is supported by the most recent (2020) Multilateral one of the most significant challenges to mainstreaming Making public commitments to climate change and Development Banks’ (MDB) joint report on climate green and sustainable finance. If consumers, investors sustainability that are not backed by consistent action finance21, which finds that 76% of climate finance went and others cannot be confident that the environmental and/or are contradicted by an organisation’s activities towards mitigation and 24% went towards adaption. benefits and impacts of products, services, investments (e.g. where a bank makes public commitments to Whilst there is inevitably some crossover between and other activities are genuine, then the integrity of the increasing its green lending, but continues to fund mitigation and adaptation projects (e.g. new, greener green and sustainable finance market is brought into businesses that engage in large-scale deforestation); infrastructure may be sited further away from coastlines), question. In April 2020, for example, a study by Schroders and there is a lack of consistent reporting on mitigation Overstating the environmental benefits of a found that 6 out of 10 institutional investors across versus adaptation, it is clear the latter is currently product, service or activity (e.g. a hybrid vehicle or 26 countries identified greenwashing as the greatest substantially underfunded. a ‘green bond’ that in fact does little to improve the deterrent to sustainable investment 22. environment); 1.2.5 Greenwashing We consider greenwashing and how it can be avoided Highlighting the positive environmental or broader The transition to a sustainable, low-carbon world (often and prevented throughout this study guide and course. In sustainability benefits and impacts of a product or referred to as ‘Net Zero’) requires systemic economic Chapter 9 (Responsible and Sustainable Investment) we service, whilst failing to mention related detriments; transformations impacting all economic activities and will also look at evolving regulations designed to maintain entities, including individuals, businesses and public Describing an investment, or an investment fund as investor confidence and market integrity in the context of sector organisations. Increasing demand for green and “green” or “sustainable” when, in fact, only a small detecting and preventing greenwashing. sustainable products and services of all kinds creates part of the fund could be described as such (this is substantial commercial opportunities for many, including explored in more detail in Chapter 9); the banking and finance sector. Without common Describing an activity, product or service as “green” definitions such as those provided by the EU and other or “sustainable” without measuring, monitoring taxonomies, as we saw previously it is impossible to and verifying outcomes, so the environmental and accurately classify economic activities or products and sustainability benefits (and/or detriments) are not truly services as “green” and/or “sustainable”. This may lead understood; to ‘greenwashing’ (and more broadly, ‘purpose-washing’) Emphasizing the environmental benefits and impacts – a key concept that all finance professionals should be of a product, service or activity without disclosing aware of and take active steps to uncover and avoid. that these would have been achieved in any case (in a similar manner, promoting the issue of green bonds when the same projects would have been financed by a regular bond issuance). 33 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance 1.3 THE DIMENSIONS OF GREEN FINANCE AND Green and green retrofit mortgages Activities that minimise the environmental impacts SUSTAINABLE FINANCE Green and sustainable FinTech products and services of the provider’s operations (such as an investment (e.g. carbon footprint trackers linked to mobile banking manager switching to renewable energy for its own The breadth of the terms ‘green finance’ and ‘sustainable building) without addressing the main impacts of finance’ means they can be used to refer to: apps) its activities (in this case, the manager’s investment But what makes a financial product ‘green’ and/or decisions). Financial products and services ‘sustainable’? In many cases the ‘green’ or ‘sustainable’ Organisational strategies and approaches aspect of the product relates to the underlying investible These examples raise the question of where the asset, such as investments in clean energy projects or boundary lies in terms of green and sustainable finance. Industry sectors reforestation. In other cases, the features of the product We explore this in more detail in subsequent chapters. In this study guide we cover all of these, and briefly are designed to encourage or reward environmentally For now, however, note that, from our definition of introduce them below. friendly or other socially beneficial activity. Examples green finance, the product, service or organisation include mortgages which are discounted in line with a should deliver positive environmental and/or social 1.3.1 Green and sustainable financial products and property’s energy efficiency, or an investment or loan sustainability impacts, and not cause significant harm. services which links the sustainable management of resources As we saw previously, greenwashing – both inadvertent Green and sustainable finance covers a wide range of with additional investment, discounted interest rates or and deliberate – can significantly harm the integrity financial products and services. These can be broadly lower collateral requirements. and development of the growing green