· 13 min read
Introduction
Climate change exerts a significant human toll - its painful negative economic effects exacerbate already rising income and wealth inequality levels, and changes in the physical environment lead to population displacement within countries and across borders and contribute to deteriorating health outcomes. Making more effective responses to climate change will require accelerated efforts across the entire world, at minimum, to meet commitments made for the Paris Agreement and related processes. In addition to making good on these pledges, governments and businesses ought to work together to partner with local communities and suppliers and create intentional space for diverse leadership. These changes will bring many benefits.
Positive changes are taking place, countries are bending the curve of global greenhouse gas emissions downward and, for the first time ever last year, the world spent as much on clean energy as it did on fossil fuels. Optimism, however, still needs to be grounded in reality and there is still lots of ground to cover.
In this article, I discuss how global corporations, institutional asset owners and managers can move beyond talk to take transformative action since this is the only currency that matters.
Mapping the terrain
Global finance for climate action reached $803 billion annually for 2019-2020—less than a fifth of the estimated $4 trillion in annual investment that is needed for public and private sector entities to meet net-zero objectives.
Global capital markets—with at least $100 trillion in assets under management—have the resources to contribute the financial capital needed for the transition away from high-emission polluting systems, limit global warming to 1.5°C and create a more sustainable global economy. Within this total, ESG-related assets under management are forecast to grow to $34 trillion by 2026—yet this financial capital is underperforming.
For the financial industry to step up, institutional asset owners and investment managers must change their mindsets, challenge investment policies and develop a new risk-return calculus, all of which are needed to facilitate investment in sustainable development.
But the reality remains that the 45 largest asset managers in the world who collectively control assets worth over $70 trillion are failing to meet their net-zero targets. Ninety-five percent of the portfolios analyzed were found to be in misalignment with targets of net-zero emissions by 2050.
Climate action has stalled, and asset managers are not prioritizing real and transformative sustainable finance practices. Since 2021, there has been a 45% reduction in the number of asset managers that have “truly ambitious and effective climate stewardship practices”.
There are technical reasons for underinvestment that include: gaps between perceived and actual risk; the misspecification inherent in capital pricing models that have not included negative externalities and the narrow definition of the purpose of capital in ways that exclude societal benefit or impact, and the lack of inclusion of the real and long-terms costs of climate change in asset valuations.
Although these flaws in traditional, dominant models are known, efforts to address them are simply not as popular or as influential as straightforward profit-maximizing models. We therefore run the risk of privileging profit maximization in the short-term and thereby destroying all possibilities of profit and sustainability in the immediate future.
Given the lack of adequate investment in response to climate change–both mitigation and adaptation–it is imperative that we find effective ways to stimulate action at scale– in both the productive and financial sectors.
Making these changes is not impossible. But it will require transformation-focused, bold leadership, and an infusion of new voices and thinking into finance and C-suites. It will require a transition away from harmful industrial technologies and practices and the ushering in of new ways of doing business.
Multiple directions to scale
Some actors are moving because they are good at opportunity sensing and capturing.
Deloitte estimates that more proactive investments in climate adaptation and mitigation today could add $43 trillion to the global economy over the next five decades. This is why we are seeing some asset owners such as AXA Investment Managers, for example, directly invest $49 million in Brazilian-based Mombak to increase the amount of carbon dioxide captured from the Amazonian atmosphere while reforesting parts of the Amazon basin.
I am also encouraged to see professional investment managers like Fidelity International develop and implement a set of proactive strategies including portfolio structuring, that would actively promote decarbonization and climate-friendly strategies in firms.
Influencing the time horizon of investment and making more dollars serve long-term beneficial impact is at the heart of the challenge facing corporations and investment companies. In the Time Value of Carbon framework by Generation Impact Management (GIM) we are given an explainer on how it is possible to make better investment decisions by balancing the transition costs required to shift to low carbon, incurred in current periods, and the cumulative benefits that accrue in the future. GIM offers a peak beneath the hood of how a large successful investment manager is going about making these changes. Here’s hoping that many more investment managers and corporate financial leaders make the shift.
Asset owners and investment managers seek out opportunities to invest and deploy financial capital when deal packages are right-sized, fit with existing investment policies, and deliver returns that align with what decision-makers in finance today understand. By educating financial decision-makers, these leaders can begin to consider broader and longer-term investment opportunities across the risk, return, and impact spectrum. To do this, we need convening power that brings together those stewarding and managing financial capital with those deploying financial resources to fuel innovations and solutions across the globe.
