Towards a greener finance landscape

by Carlo Carraro, Director of International Center for Climate Governance (link to the original blog article)

The first weeks of 2017 have seen moves that mark progress towards a greener, more sustainable and balanced global economy, although overshadowed by the turmoil brought by the new U.S. presidency.

During the annual meeting of the World Economic Forum in Davos, a new partnership, named “Green Digital Finance Alliance”, was launched to channel the potential of digital technologies in mobilizing finance (including investment, lending and insurance) for global environmental challenges. The two founders of the initiative are the United Nations’ environment agency (UNEP) and Ant Financial, a major Chinese online and mobile financial services provider.

The event is remarkable for at least two reasons. First of all, it is a new and (for the time being) unique partnership in a rapidly changing environment, where a growing number of public and private actors are eyeing the opportunities of enlisting the swift developments of FinTech (Financial Technology) for the causes of economic inclusion and sustainable development. Presenting the initiative, UNEP Executive Director Erik Solheim explained that it aims to “align tomorrow’s fintech-powered global financial system with sustainable development” and make “green finance an integral part of the daily life of every individual and business”. The Green Digital Finance Alliance is the first institutional pioneer in a world so far consisting mostly of start-ups and is likely to quickly inspire further initiatives.

Secondly, the Alliance gathers one of the most authoritative global environmental organizations and a leading Chinese enterprise. It gives further proof that China, the world’s third largest economy and the top global emitter, is drawing the path of its economic growth with increasing attention to environmental protection and overall sustainability, not only in government, but also within the private business sector (during the same days in Davos, Chinese premier Xi Jinping delivered a landmark speech in support of global climate action and international cooperation). For instance, ANT Financial Services has launched an app which provides users of its Alipay mobile payment platform with a personal carbon account, in addition to the credit and savings accounts. Taking advantage of the capabilities of mobile internet, cloud computing and big data, the app tracks digital payments and assesses users’ carbon-saving activities, translating them into “green energy” credits which are turned into carbon-offsetting commitments by ANT. According to an official release, in the first four months of the trial 54 million users have participated in the app and saved sufficient credits to plant over 760,000 trees in the Inner Mongolia autonomous region.

The second remarkable event was the release of the “Principles for Positive Impact Finance” by a group of global leading banks and investors. Launched at the end of January, the Principles are a first of its kind set of criteria that identify “sustainable” investments and measure their contribution to the achievement of the Sustainable Development Goals (SDGs). Based on an holistic evaluation of the three pillars of sustainable development (economic, environmental and social), the Principles provide a clear and comprehensive framework for the finance community and a broader range of stakeholders (including governments and civil society) to analyze, monitor, and disclose positive and negative impacts of the financial products and services delivered.

The core developers are 19 banking and investment entities, united under the name of Positive Impact Working Group and under the umbrella of the UNEP Finance Initiative. The Group’s members include BNP Paribas, ING and Société Générale, and together account for over USD 6 trillion in assets.

Although independent from one another, the Principles may be considered a “partner in the cause” of the Recommendation report released at the end of last year by Bloomberg’s Task Force on Climate-related Financial Disclosures (TCFD). The TCFD was established by the Financial Stability Board to help companies identify and disclose information  on climate-related financial risk, which is increasingly sought by investors. Under the leadership of Michael Bloomberg, it gathers companies with market capitalization of USD 1.5 trillion and financial institutions responsible for assets of USD 20 trillion, all supporting the disclosure recommendations.

Looking at this growing number of initiatives and the actors involved, it is easy to guess that the business case for sustainability has largely crossed the niche borders. According to the recent report Better Business, Better World, putting the Sustainable Development Goals at the heart of the world’s economic strategy could unlock opportunities worth up to USD 12 trillion and create hundreds of millions of jobs. The genie is out of the bottle. At this point, harmonizing economic growth and the SDGs is on the radar of not only  international organizations and governments, but also  the private business and financial sectors. The authors of the Principles for Positive Impact Finance clearly highlighted “the appetite of the financial market” for business and products aligned with sustainability objectives.

Despite the increasing economic appeal of sustainability, the magnitude of the challenge can make anyone’s head spin. According to UN estimates, global investments needed to implement the SDGs are in the order of USD 5 to 7 trillion per year up to 2030, of which about two thirds (USD 3.3-4.5 trillion per year) are estimated for basic infrastructure, food security, climate change mitigation and adaptation, health, and education in developing countries. Considering current levels of investment in SDG-relevant sectors, developing and least-developed countries face an annual gap of USD 2.5 trillion that can only be filled with a step-change in the levels of both public and private investment.

On the other hand, looking at global wealth (the global GDP in 2015 amounted to over 74 trillion), or even just at the financial resources that the above-mentioned institutions can mobilize, helps to put these gargantuan figures in perspective.

The key challenges of financing sustainable development are thus to mainstream sustainability in current financial decision making and to mobilize investments in a way that benefits the largest possible population, guarantees inclusion of the most vulnerable and underserved groups, and supports the deployment of sustainable and resilient infrastructure as well as progress in key areas of innovation. The two events in January (the launch of the Green Digital Finance Alliance and the release of the Principles for Positive Impact Finance) make headway in overcoming those challenges.

New initiatives and efforts are coming up not only from institutional actors but also from the bottom up. We have seen a sample of this innovation trend during the Best Climate Practices 2016 Awards, the annual contest for ideas and projects on climate-related challenges organized by ICCG. The 2016 edition focused on concrete solutions to expand access to climate financing. Out of over 50 applications, the competition featured 14 shortlisted candidates proposing diverse ideas and projects to raise and drive financial support toward local mitigation and adaptation actions and to simplify access to climate finance.