and sustainable divided into banking, investment, and insurance products finance market. and services. Examples of these are explored in more Other products, services and activities labelled ‘green’ and/or ‘sustainable’ may not be universally accepted as 1.3.2 Green and sustainable finance as an detail in Chapters 6-11 and include, but are by no means such. For example: organisational approach limited to: Green and sustainable finance principles can be applied Bonds (such as green bonds, social bonds, Financial products (such as credit cards) which offer across an entire financial services organisation, not just sustainability bonds and transition bonds) a donation to a social cause (e.g. a cancer research at a product or individual process level. For some such charity) in reward for a certain level of spending organisations, such as Abundance, Triodos, Ecology Green, social and sustainability-linked loans Financial products which respond to an environmental Building Society, Naturesave Insurance or Banca Etica, Green/sustainable/ESG stock exchange listings and environmental and social sustainability have been central and/or social issue (such as flood insurance) but do not indices to their strategy, purpose, culture and decision-making seek to address the causes of this issue (in this case, Green/sustainable/ESG investment and pension funds climate change) for many years. This is also the case, particularly in terms (including index-tracking and exchange-traded funds) of social sustainability, for many building societies, credit Green bonds and loans that fund sustainable projects unions, co-operative banks and insurers, and other (often Impact underwriting (green and sustainable insurance and activities that would have happened anyway using mutually-owned) financial institutions. products and services) regular bonds and loans Climate risk insurance Investment funds labelled as ‘green’, ‘sustainable’ or Green current, deposit and savings accounts ‘ESG’ when in fact they contain substantial proportions of assets that are harmful to the environment 34 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance A growing number of large, mainstream financial institutions are incorporating green and sustainable QUICK QUESTION: CAN YOU THINK OF OTHER EXAMPLES finance principles into their activities. This trend has been accelerating, particularly since the Paris Climate OF FINANCIAL SERVICES FIRMS THAT HAVE ADOPTED Agreement was concluded in 2015 and the UN SDGs GREEN AND/OR SUSTAINABLE FINANCE AS AN were launched that same year. In 2020, for example, ORGANISATIONAL APPROACH? the UK bank NatWest made tackling climate change one of the three pillars of its new, “purpose-led” strategy23. Write your answer here before reading on. ING, the Netherlands-based financial services group, has been climate-neutral since 2007 in terms of its direct emissions, and has committed to reducing its lending to and investment in coal power generation to ‘close to zero’ by 2025. Every client and transaction is assessed, monitored and evaluated against the bank’s Environmental and Social Risk Framework 24. The European Investment Bank (EIB) has committed to aligning all its financing activities with the principles and goals of the Paris Agreement, becoming the first multilateral development bank (MDB) to do so. The launch of the UN Principles for Responsible Banking in 2019 further encouraged financial institutions to incorporate these principles into their strategies and activities, and as of 2022 they have been adopted by more than 270 banks. The Principles for Responsible Banking are similar in many respects to the well- established UN Principles for Responsible Investment, adopted by nearly 4,000 investment firms. These, together with the UN Principles for Sustainable Insurance, are discussed in more detail in later chapters. The establishment of several coalitions of major financial institutions, in particular the UN-convened Net Zero Banking Alliance, Net Zero Asset Owners Alliance and Net Zero Asset Managers Alliance, brought together under the umbrella of the Glasgow Financial Alliance for Net Zero (GFANZ)25, has given further impetus and collective ambition to embedding green and sustainable finance into organisations and the finance sector overall. 35 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance This whole-organisation approach to green and sustainable finance is rooted in an understanding that CASE STUDY: TRIODOS AND SUSTAINABLE BANKING the financial system both serves and relies on the economy, which itself serves society and is embedded in Triodos Bank is a global pioneer in sustainable banking, using the power of finance to support projects that benefit the environment. Such an ‘embedded’ approach means people and the planet. Its approach is based on the fundamental belief that economic activity can and should have that business decisions take into account the wider a positive impact on society, the environment and culture. Triodos values people, planet and profit – the ‘triple economy, society and the environment, as well as the bottom line’ – and takes all three into account in its strategy, structure, lending and culture. financial implications. This mindset can influence every Founded in 1980, Triodos is overseen by a supervisory board, and its shares are administered by a separate area of a business, from operations and staff recruitment Foundation, both of which aim to balance the needs of all of Triodos’ stakeholders. It has branches in the and development to investment strategy, product design Netherlands, UK, Germany, France, Spain and Belgium, and in 2020 had assets