While attending the Financial Inquiry India Report launch this past May, I heard Nick Robins— the UNEP (United Nations Environment Programme) financial inquiry team co-director—mention the need to address the issue of climate change in relation to the global financial system. It got me thinking about how our carbon-intensive economies were not built with the intention of tackling the hurdles that climate change throws at us. It is in this "survival of the fittest" kind of moment that we and our economies must either adapt or perish under the changing climate.
Green bonds provide countries and investors with the ability to invest in capital-intensive projects that are specifically targeted towards climate change adaption.
Ever since we agreed that climate change is a global threat, the need of the hour has been to address this "tragedy of the horizons" using a financial tool that can do so effectively and in time. While the world agrees that carbon emissions are causing irreparable damage to our planet, the need for an incentivized solution is imminent. The solution to our "tragedy of the horizons" is in providing attractively priced financial alternatives that can allow people to invest in their future, without feeling like they are losing a buck. Keeping this in mind, the green champions of the financial community have come out with an innovative tool that can finally change the way we do business while also addressing climate change concerns in our globalized economy. This innovative tool is what is known as a green bond. First, why do we need green bonds?
The gap in climate finance
Studies have shown that while climate change will affect everyone, the poorest people from the least developed countries will bear the brunt of it. In order to address this grave injustice, the world's developed nations have agreed to mobilize $100 billion a year by 2020, from public and private sources, to help developing countries adapt to the impacts of climate change as well as reduce their emissions.
A report by the Climate Policy Initiative shows that out of the estimated $331 billion climate finance allocations in 2013, only $34 billion were transferred by developed countries to developing countries for adaptation and mitigation, leaving an annual gap of about $70 billion. Closing this gap is an important step if the world is going to work towards reducing emissions in a timely manner.
Additionally, even governments in developed countries aren't immune to the handicaps of budgetary constraints and at times look to the private sector to provide capital for public projects. One can say that the private sector, in both developing and developed countries, plays a pivotal role in not only financing this transition but also changing the social realities of the issue of climate change.
How can green bonds help?
Ever since the time of the industrial revolution, bonds have always been the preferred instrument for public and private sectors to fund large-scale and long-term infrastructure projects that need upfront capital. A green bond puts a new spin on the concept of a traditional bond. It looks to provide stable and long-term capital, with financial (matching interest rates shown by traditional bonds) as well as added social and environmental (and in extension moral) returns for the investors.
There is oversubscription in the current green bond market— meaning that demand significantly exceeds the supply.
Green bonds provide countries and investors with the ability to invest in capital-intensive projects that are specifically targeted towards climate change adaption. They can be issued by both public and private sector issuers, including banks (ranging from World Bank to private sector banks like India's Yes Bank), institutional investors (such as pension funds to insurance companies), municipalities (Washington D.C. and city of Gothenburg to name a few), universities (MIT and University of Cincinnati) and corporations (Unilever, Toyota and Apple for example). It is important to have the involvement of a wide range of public and private sector actors because infrastructure is a common need that spans across various sectors and countries.
In order to have global low-carbon climate change resilient (LCR) transitions, our most important and immediate financing gap lies in our infrastructure needs. Climate change impacts present huge challenges to existing and future infrastructure of both developed and developing countries. Advanced economies such as the US, Canada and other OECD nations have massive infrastructure upgrade needs. On the other hand, emerging economies like India and China need to build extensive infrastructure (from scratch) that can cater to the needs of almost 85% of the world's population.
Notwithstanding the urgent need to build LCR infrastructure, funding of regular or non-LCR infrastructure projects falls short of an estimate $1 trillion every year. In addition, only 7-13% of the current infrastructure projects are estimated to be low-carbon and designed to deal with climate change impacts. It is now a well know fact that extreme weather events are only going to become more frequent. The question is whether the world is prepared to tackle dangerous hurricanes like Hurricane Matthew, droughts like those in Syria or raging forest fires like those destroying Fort McMurray.
With climate change looming large, a city or region's infrastructure has to be able to withstand frequent and extreme weather on a long term basis. This will not be possible without our ability to factor in climate change in the process of planning, funding, building and upgrading the infrastructure around us. Green bonds that fund infrastructure designed to withstand Category 5 hurricanes or establish low-carbon transportation systems will be instrumental in locking-in green house gas (GHG) emissions for several decades to come.
Who should run the green bond world?
As the developed countries face their own needs, the resources set aside for developmental or financial aid can often be eclipsed by problems such as lack of political support, domestic lobbying groups and economic constraints. To add to this, socioeconomic problems affecting the developed world—such as immigration fears, environmental refugees and the threat of terrorism—have added pressure on politicians to reduce channelling tax payer money into foreign projects. In face of these growing problems and constraints, each country needs to tap into its private sector for climate capital that will help close this gap.
Can investing into green bonds be a responsible investment into our future? The answer for me and other millennials is yes.
More recently, climate change resilience has become a buzzword in the investment community and has started creating a trend of socially responsible investment from the mainstream finance community (such as pension funds and other institutional investors). Green bonds provide investors with an opportunity to be responsible and socially conscious in directing their capital into projects that have good financial returns.
On the other hand, climate change is a global and transnational issue; there is no excludability or competitiveness in this problem. And while the private sector can hold the purse to the solution, the regulation and overseeing has to be done by the public sector. This is important because the initial accountability and legitimacy provided by governments (or other public actors) will be a critical factor in transitioning our carbon-based economy into a green economy.
The public sector, consisting of governments or multinational development actors (like the World Bank), bring in a sense of authority and long term vision that a private company or investor does not provide. Imagine if you were to choose between a private and a government-backed bond; you will most likely choose the latter, as it has been known to provide a sense of security and stability in its investment. Similarly, if a green bond has government-backing or guarantees, it will definitely be the main choice for investors that are looking to invest their hard-earned money into it.
Nudging out our inner "green investor"
Bonds offer long-term maturities, making it an attractive investment opportunity for many of us that are risk-averse. However, there is oversubscription in the current green bond market— meaning that demand significantly exceeds the supply. Oversubscription shows that there is big appetite from investors but not enough projects to sustain this appetite. Here is where private and public actors can work together to grow a small market into something that can eventually transform our economy into the sustainably developed financial system that we wish it to be.
Given that the world is already at the verge of crossing the 1.5°C threshold this year, it becomes imperative to transform our economies to accommodate climate change and its significant impacts. Green bonds provide a vehicle to do this—we must nudge our "inner green investor" to keep from crossing that dangerous 2°C threshold. So, can investing into green bonds be a responsible investment into our future? The answer for me and other millennials is yes.