Among a diverse set of remarkable contestants, the prize was awarded to two operative organizations implementing microfinance strategies and delivering concrete results in climate-vulnerable developing countries: the “Carbon Finance for Families in Mozambique” project, presented by the Italian consultancy firm CarbonSink, and the “Clean Energy Promotion through Microfinance in Ethiopia” project, operated by a consortium of organizations and led by the Finland-based Gaia Consulting Oy.

The project “Carbon Finance for families” aims to promote energy efficiency, conserve natural resources, and improve living conditions in Maputo, the capital of Mozambique, and in the city of Pemba, by distributing highly efficient cooking stoves financed with revenues from the generation of carbon credits. The project provided 5,000 cooking stoves in the 2014-2015 period and plans to distribute a further 6,500, in part locally made, during the following phase.

The project “Clean Energy Promotion through Microfinance in Ethiopia” in 2014 initiated an innovative and replicable mechanism to finance clean energy technologies for households and micro, small, and middle-size enterprises through microcredit financing. The project established a business concept for three Ethiopian microfinance institutions, with a total outreach of more than 130,000 current clients, of which 82,000 are women.

The jury’s task was particularly challenging owing to the quality of the projects and the different approaches proposed by the candidates, ranging from digital-driven solutions and conscious use of carbon credits to community-based and micro-finance projects (see the table below).

As observed in the microcosm of ICCG Best Climate Practices’ experience, digital innovation is already acknowledged for its potential to align investments with the need for sustainable, climate-coherent and inclusive growth. Half of the 14 shortlisted participants proposed ideas based on digital platforms, some of which are already in place. For instance, the Matchmaker platform, developed by Climate-KIC, aims to facilitate cities’ access to financing for sustainable transport, renewable energy, waste management and energy efficiency. This project helps create partnerships between cities and investors by providing a standardized, uniform and comparable method of presenting bankable projects. The Best Climate Practices 2016 jury accorded a special mention to Matchmaker for its systemic, smart approach in targeting the key sector of urban climate finance. Other examples of this approach are the OpenForests platform, focused on matching investors and investees engaged in forest management projects, and ClimatePlace, designed to connect developers of climate-related projects with investors from emerging markets.

According to a recent report by UNEP Inquiry, “Fintech and Sustainable Development: Assessing the Implications”, new technologies have a revolutionary potential to embed sustainability in all the core functions of the financial system: moving value, storing value, exchanging value, funding value creation and managing value at risk. The global financial framework is undergoing a phase of transition and, given the pace of technological progress, the way money and transactions are managed will change deeply in the next decades (if not years). Riding the wave of digital developments, the fintech sector is already bringing disruptive changes. Consider, for instance, the application of mobile and internet technology to payments and banking services, the integration of big data in lending and insurance profiling, the advent of blockchain technology that opened the path to virtual currencies and smart contracts, but also high-frequency trading, crowdfunding systems, and peer-to-peer lending, among others. According to experts, what we have seen in the past few years maybe only a small share of what the sector has in store for the future.

Whether the financial transition will benefit all population groups while enabling a forward-looking use of natural resources and enhanced environmental protection, will largely depend on how tech progress is shaped and guided in the upcoming phase.

UNEP Inquiry’s report provides a fascinating and immersive journey into opportunities which, if developed at scale, may evolve into services and tools capable of enhancing the transparency and efficiency of financial transactions and including the most vulnerable populations, low-income countries, and small and medium enterprises on a pathway to more sustainable and resilient economic growth. This set of innovation areas, synthetically grouped under the acronym FT4SD (“FinTech for Sustainable Development”) includes, for instance, the creation of economic identities for refugees, the introduction of smart contracts in the international aid sector, and the deployment of community-distributed energy generation.

Currently these innovations are between the conceptual and the early adoption stage (see graph below) and face several regulatory and operational barriers, such as the high energy consumption of blockchain processes and the governance of personal data (including both privacy protection as well as customer identity and anti-money laundering rules by which traditional financial operators have to abide).

Similar attention should be paid in the next phase to reducing or neutralizing the unintended consequences of  widespread adoption of fintech solutions, such as the increase in cyber security risk and the potential unemployment that the combination of the most disruptive technological advancements (blockchain technology, AI-driven intelligence automation and IoT – Internet of Things – devices) may bring along.

Moreover, specific challenges lie ahead for financing sustainability. Formalized last year to replace the Millennium Development Goals, the new United Nations strategy relies on a complex system of 17 Sustainable Development Goals (SDGs) and 169 targets. Emerging technologies will be fundamental to improve data collection and management, and to reduce the costs associated with the monitoring of actions by better identifying the areas that need more attention. On the other hand, technology alone cannot support a substantial transition of the current economic structures and societal organizations. Developing local knowledge and competencies is necessary to identify specific SDG-relevant projects and package them into investment opportunities for domestic and international investors. In this area the role of governments remains crucial, as the process of developing bankable projects has high upfront costs, often unbearable by small local entities and communities. Public intervention will thus be more effective where it targets local capacity building and strives to overcome impediments of scale (e.g. setting up pooled finance facilities) so that private investments can be fully mobilized.

The FT4SD sector represents a strategic ally, not an alternative route, towards a greener, inclusive, and resilient economy.

References:

UNEP Finance Initiative (2017) Principles for Positive Impact Finance

TCFD (2016) Recommendations of the Task Force on Climate-related Financial Disclosures

Business & Sustainable Development Commission (2017) Better Business, Better World

UNCTAD (2014) World Investment Report 2014. Investing in the SDGs: An Action Plan

ICCG Best Climate Practices observatory

UNEP Inquiry (2017) Fintech and Sustainable Development: Assessing the Implications

Aknowledgements

Aurora D’Aprile also contributed to this blog post