under management of €20.3 billion. and pricing, risk management, marketing and financial management. Triodos finances organisations and sectors that benefit people and the planet, and focuses on the environmental, social and cultural sectors. Examples include organic farming, sustainable property and renewable energy, leisure THE EMBEDDED APPROACH TO GREEN AND and childcare, and lending to SMEs and social enterprises. As part of the application review process, Triodos applies SUSTAINABLE FINANCE its own strict social and environmental lending criteria and publishes a full list of all the organisations it lends to, as well as an annual impact report as part of the bank’s statutory annual report. Approximately 20% of Triodos’ environment lending is also for residential sustainable mortgages. Many of Triodos’ loans are in the environmental sector; by the end of 2020 it was co-financing 561 projects in the society sustainable energy sector, contributing to a generating capacity of 5,100 MW of energy – equivalent to the energy needs of nearly 5 million households. Approximately 0.9m tonnes of CO2 equivalent emissions were avoided. Triodos also financed 17,600 sustainable residential and 480 sustainable commercial properties, 30,000 hectares economy of nature and conservation land, and 600 education projects benefitting some 632,000 individuals. It is important to note that Triodos operates on a commercial basis, and in 2020 reported a net profit of Euro 27.2m. financial This was a decline from Euro 39m in 2019, but still represented a positive return given the challenges of COVID-19 system faced during the year. Source: Adapted from Triodos UK / Triodos Bank materials (2020): https://www.triodos.co.uk [Accessed: 13 January 2023] 36 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance 1.3.3 Green and sustainable economic activities Many definitions of green and sustainable finance focus on its role in directing investment towards QUICK QUESTION: WHICH INDUSTRY (I.E. NON-FINANCE) environmentally sustainable economic activities. The SECTORS WOULD YOU CURRENTLY ASSOCIATE WITH EU Taxonomy introduced previously is an example of a tool designed to establish which sectors are ‘green’ (and, GREEN AND SUSTAINABLE FINANCE? by omission, which are not). Some sectors are more Write your answer here before reading on. universally accepted as ‘green’ than others, as shown in the diagram on the next page. 37 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance Clean energy Clean coal Low-carbon infrastructure CCS Efficiency Large hydropower Nuclear Low-carbon base Bioenergy, Marine Fossil fuel stations broadband power efficiency General grid efficiency Advanced materials Wind, solar, Smart/Mini grid Geothermal, Green buildings Lighting Small hydropower Grid Industrial integration energy Storage efficiency Most commonly included Afforestation Metro, BRT, Reforestation Non-diesel trains Energy and Pollution water efficiency prevention, Electric cars, Alternative Recycling fuel vehicles Green agriculture Protected areas Biodiversity Wastewater Logistics treatment Waste systems Land Transport Water supply Least commonly included Pollution, waste and water Source: UNEP (2016) Inquiry into the Design of a Sustainable Financial System: Definitions and Concepts (online). Available at: https://wedocs. unep.org/bitstream/handle/20.500.11822/10603/definitions_concept.pdf?sequence=1&isAllowed=y [Accessed: 13 January 2023] 38 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance 1.3.4 Green and Sustainable Industry Sectors Sectors commonly accepted with little controversy as ‘green’ and ‘sustainable’ include renewable energy production, distribution and storage, energy efficiency in domestic and industrial buildings, green transport, recycling, pollution prevention, water conservation and afforestation/reforestation. Sectors that are more contested or infrequently cited include Carbon Capture and Storage (CCS), nuclear energy and fossil fuel efficiency. The development of taxonomies, in particular the EU Sustainable Finance Taxonomy introduced previously, and examined in more detail in Chapter 3, is a key step towards a common understanding of which sectors and economic activities can be described as ‘green’ and ‘sustainable’, and which cannot. EXAMPLES OF GREEN AND SUSTAINABLE ECONOMIC ACTIVITIES INDUSTRY SECTOR DESCRIPTION Renewable energy comes from a source that is not depleted when it is used or is naturally replenished within a human timescale. This includes solar, wind, geothermal, tidal, Renewable energy wave, hydroelectric and biomass power. Most energy is distributed through a grid (an interconnected network for transmitting power). Green energy distribution tends to focus on the integration of renewable Energy distribution energy into the main grid, distributed generation, microgrids (running separately from the main grid), and smart grids that detect and react to changes in energy usage. Renewable energy storage is key to enabling an increase in the take-up and efficiency of renewables, and can include mechanical storage (for example, pumped water), Energy storage batteries and thermal energy storage. Emissions reduction and Carbon emission reduction technologies aim to reduce the carbon dioxide produced by energy generation, transport, and industrial processes. Emissions capture tends to capture refer to Carbon Capture and Storage (CCS) – technology to capture emissions produced in electricity generation and industrial processes. Energy efficiency means reducing the amount of energy that is required to provide a product or service, and is often applied to buildings (domestic, commercial, and