The recent Deploy 23 conference, quarterbacked by the United States Department of Energy, provided many focused deal-orientated conversations with machinery for follow-up. This design is very noticeably different from efforts to close the global climate financing gap where the notion of private sector-led and government-enabled is foreign and strange.
As we approach COP 28 hosted by the United Emirates, it is important to reflect on the lack of effectiveness and the slow pace of change in the multilateral processes around climate change - The United Nations Summits and Conference of Parties need a fillip. There needs to be much more of a focus on working sessions where counterparties meet to take action. The style of COPs bear the imprimatur of multilateralism with a plethora of speeches and announcements by very important people. Even for the Glasgow COP26, private sector leaders could not resist the urge to declare more than they could deliver.
The Triple B Framework makes the case for focusing on the action by strengthening ecosystems and facilitating activators that can range from the Federal government, nonprofits, coalitions, think tanks, academics, and individual scholars. Developed by our team at Resilience Capital Ventures, the framework involves combining non-financial forms of capital with finance to create value. Our work has shown that by sequencing injections of knowledge, social and political capital first, societies can get more bang for the buck. This approach has also worked to improve the discovery of financial capital from non-traditional sources such as credit unions. Resilience Capital Ventures, through a mandate with the government of The Bahamas, is executing The Bahamas Sustainable Investment Program is putting these ideas into action on a national scale.
In the U.S., when it comes to directing capital to underserved communities, community development financial institutions funds (CDFIs) are doing a much better job than large banks and investment companies. Since 2020, although much more is needed, there has been success in the collaborative efforts of CDFIs and national not-for-profits such as LISC (Local Initiatives Support Corporation).
From a private sector standpoint, there are consulting companies such as Lebec Consulting working with corporations to guide their work in climate action including by developing playbooks that are customized for specific sectors. Their work with the Global Business Coalition for Education produced the ESG+Education Playbook that rigorously ties a specific issue–education–to material ESG issues companies face.
Doing the heavy lifting
In order for leaders to use better approaches they will first have to undergo a change in personal orientation, one that helps them to recognize what’s needed and to seek help. Emily Gendron of Human Possible refers to this as “putting your hands up” for change and serves as a trusted guide for business leaders helping them to navigate the systems transformation required. She said “To be successful, leaders must evolve their worldview to handle the complexity of aligning business incentives and the future viability of humanity. Human Possible helps them cross the chasm because it is wide and complex and without a guide, most will falter.”
Part of the change process involves something akin to evangelizing or spreading the good news. Analysts and commentators must be intentional about “widening the solution space” by collaborating on active search efforts to discover and amplify solutions across the capital continuum that leverage every capital tool in the toolbox.
Here are some salutary examples:
- Climate tech investments by Azolla Ventures, including a $239 million blended fund focused on investing in early-stage companies (mostly pre-seed and seed with some Series A) that would otherwise be overlooked by other VCs. For example, Azolla’s blended climate fund is not just drawing on original investors but rather pairing investors with philanthropic partners who are hoping to maximize the impact of their dollars.
- Uruguay’s efforts to change its energy mix to favor renewable sources.
- Patagonia reimagining its entire business model where sustainability is the driving force of all its actions and culture.
- Private equity firm Alpine Investors transitioning to a B Corp to attract the best talent and redefine what types of businesses it will grow.
- Efforts by leading research universities such as MIT and Penn State among others to showcase climate solutions and the work of policy-oriented academic think tanks including at Tufts and Columbia University set a high benchmark.
- The work of global corporations including tech giants Apple, Microsoft, Google, Amazon, and Facebook to reduce climate emissions, move to renewable energy, and manage waste is also positive but requires in-depth engagement and amplification.
- Increased investments in renewable energy by J.P. Morgan are reportedly on track to finance $1 trillion for green energy by 2030.
There is a global ecosystem of start-ups and social enterprises that is disrupting and transforming industries from agriculture, energy, and healthcare to water access, fashion, and fintech and proptech in ways that are better serving the needs of consumers who want sustainable products. These innovators are demonstrating that sustainability is the business model and are redefining what good investment means.
