Green Finance for Sustainable Investment

IndraStra Global

Green Finance for Sustainable Investment

By Ulrich Volz
via ADB Institute's Asia Pathways Blog

Green Finance for Sustainable Investment

To place the Asian economies onto a sustainable development pathway requires an unprecedented shift in investment away from industries relying intensively on greenhouse gases, fossil fuels, and natural resources toward more resource-efficient technologies and business models. The finance sector will have to play a central role in this green transformation. Important aspects of green finance are sustainable investment and banking, where investment and lending decisions are taken based on environmental screening and risk assessment to meet sustainability standards, as well as insurance services that cover environmental and climate risk.

Against the backdrop of climate change vulnerability and the need for a reduction of carbon emissions, huge investments in green and climate-resilient infrastructure are needed across the region. The Asian Development Bank (ADB) has assessed the infrastructure gap in developing Asia to amount to US$26.2 trillion between 2016 and 2030 or US$1.7 trillion annually (ADB 2017). Of the US$26.2 trillion that needs to be invested by ADB’s 45 developing member countries, US$3.6 trillion is specifically required for climate change mitigation and adaption costs—56% of the investment is needed for power, 32% for transportation, 9% for telecommunication, and 3% for sanitation. For Southeast Asia alone, the ASEAN Investment Report 2015 estimates that US$110 billion a year will be needed for infrastructure investment in power, transport, information, and communication technology, and water and sanitation in the Association of Southeast Asian Nations (ASEAN) region through 2025 (ASEAN Secretariat and UNCTAD 2015).

All of this investment will have to be sensitive to environmental, climate, and associated policy risks. Funds for this investment will need to come from both the private and public sector, including domestic and international sources. The financing of sustainable infrastructure requires new approaches for mobilizing and intermediating long-term finance in the region. Integrating environmental and social considerations into lending decisions and product design is only a first step in making the financial systems instrumental in funding the required transformation toward a green economy in the region. The funding of energy efficiency, renewable energy, and sustainable infrastructure requires new concepts and new financial instruments that are adapted to local circumstances. Green banks, green bonds, and appropriate regulatory frameworks will be introduced in a coordinated framework. Last but not least, there is also a need for developing the insurance of climate risk, including risk mitigation instruments for agriculture, which for many countries in developing Asia remains a major economic sector.

There is no question about the importance of implementing an adequate environmental policy and regulation and the need for targeted industrial policies to create the conditions for sustainable investment and thereby enhance green, low-carbon growth. There has been a growing recognition, however, that aligning the financial system with sustainability goals is crucial to achieving a green transformation, given that the financial system is the place where investment decisions are taken or influenced. The need for financial institutions to “incorporate climate-proofing and climate resilience measures” (UNFCCC 2015: §44) has also been recognized in the Paris Agreement. Accounting for climate and other environmental risk is not least important with respect to safeguarding the stability of financial systems. A failure to address systemic sustainability challenges will in the longer term impinge on the growth and returns of individual firms and economies at large, with repercussions for the financial institutions that have financed non-sustainable investments. There is hence a strong case for financial institutions as well as for financial regulators to take account of environmental, social, and governance (ESG) risks.

For the time being, only relatively few financial institutions in Asia systematically integrate ESG factors into their lending or investment decision-making processes. Green banking and sustainable investment are still a niche market, and few staff in the industry have been trained in ESG issues. But the situation is changing.

Several Asian economies have been at the forefront of introducing sustainable finance guidelines and regulation. Financial authorities in Bangladesh; the People’s Republic of China; Hong Kong, China; India; Indonesia; Japan; Mongolia; Singapore; and Viet Nam have already started taking concrete steps to align their financial system or parts of it with sustainable development. Financial authorities in Cambodia, the Lao People’s Democratic Republic, Nepal, Pakistan, the Philippines, Sri Lanka, and Thailand are currently working on green finance policies.

Many different instruments can be used to enhance green finance. The most adequate choice of instruments will depend on the specific country context. While certain market-based instruments may be more appropriate in one country, another country may opt for more interventionist policies. Yet what is needed in all countries to enable a fundamental cultural change in financial markets and to mainstream sustainability in financing—and investment is a coordinated and systematic approach that involves all relevant stakeholders. Financial authorities need to set incentives for financial firms to enhance green finance and provide support and guidance, but experience from different countries suggests also that often rules and regulations are needed for financial firms to act.

To successfully align the financial system with sustainability goals, financial governance should target the following goals:
  • raising awareness among regulators and market participants in the finance sector for environmental and climate risks;
  • developing capacities in the financial industry for environmental risk analysis and management through knowledge building and sharing;
  • building up the capacities in the financial industry needed to develop sustainable financing practices and new lending instruments for financing sustainable projects such as renewable energy;
  • enhancing transparency through ESG disclosure requirements;
  • providing incentives, where needed, to banks and non-bank financial institutions for the financing of green projects;
  • supporting the development of new market segments such as the green bond market or climate risk insurance; and
  • developing long-term, local currency refinancing sources for banks to enable them to extend long-term credit.

To achieve these goals, a dialogue among all relevant domestic stakeholders is needed. Public financial institutions, including central banks, development banks, and public pension funds, can play an important role in developing and promoting the adaption of new green financial products. International initiatives and networks such as the United Nations Environment Programme Finance Initiative, the Sustainable Banking Network, the Sustainable Stock Exchanges Initiative, the G7 Initiative on Climate Risk Insurance (InsuResilience), and the G20 Sustainable Finance Study Group can help countries leverage international experiences.

Despite being a niche market, growth rates of green finance and investment have been high, and different Asian markets have already seen various green financial innovations. The challenges for achieving a green transformation to a low-carbon economy are large. Aligning the finance sector with sustainable development will be a key element for Asian economies to succeed.

This article was first published in Asia Pathways, the blog of the Asian Development Bank Institute (www.asiapathways-adbi.org).

About the Author:

Ulrich Volz is head of the Department of Economics and associate professor of Economics at SOAS University of London (School of Oriental and African Studies). He is also a senior research fellow at the German Development Institute.

References:

[1] Asian Development Bank (ADB). 2017. Meeting Asia’s Infrastructure Needs. Manila.

[2] Association of Southeast Asian Nations (ASEAN) Secretariat and United Nations Conference on Trade and Development (UNCTAD). 2015. ASEAN Investment Report 2015: Infrastructure Investment and Connectivity. Jakarta.

[3] United Nations Framework Convention on Climate Change (UNFCCC). 2015. Adoption of the Paris Agreement. Conference of the Parties, Twenty-first session, Paris, 30 November to 11 December 2015. Paris.

[4] Volz, Ulrich. 2018. Fostering Green Finance for Sustainable Development in Asia. ADBI Working Paper No. 814. Tokyo: Asian Development Bank Institute.

DISCLAIMER: The views expressed in this insight piece are those of the author and do not necessarily reflect the official policy or position of the IndraStra Global.