Energy efficiency industrial), appliances and vehicles. Green buildings are designed, built, and used in a way that is energy-efficient, minimises the use of resources and water, encourages biodiversity, and provides a healthy Green buildings indoor environment. Green transport minimises carbon and other harmful emissions, uses renewable energy, is energy-efficient, and supports sustainable communities. The term can refer to Green transport public transport systems and infrastructure as well as private vehicles. Water conservation Water conservation aims to sustainably manage freshwater resources and prevent water pollution in nearby lakes, rivers, and local watersheds. Pollution control aims to reduce or avoid the release of harmful substances into the environment, including the air, water, and soil. Pollution can also be defined by the type of Pollution control pollutant, including plastic pollution and thermal pollution. Waste reduction and Waste reduction aims to minimise the amount of waste produced by individuals, households, and organisations, including through resource efficiency and reuse. Waste management management involves the collection, treatment, recycling, reprocessing and disposal of waste. Biodiversity and habitat Biodiversity protection aims to preserve the full range of ecosystems, species, and gene pools in the environment – the full variety of life on earth. Habitat protection aims to protection conserve, protect and restore the natural environments which sustain these plants and animals. Afforestation means the establishment of forests where previously they did not exist, while reforestation means the re-establishment of forests where they previously Afforestation / reforestation existed, either through direct planting or natural growth. 39 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance Green and sustainable industry sectors have recently expanded to include areas such as meat substitutes, eco-fashion, plastic alternatives and eco-friendly and/or cruelty-free products, targeted at a rapidly growing retail consumer audience. FURTHER EXAMPLES OF GREEN AND SUSTAINABLE ECONOMIC ACTIVITIES INDUSTRY SECTOR DESCRIPTION Also known as ‘meat analogues’ or ‘meat alternatives’, these are (usually) plant-based foods that taste like meat. Meat substitutes Meat and dairy products account for 14.5% of global greenhouse gas emissions. By reducing meat consumption, we reduce these emissions and help to prevent further deforestation. Eco-fashion, also referred to as ‘sustainable’ or ‘ethical fashion’ combines organic, recycled, or natural materials such as bamboo with fair trade practices and low carbon emissions. Eco-fashion According to The World Bank, the fashion sector is responsible for 10% of global emissions. It is also one of the leading polluters through waste products being released into rivers, lakes and oceans. From a wider sustainability perspective, it is estimated that some 40 million garment workers (including children) work gruelling 14-16 hour shifts on average in physically taxing conditions. Plastic alternatives are generally either biodegradable plastics, or are made from recycled plastic. Other materials, e.g. bamboo, are used instead of plastic. This seeks Plastic alternatives to reduce the 320 million tonnes of plastic produced each year, of which an estimated 8 million tonnes per year or more pollutes the oceans. Much more plastic waste is buried in landfill sites. Eco-friendly products are everyday items which do not cause damage, or only very limited damage, to the environment. This is due to the way they are manufactured, the materials they contain, or the way that the products are consumed. Eco-friendly products Eco-products are extremely diverse. Examples include: bamboo toothbrushes, recycled paper, metal water flasks, non-toxic cleaning products, beeswax sandwich wraps, and Fair Trade clothing. Household and self-care products which do not employ animal testing as part of their process. Cruelty-free products Advocates claim that the use of non-toxic chemicals used in cruelty-free products reduces harmful toxins in our atmosphere. Cruelty-free products generally produce less carbon emissions and champion other sustainable causes, too. 40 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance Finance can support these and other green and Sometimes projects may have competing environmental Divestment does not necessarily have to be justified in sustainable sectors in many ways, which we explore in and social impacts, and this can lead to controversial terms of environmental benefits alone. As we will see later chapters in this study guide. Examples include: financing decisions. New battery storage technologies, later in this study guide, the implications of the net zero for example, may support the growth of solar or wind transition are substantial, and in some cases existential, Green bond financing for offshore wind farms energy by providing the means to store and deliver power for the business models of some sectors and firms – and Investment funds specialising in green transport and when weather conditions would not normally allow this, for the financial institutions exposed to these through related infrastructure investments but may require the mining of rare minerals, causing their lending and investment decisions. Divestment may, significant environmental damage and social harm. therefore, be an important risk management tool to avoid Sustainability-linked loans linked to improvements in Similarly, the closure of a thermal coal power generation exposure to significant transition risks and stranded pollution