Green finance: a beginner’s guide
Climate change may still be a matter of debate for some politicians, but investors are increasingly clear.
A growing number of governments are turning up their investments and subsidies for ‘green’ industries, which in turn has kick-started a huge trend in equity markets that could see green stocks become some of the world’s most valuable companies.
Green finance is defined as the financing of investment in all financial sectors and asset classes that integrate environmental, social and governance (ESG) criteria into the investment decision-making process.
It also aims to embed sustainability into risk management for encouraging the development of a more sustainable economy. The predominant financial instruments in green finance are debt and equity.
Lee Owen, director at Hays Accountancy & Finance, says: ‘In short, green finance describes financial products and services that meet demands, while also positively contributing to the environment.
‘It involves things such as green bonds and carbon market instruments, as well as the emergence of green banks and green funds.
‘The “green” element might focus on making existing infrastructure more environmentally considered, or investing in sectors such as clean energy, natural resource management and pollution prevention and control.’
The two main goals of green finance are to internalise environmental externalities and to reduce risk perceptions. It covers a wide range of financial products and services, which can be divided into investment, banking and insurance products.
Saxo Bank chief economist Steen Jakobsen discusses a couple of major examples in an outlook report. He says: ‘Germany is unveiling plans to move entirely from coal to renewable energy by 2038, while China is the largest manufacturer and buyer of electric vehicles in the world.’
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Green finance also aims to encourage transparency and the long-term thinking of investments into environmental objectives and includes all sustainable development criteria identified by the UN’s Sustainable Development Goals (SDGs).
These goals include clean energy, clean water, sustainability and responsible consumption.
According to the 2019 edition of Climate Policy Initiative’s Global Landscape of Climate Finance, flows of climate finance reached $546 billion in 2018, driven by renewable energy capacity additions in China, the US and India, plus increased public commitments to land use and energy efficiency.
To meet growing demand, new financial instruments, such as green bonds and carbon market instruments, have been established, along with new financial institutions, such as green banks and green funds.
As ESG reporting shifts from niche to mainstream and begins to have implications on the balance sheet, investors are raising challenging questions on how ESG performance is assessed, managed and reported.
ESG factors are critical in the assessment of the risks to insurer’s assets and liabilities, which are threefold: physical risk, transition risk and liability risk.
The adoption of ESG considerations in private investments is evolving from a risk management practice to a driver of innovation and new opportunities that create long-term value for both business and society.
Green finance terms
The provision of targeted capital for the ‘development and implementation of green technologies/activities/projects’
The integration of sustainability considerations (social, environmental, economic aspects, and/or increasingly the UN Sustainable Development Goals)
An investment strategy that integrates ESG criteria into investment decisions to mitigate risk and yield long-term results
An investment strategy that aims to achieve financial returns while creating positive, measurable social and environmental impacts on/for society
Investment in techniques that involve nature as part of the solution
Investment in conserving or enhancing the natural environment to unlock valuable benefits to nature and, from these, society
This article was first published in Student Accountant in October 2020