As more countries and corporations declare their net zero commitments, they pose an immediate, practical question: is capital flowing in the right direction to help their pledges be met?
While investment in green assets and technologies has grown, their popularity offers only part of the solution and raises new, complex problems. At the same time, if turning “brown” companies into green ones is intuitively beneficial, the financing of such a transition is far from straightforward.
Spiralling demand for minerals such as lithium, for example, is indicative of a cleaner automotive industry as the material is integral to batteries powering electric cars. But it is also a cause of concern because of the environmental impact of its mining.
Extracting lithium from the ground involves displacing vast amounts of groundwater and the risk of contributing to desertification. In 2050, the World Bank estimates that demand for the mineral will have grown to nearly five times the levels of production seen in 2018.
Other raw materials essential for electric vehicles and renewable energy technology pose further quandaries. Cobalt, for example, is mostly produced in the DRC in hazardous conditions involving child labour, as campaign organisations have long warned. And this is something investors are well aware of, too.
“If you’ve ever seen a lithium mine or a cobalt mine, they’re not the most environmentally friendly — not to mention the social aspects around them,” notes Robert Furdak, chief investment officer for environmental, social and governance (ESG) at Man Group. “ESG aspects are oftentimes very nuanced, and you just have to understand the complications of some of these issues.”
While technology is improving — electric automaker Tesla is working on cobalt-free batteries — evaluating the overall impact of investments is tricky. In addition, there are other factors that can make directing capital towards climate goals even trickier.
While financing for green assets is abundant, financing the green transformation of heavy emitters is rather more arduous. Arguably, this is most evident in a jurisdiction such as the EU, which has created a green taxonomy setting clear boundaries between the “colours” of different companies but not guided on what is permissible, or even encouraged, in the transition from brown to green.
This tension is exemplified by the still tentative market of transition bonds, intended to finance the process. “Every time a client wants to issue a transition bond, they fear that [this will attract] a reputational risk,” says Hacina Py, head of impact finance solutions at Société Générale. “What is brown, according to the EU, is what is never going to become green but, in the middle, there is not enough space.”
The European Commission’s director-general for climate action, Mauro Petriccione, admits that the EU could do “a little better” in clarifying its position and expectations regarding the energy sources needed in the transition to a greener economy. He says natural gas is essential in the short term, but that by 2050 it should be out of the system entirely.
Speaking at a recent Financial Times conference, Petriccione added that, “there are financial institutions that have taken the bull by the horns and gone ahead [with transition financing] and I don’t think they have suffered [as a consequence].”
Though numbers remain low — $4.5bn this year, according to data provider Refinitiv — there are signs that transition bonds are set to grow. In February, the London Stock Exchange created a transition bond segment on its venue, expecting rising activity.
Italian energy infrastructure company Snam has already tapped the market four times during 2020 and 2021, for a total of €2.35bn to help finance its 2040 net zero goals. And the supply of green bonds is still relatively low compared with demand, leaving ESG investors looking for more — the EU’s debut green bond, to raise the groundbreaking sum of €12bn, was 11 times subscribed.
Outside the EU, Dean Alborough, head of ESG at Old Mutual Alternatives, wishes regulators would encourage transition finance so that corporates, as well as multilateral banks, may feel inspired to tap the market. “If there’s a regulation that allows for this transition, development finance and private sector finance will be protected from a reputational perspective,” he says.
Some estimate low-carbon technologies will require over $90tn of investment over the next 15 years. Meanwhile, the financing of fossil fuel production is attracting more controversy. Many argue that green technology and infrastructure do not yet allow for the abandonment of this industry.
“There is still a lot of ground to [cover to] define exactly what transition is, and how you apply it in different sectors,” says Demetrio Salorio, UK head of global banking and advisory at Société Générale. But he adds: “We cannot abandon the financing of oil and gas today, it would be impossible.”
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Funding is key to helping polluters go green
