Carboeconomics, ESG Investments, Green Finance: A Cocoon of Confusion and Implementation Challenges

Shresth Goel and Talvin Bath

Introduction

Sustainable investing is being prioritized by financial institutions across the world following international agreements on the urgency of addressing climate change. Finance executives have been at the forefront of getting creative with green financing through the utilization of financial instruments, both new and old. Inevitably, market sensitivity to green technology has increased quickly, but with cautious skepticism from some. 

Our focus is on the implementation challenges of these methods and their macroeconomic impacts. Generally speaking, the issue at hand is one of excess capital in a relatively young market without the levels of scrutiny received by previous landmark shifts in the market. This problem is exacerbated by a supply-demand mismatch in terms of market investors and reliable investment opportunities. With multiple competitive firms operating in the same sphere – chasing the same resources – failure of some is inevitable. Overbidding on a select few reliable opportunities may lead to underwhelming (but realistic) returns, leading to broad market corrections in the future, with drastic short and long-term effects. [1] [2]

Green enterprises are also heavily reliant on fossil fuels to develop green infrastructure in the first place. The ongoing energy shortage suggests delays in meeting time-bound climate goals, thus indicating potential problems with the timely realization of economic returns. 

Policy Status Quo

Current UK policy concerning the transition to net-zero emissions is based on 3 pillars: 1) greening finance; 2) financing green; 3) capturing the opportunity

  1. Greening Finance 

The idea behind greening finance is to make environmental factors a central factor in the evaluation of public/private investments. And this is to be achieved by making sustainability disclosures a routine practice in the industry. For e.g., by mandating financial institutions to provide consistent information on their green investments, enforcing mandatory reporting by the Task Force on Climate-related Financial Disclosures (TCFD) by 2025, emphasizing consumer-focused product labelling, requiring the substantiation of sustainability claims from finance professionals and developing a ‘green taxonomy’ to bring uniformity in the understanding of sustainable practices. [3]

  1. Financing Green

Given that the transition to net-zero emissions is a capital-intensive process, making credit facilities more accessible for green ventures is critical. The government has made initial steps by establishing mechanisms within the UK Infrastructure Bank (UKIB) that allow green businesses to obtain financing more conveniently. They have also resorted to issuing debt to finance public/private ventures in the form of green bonds in order to counter market barriers and capacity building issues surrounding the industry by making green technology more accessible and also incentivizing their usage. 

3. Capturing the Opportunity

With green markets being a relatively recent development, sovereigns across the world are battling to assert dominance from an early stage. The UK plans to invest heavily in talent development to be the ‘first-to-market’ with innovations in the field of clean energy. Additionally, the UK also envisions being the hub for data and analytics related to the transition to net-zero emissions. The idea is to manufacture a ‘low carbon workforce’ that not only represents UK’s progress in the field internationally, but also help rejuvenate regional economies in the UK through the utilization of natural resources in the remote/less-urbanized regions of the nation. 

Policy Proposals

Taking into consideration the above-mentioned factors, the challenges faced by policy makers can be categorized as: (1) Policy Formulation and (2) Implementation Challenges.

  1. Policy Formulation:

(1a) Finding Consistent Metrics – continuity of terms:

Issue

Over time, the ‘goal-posts’ of sustainability shift to mirror the urgency of the climate crisis at that given moment. Therefore, the TCFD metrics have a limited scope for continuity; what may pass the criteria for sustainability in 2021 may fail by the following year.

Proposal

Metrics used by the TCFD must be reevaluated as the climate crisis evolves. Given the temporal nature of the metric, the sustainability ratings achieved by organizations in a given year must only be applicable during that metric’s availability.

Evaluation: 

The frequent (likely annual) evaluation of organizations and the sustainability metric itself is a laborious and ambitious task. However, it is necessary and possible; the government body Ofsted has provided a similar service for two decades, applying changes in technology and job-markets to a framework which they routinely assess schools with. As such, the government has already displayed the capacity to complete this task.

(1b) Finding Consistent Metrics – international comparability:

Issue: 

The UK is TCFD’s only client as of now, meaning that the TCFD metric has no continuity with that of other economies. This lack of cohesion leaves terms such as sustainable (and therefore the metrics used by the TCFD) vulnerable to being diluted; as foreign organizations gain ‘sustainable’ ratings for meeting more relaxed criteria, the term loses its meaning. 

