[REFLEXIONS] Green finance, the driving force behind the transition?
Channelling savings into financing the transition
The conversion of all infrastructure and industry to low-carbon technologies will require massive investment. As well as financing green energies and decarbonization, we also need to limit investment in fossil fuels and polluting infrastructures. Channelling savings towards virtuous technologies is therefore one of the key points of the energy transition. All the more so, as Nicolas Mottis, Professor at Ecole Polytechnique - IP Paris, points out, "as the investment needed to finance this transition does exist, but in France, for example, it only represents a few tens of billions of euros a year. The main problem is how to allocate financial resources to carbon-neutral investments."
ESG performance, responsible finance, green finance - what are we talking about?
The idea that economic activities have social and environmental impacts beyond their mere productive role has existed since the Industrial Revolution. More recently, the concept of corporate social responsibility appeared in the 1950s, and the integration of non-financial criteria into investment decisions emerged in the 2000s. In 2007, terms such as impact investing emerged, while the European Investment Bank issued the first green bonds (2). Since then, the sector has undergone significant development and structuring.
Responsible finance or socially responsible investment (SRI) encompasses all initiatives aimed at taking environmental, social and governance (ESG) performance into account when steering investment decisions. As Nicolas Mottis reminds us, "taking extra-financial parameters into account has long been the blind spot in the relationship between investors and companies. This is what we now call ESG criteria, which for the Environment cover energy consumption, water, biodiversity, the circular economy, pollutant emissions, etc.; for Social: diversity, gender equality, accident levels, well-being in the workplace, training, etc.; and for Governance: the independence of the board of directors, its composition, the fight against corruption, etc.".
Green finance focuses in particular on environmental criteria. It is often confused with climate finance, which focuses on reducing greenhouse gas emissions. It's not easy to define the precise contours of climate finance, especially as the vocabulary is sometimes used loosely. Its objectives range from financing green energies to adapting to the consequences of climate change already underway.
A field in search of standards
A 2°C-aligned portfolio, climate trajectory of an investment, exclusion of fossil fuels, intentionality, additionality... The terms and indicators used are legion, and at a time when it's fashionable to claim carbon neutrality, it can be difficult to differentiate between what's mere communication and real commitment. In other words, the quality of ESG data is a real issue.
Initiatives such as Science Based Targets (SBTi) or TCFD, widely used by investors, aim to help companies address these issues and define science-based greenhouse gas (GHG) emission reduction targets to meet the objectives of the Paris Climate Agreement.
For its part, the European Parliament adopted the "Taxonomy" regulation on June 18, 2020, followed by two additional delegated acts published to date, which specify its implementing procedures. Also known as the "Green Taxonomy" (3), this regulation aims to define investment nomenclature standards as well as reporting obligations for companies. It is part of the Green Deal (4), which refers to the need for "reliable, comparable and verifiable information (...) to reduce the risk of 'greenwashing'". The standards are seen as a means of "combating misleading environmental claims". The European Taxonomy defines the notion of sustainable economic activity in a broad sense, since it must contribute significantly to one of the following six environmental objectives:
- Mitigation of climate change
- Adaptation to climate change
- Sustainable use and protection of aquatic and marine resources
- Transition to a circular economy
- Pollution prevention and reduction
- Protection and restoration of biodiversity and ecosystems.
The difficulty, however, lies in the technical details. The numerous debates on whether or not to include nuclear and gas activities in the taxonomy, which are ultimately designated as transitional activities, are just the tip of the iceberg.
Shareholder commitment and regulation by financial markets
Today, shareholders have a key role to play in making issues such as global warming and transition operational at the heart of corporate strategies," asserts Nicolas Mottis. So, for example, at annual general meetings, responsible finance players are calling on company directors to integrate climate issues, by tabling resolutions demanding ESG performance alongside the usual financial performance".
Nicolas Mottis, who is also a member of the Climate and Sustainable Finance Commission (CCFD) of the Autorité des Marchés Financiers (AMF), adds: "Changes in the regulatory and legislative framework can also play an important role in encouraging climate action. Following the example of 'say on pay', which has changed corporate practices in terms of executive compensation, if we put the climate issue on the table with 'say on climate', we'll make progress on this subject".
The CCFD recently recommended that a company's strategy and objectives in terms of climate and the reduction of greenhouse gas emissions should be put to the vote at general meetings, and that resolutions submitted by shareholders should be easier to propose and vote on at general meetings. These proposals are currently the subject of opposition from certain companies, who consider them incompatible with the strategic prerogatives of the Board of Directors. The debate is ongoing, attesting the potential of financial market regulation.
Challenges and limits
How can we assess the impact and ensure that there are no hidden adverse effects, such as the rebound effect or relocation? Over what time horizon? How can we weigh up impacts of different kinds? Should investments be evaluated a priori, or a posteriori, even if this means setting up contracts with bonus/malus systems between the investment fund and the company? Despite the complexity of these questions, which is not encouraging the democratization of green finance, it will certainly have its place in financing the transition, alongside complementary mechanisms such as carbon taxes and quota markets.
Energy transition, carbon tax and markets, green finance, civil society involvement, climate action is multifaceted. Find out more about these themes during the REFLEXIONS conference which will take place on June 9 on the campus of Institut Polytechnique de Paris.
(2) Impact Investing, Transforming How We Make Money while Making a Difference, by Antony Bugg-Levine and Jed Emerson, traces the history of the main concepts associated with social impact finance.
(3) The term "green taxonomy" is never used as such in the regulation, although in common use it refers to the "sustainable activities" defined by Regulation (EU) 2020/852.
(4) European Commission, December 11, 2019, Communication from the Commission to the European Parliament, the European Council, the Council, the European Economic and Social Committee and the Committee of the Regions, "The Green Deal for Europe".