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As President Joe Biden and the Securities and Exchange Commission consider enhanced climate-risk reporting and stepped-up climate change mitigation initiatives, there is one key area that demands his Administration’s greater attention – greening of the financial markets.
Trillions in additional investment in carbon cutting technology, projects and services is required to meet the goals of the Paris Climate Accord. Smart regulations can contribute. But experience shows that sustainable investment instruments help decarbonize sectors that often fall behind on the policy agenda. Taking meaningful government action would not only accelerate private sector investment in major carbon emitting areas such as buildings, industry and infrastructure, it would also bring greater accuracy and transparency to corporate emissions data, thereby achieving net zero faster and more reliably. Clarifying and rigorously defining what constitutes green is among the most critical actions.
Trends in green investing show that purposeful action by the financial community can drive emission reductions across all sectors. Investor appetite in green financing instruments is strong, with most green bonds oversubscribed. In spite of COVID-19, during the first half of 2020 USD green bonds were on average 2.6x oversubscribed, according to Climate Bonds Initiative.
From a corporate viewpoint, tying green financing to the bottom line is also one of the most meaningful decisions a company can make. Johnson Controls was one of the first industrial companies to issue a green bond in the U.S. in 2020. One of the largest such bonds issued by an industrial, it funds multiple clean technology projects. The extraordinary market response to the issuance clearly signaled that the financial sector understands the importance of green investments. Johnson Controls was also among the first to link U.S dollar syndicated loans, such as variable interest and fees for credit facilities, to meeting specific performance targets for environmental, social and governance (ESG) commitments. Further, its entire green finance framework is audited by an independent third-party and is aligned with Green Bond and Green Loan principles developed by the International Capital Markets Association.
A greener financing market that makes use of such instruments as green bonds and ESG-tied loans, is not only a vehicle for one-off green projects, but also necessitates greater corporate accountability and transparency with respect to carbon emissions data. Potential investors look for rigorous, detailed information that goes well beyond green commitments contained in sustainability reports. Transparent and comparable data is essential to climate risk disclosures and achieving meaningful reductions.
Yet, challenges remain that currently limit investor confidence and the ability of green finance to help drive progress towards net zero. Investors are looking for reliable objective evidence that the projects funded are genuinely sustainable. The maze of competing frameworks and proposed standards makes it hard to identify what constitutes “green.” Sustainability action data is not easily comparable or useful in decision making. Even within the green bond market there are no common definitions, resulting in some climate-related bonds being excluded from the third-party green bond standards such as Climate Bonds Initiative and some bonds being counted as “green” by sovereigns but not conforming with Climate Bonds Initiative criteria for “green.”
An additional challenge is a lack of ESG reporting harmonization, resulting in a weak correlation among ratings and rankings. While numerous entities rate and rank corporate sustainability performance, the approaches vary dramatically, making meaningful comparison across systems impossible. Driving clarity, standardization and coherence among ESG disclosures could boost their usefulness as a tool to measure climate action and performance.
The Biden administration can address some of these challenges by engaging in three key actions. First, it should help develop definitions and parameters around green (and climate-related) bonds in cooperation with the global financial community, ensuring measurable impact. Second, it can work to harmonize the standards for reporting emissions and climate data, increasing transparency and improving comparability. And third, the administration should engage the private sector — industry, the service sector, the tech community, finance, and others — in discussions on how to identify and disclose climate risks and opportunities in a way that is meaningful, measurable and transparent.
Tackling the climate challenge means that private capital flows need to turn dramatically and decisively towards sustainability. The good news is that there is plenty of opportunity for green investment growth — the green bond market may reach a cumulative $1 trillion in 2021, but that is still only one percent of the total $100 trillion bond market.
Catalyzing a green transformation through private investment is a necessary step on the path to net zero, and smart public policy can serve as a key enabler. Swift action by the Biden administration can help accelerate the global race to a net zero carbon economy.
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