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Can the international financial market contribute to the urgent need to combat climate change? The boom in green finance would suggest it can, a lot.
Never before has so much money for sustainability purposes been raised on capital markets as this year; the total global volume is approaching the two-trillion euro mark.
Discussions at COP26 in recent weeks brought even further attention to the potential role finance could have.
It’s becoming ever more evident that financial products just have to be given the ‘green’ label to be flooded with investment money. Not only are companies riding this wave, but governments are, too.
How are governments reacting?
In an international comparison, Europe has clearly taken the lead, with the USA and Asia following far behind.
Some are already jubilant that Europe is the big winner in green financing. The particularly large amount of green capital available, they say, will drive the transformation of the economy faster than in the USA and China.
However, such a view fundamentally fails to recognize the interdependencies of capital markets.
The first critical question is: What is green finance anyway?
Views on this differ from country to country, and there is no uniform classification. For example, while nuclear energy is considered environmentally friendly in France, the opposite is true in Germany.
As a result of this uncertainty, some financial institutions are increasingly being accused of not taking the classification of green investments too seriously, and of prioritizing marketing over substance.
This accusation is summarized under the keyword “greenwashing”. But even if there were a uniform, generally accepted classification of green investment opportunities, this wouldn’t change much.
The second critical question is: Does green financing provide additional funds for the sustainable transformation of the economy at all?
In many cases, the answer to this question is a clear no.
One example is the case of the “green” sovereign bonds issued for the first time in September 2020 in Germany. The German federal budget was only examined to see which already planned expenditures could be classified as green.
After the sum was determined, the government sold green bonds in exactly this amount – so nothing changed.
How are banks tackling climate change?
Banks, by contrast, can deny their borrowers funds, or offer funds only on very unfavorable terms, if they expect more commitment to climate protection from a company.
This results in the seemingly paradoxical situation that climate-conscious investors may achieve the most when they invest in companies that have previously been known as climate sinners.
With these companies, they can reduce CO2 emissions significantly more through their intervention than with already climate-friendly companies.
However, investors should not be under the misapprehension that investments in the ‘greening’ of companies will automatically lead to higher returns.
This can be the case if they realize earlier than others that a company is on a climate-damaging track with its production technology, and that a quick change of course can increase earnings opportunities.
But this is not the rule. Investments in exclusively green asset classes deny investors the opportunity to diversify their capital as widely as possible.
What effective steps can we take?
In competition with the US and China, Europe would do well not to rejoice too soon in its current pioneering role.
Rather, Europe should seize the momentum and create the conditions for investors to actually contribute to a green shift in companies through their actions.
There are a number of good starting points for this. For example, the rules on corporate governance should be strengthened.
The tendency towards passive index investments, which has been observed for many years in all major international capital markets, should be reversed and soon, if the great importance of interventions by capital providers in the green transformation of the economy is recognized.
A thriving market for venture capital would be another key element. While Europe lags behind the US and China in many technological developments, there is an opportunity to create the next crop of climate technology ‘unicorns’ on the old continent through a close meshing of science and practice.
And what about European companies?
It is often said that Europe only contributes 10 percent to global CO2 emissions anyway.
But European companies could, through their innovative power, not only significantly reduce emissions caused by Europe but also become the benchmark and sought-after supplier for CO2 reductions all over the world.
This would reverse the distortion in the market values of European companies, compared to American and Chinese competitors.
The fight against climate change is too important to follow only seemingly plausible arguments. It is high time we move from a naïve to an enlightened approach to sustainable financing – in the interests of both investors and the environment.
Jörg Rocholl is the president of ESMT Berlin and deputy chairman of the Scientific Advisory Board at the German Federal Ministry of Finance.