Proposal: 

A ‘hard’ approach to this issue could be to mandate the TCFDs financial reporting standards upon any economy with a trading contract with the UK. A ‘softer’ approach would be to create a report similar to that of the Corporate Reporting Dialogue, mapping the alignment between the TCFD’s recommended disclosures with that of the CDP, GRI, and SASB indicators. Publishing a report comparing metrics of sustainability internationally – establishing, for example, that the rating ‘A’ in country X is equivalent to the rating ‘C’ in Y – would also be a useful undertaking.

Evaluation: 

If the UK were to adopt the ‘hard’ approach to the issue, other economies may view this as an act of protectionism, as in enforcing tariffs upon unsustainable goods – possibly leading to retaliation from our trading partners. This tension could be preempted with well-conceived and transparent statements regarding the policy’s imposition; however, their success is unpredictable. The alternative approach to the issue carries logistical barriers: how can we compare metrics based upon different criteria? However, when two metrics for the same quality are incompatible for comparison, it follows that one is underdeveloped. In the case that it is the domestic metric, then this ‘barrier’ is an opportunity to improve our domestic standards. 

  1. Implementation Challenges:

(2a) Increasing credit accessibility:

Issue

Although Green Saving Bonds are being issued to fund green ventures across the UK, the scheme is new and therefore revenues linked to fossil fuels are still in use. Policy makers therefore need to move financing away from long-term bonds that are derivatives of non-green public corporations and tax revenue linked to oil and gas corporations, until the issuance of Green Saving Bonds increases enough to fund such ventures entirely.

Proposal: 

The government could take a localized approach to financing green ventures. Local councils have access to alternative debt funding sources such as: Green Lenders, which lends against the project’s assets; the Crowdfunding/Community Municipal Bond (CMB), which secures funding against the local authority credit rating; or Salix, which lends against the local authority. Doing this, until the capital from the Green Saving Bonds becomes sufficient to fund one hundred percent of the projects, will allow the government to reduce reliance on fossil-fuel sourced revenues .

Evaluation: 

If funding is secured on a localized level, administrative issues arise – ventures across council-lines will either have to file for funding in multiple councils or are limited to applying with just one. The former creates a disincentive for larger projects due to administration costs, whilst the latter stifles the scope and scale of projects. However, this is easily resolved; revenue from Green Saving Bonds, which will only continue to grow with time, can be used for larger projects; projects isolated within one district can apply through the local council, using one of the alternative debt funding resources. 

A less resolvable issue is the geographical inequality in credit accessibility that would arise due to discrepancies in between councils’ size, credit ratings, and administrative abilities.

Conclusion

Overall, institutions need to recognize the boundaries within which the transition to net-zero emissions can take place. With a myriad of unresolved issues, and some yet to be identified, more emphasis needs to be placed on coordinated green agendas – instead of a fragmented development chain. In essence: development of a collective international taxonomy, settlement on universally acceptable definitions of terms like ‘ESG’, ‘sustainability’ etc., and their respective metrics should be the first steps towards preventing a green bubble, which will not only threaten our future but also exacerbate the present lingering effects of the pandemic, effectively making it harder for the global economy to regain solid footing quickly. Additionally, considerations need to be made about the value of stranded assets and its effect on the cost of production for businesses fundamentally reliant on non-renewables – making the financial transition to a green economy a fragile process for both, green and non-green enterprises.

References

[1] Jessop, S. and Murugaboopathy, P., 2021. SPACs target more ESG companies in 2021 -Nomura Greentech. [online] Reuters. Available at: https://www.reuters.com/business/sustainable-business/spacs-target-more-esg-companies-2021-nomura-greentech-2021-05-20/.

[2] Ft.com. 2021. Silicon Valley veteran warns of ‘very frothy’ markets. [online] Available at: https://www.ft.com/content/36180ce3-1ae6-40a3-b3a3-9eb1b4312f3d.

[3] Assets.publishing.service.gov.uk. 2021. Greening Finance: A Roadmap to Sustainable Investing. [online] Available at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1031805/CCS0821102722-006_Green_Finance_Paper_2021_v6_Web_Accessible.pdf.

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