Recommendations for a path forward
Moving to action requires a commitment of time, talent and treasure. As this essay makes recommendations on how to mobilize and deploy money and other forms of capital, I take inspiration from companies, organizations, scholars and some institutional investors from around the world. The path notes that finance and investment firms will have differentiated roles and responsibilities from other leaders in corporations, small to medium-sized enterprises (SMEs), civil society organizations, government, regulators, and ecosystem builders including academic/think tanks.
Technical dimensions
Make improvements in the analysis and evaluation of investment opportunities by factoring in the price of carbon and other negative externalities; ensuring we have a transparent and regulated carbon market; improving risk assessment and the risk/return calculus to more accurately reflect today’s world and priorities; and tracking a firm’s impact on society and the global environment.
Corporations and institutional investors ought to use globally standardized and best-in-class ESG ratings and scores where a firm’s efforts in addressing double materiality become standard business practices that can be disclosed and tracked using standardized, verifiable methods. When information is more readily available and standardized, the layers of decision-making in corporations and investment houses can move more towards human thriving and planetary stewardship.
Portfolio managers and capital markets professionals should design and construct indexes and portfolios that allow institutional and retail investors to choose companies that are genuinely addressing poly-crisis issues and adapting their business models accordingly.
Investment strategies
Based on technical improvements can re-evaluate risk, return, and impact calculations based on the real costs of climate change being embedded in asset valuation, we can start to prioritize investments differently and re-allocate capital where it deeply matters. This includes looking at financial returns, leadership, and performance from a long-term perspective versus just quarterly performance.
These shifts arise through fundamentally reassessing the role of business in society and the value of business. While this work with Jed Emerson posits that it is best to include a critique of the operational logic of capitalism and modernity, others offer an analysis of how businesses can make within-system shifts to meet sustainability objectives
Institutional investors can tap opportunities that exist in the impressive global startup and social enterprise ecosystem. There are firms and organizations working to improve service delivery and extend infrastructure those that serve people of color and low-income communities are starved of capital. This is true within countries and across the world where emerging markets are poorly served.
There are outliers already doing this work, and, as we have suggested, the signal-to-noise effect can be improved if we trumpet those successes.
Stakeholder engagement
Business leaders, institutional asset owners and investment managers must open up beyond their narrow circles and echo chambers. By standing up active intelligence gathering systems and processes for dialogue firms will access a wider array of sources of knowledge and insight—including Global Majority entrepreneurs, fund managers, and company leaders who are immersed and have experienced the issues the world is trying to solve and have a wealth of knowledge to offer. This entails stepping away from the well-trodden path to embrace other ways of thinking and engaging with cultures that are less destructive and more in-tuned with stewarding nature.
Stakeholders include owners and stewards of stocks of natural capital – mangroves, seagrass meadows, forests and the vast ocean. Without the protection and healing of these stocks, all other efforts will not be as effective.
Financial and systems innovation
The Green Climate Fund and the emergence of the Loss and Damage Fund (the outcome earned in COP27 after decades of negotiations ) are examples of how the international system undertakes innovation by creating specialist funds. These efforts seek to provide a mechanism for attracting financial capital from different streams and deploying for real progress. However, even these special purpose vehicles like the GCF have proven to be too risk averse and plagued with convoluted processes and, bureaucratic systems. There are reportedly efforts underway to improve nimbleness in decision-making.
Few venues exist for engagement among stakeholders on the basis of mutual respect and so they ought to be created. There are opportunities within mining, agriculture and energy (hydropower) for Western firms to transform systems of extractive commerce and work alongside First Peoples and indigenous communities. Australia provides some good examples of these experiments despite setbacks with the referendum.
Climate change and response to anthropogenic effects cannot be on a country-to-country basis. The polycrisis our world faces takes place on a global scale and therefore, it is imperative that solutions are identified and implemented all around the world. This will mean designing mechanisms to move financial capital from where it is concentrated to parts of the world greatly affected by changing climatic patterns such as the Sahel region of the African continent.
In conclusion, this essay suggests that what is required of business leaders and institutional investors is genuine engagement in transformative actions that take them out of their current comfort zones to a new state of being where financial returns and societal benefits are not incompatible but are synergistic.
illuminem Voices is a democratic space presenting the thoughts and opinions of leading Sustainability & Energy writers, their opinions do not necessarily represent those of illuminem.