control and management plant may have significant environmental benefits in assets. Risk management is covered in more detail in Green mortgages which link repayments to home terms of reducing greenhouse gas emissions but at the Chapter 5, and divestment, and the decarbonisation energy efficiency improvements same time create substantial unemployment and related of investment portfolios, is covered in more detail in Climate insurance to support farmers and social problems in a town or region heavily dependent on Chapter 9. smallholders employment from fossil fuel producers and consumers. Circular finance to support eco-fashion producers and Finance can also play a role in encouraging and recyclers incentivising firms or industry sectors to decarbonise Venture capital to support innovative new ‘meat-free’ by divesting, or threatening to divest, from firms or products. sectors perceived as damaging the environment. A well-known example is Climate Action 100+, a major Green and sustainable finance are growing rapidly, investor group that seeks to engage greenhouse gas therefore, and there are very significant commercial emitters and encourage them to shift their resources opportunities for banks, investment funds, insurers to cleaner energy, supporting the Paris Agreement. and other financial services organisations to support In 2018, Royal Dutch Shell, at least in part in response the transition to a sustainable, low-carbon world. As we to Climate Action 100+ and other groups, agreed to described previously, however, despite growth in recent set short- and long-term carbon emissions targets years a substantial investment gap remains. The scale linked to executive remuneration – the first of the large of the challenge is beyond that of public finances alone, oil companies to do so. Shell aims to reduce its Net and a significant and sustained increase in support from Carbon Footprint by approximately 50% by 2050 and by the financial services sector is required to achieve the approximately 20% by 2035 as an interim step; earlier objectives of the Paris Agreement, the UN Sustainable that year, Shell had announced that divestment should Development Goals and broader sustainability objectives. be considered a “material risk” to its business. Climate Action 100+ currently (March 2022) engages with nearly 170 organisations estimated to account for some 80% of global, industrial greenhouse gas emissions. 41 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance 1.4 CHALLENGES FOR GREEN AND SUSTAINABLE CASE STUDY: ØRSTED FINANCE Today, Danish company Ørsted is one of the world’s best known and most respected green energy providers. It Our financial system has three key characteristics that was named as the world’s ‘most sustainable company’ by Corporate Knights in 2020. can contribute to environmental and other problems of sustainability, rather than offer solutions: Just over a decade ago, however, it was one of the very worst greenhouse gas emitters, with 85% of its business reliant on fossil fuels. The state-owned company, then called DONG Energy (Danish Oil and Natural Gas), was A bias towards short-termism in decision-making responsible for considerable air pollution too, leaving a literal and metaphorical dark cloud over Copenhagen. A narrow focus on profit and shareholders DONG Energy set out to change this, aiming to transition their business to 85% green energy and 15% dark (fossil A tendency not to address ‘externalities’. fuel) energy, using green finance to fund the transformation. In 2017, DONG Energy – soon to be Ørsted – entered the green bond market. By the end of 2021, Ørsted had issued a total of about DKK 34,500m ($5bn) of green bonds. Green bonds account for more than half of the company’s total bond portfolio, and all bonds issued in the future will be green bonds. In addition to reducing their carbon emissions by 85%, Ørsted has gained considerable commercial success. Before their transition, Ørsted was largely a domestic supplier, but today they have offshore windfarms all over the world and aim to supply green energy for 30 million people by 2025. The group is also on track to become carbon neutral in 2025, profiting from the reputational benefits this will bring, and avoiding the impact of carbon pricing and increasing environmental regulation that may reduce competitors’ returns. Source: Adapted from Ørsted company materials and Green Bond Impact Report 2021: https://orstedcdn.azureedge.net/-/media/annual2021/green-bond-impact-report-2021. ashx?la=en&rev=7b82631fb4d64f51bdea9d94c7491920&hash=9823EE900901654B3DDF91ACBA13F727 [Accessed: 13 January 2023] 42 | Principles and Practice of Green and Sustainable Finance Unit 1: An Introduction to Green and Sustainable Finance 1.4.1 Short-termism The time horizons in which financial institutions and QUICK QUESTION: WHO ARE THE KEY STAKEHOLDERS FOR finance professionals make decisions are often too short YOUR ORGANISATION? to consider the longer-term environmental or social effects of an investment or activity. This short-termism Write your answer here before reading on. is intensified by the pressure to deliver positive, often quarterly results for shareholders. This can discourage financial institutions from investing in sectors that offer long-term value rather than short-term gain, and can encourage them to discount the long-term risks of their activities, which often include environmental risks. Regulatory pressures to enhance liquidity can also dissuade financial institutions from offering products designed to build value over the long term. The impacts of short-termism demonstrate the link between time horizons and