Mobilising finance to fight climate change

At first glance, the finance industry’s links to climate change may not be obvious, especially compared to others like the automotive and oil and gas industries. Yet, financial factors like high costs and carbon taxes crop up frequently in discussions about the climate crisis, and the planet’s future hangs in the balance while corporations and governments weigh funding and profits to make decisions and policies that impact the environment.

Taking action on sustainability can be costly and even detrimental for some businesses and industries. However, it also creates opportunities for those willing to transform and contribute to a greener and more equitable future, a point that was underscored in the NUS Sustainable and Green Finance Institute’s (SGFIN) Sustainability Summit 2024 held from 21-22 March 2024 under the theme “Costs and Opportunities of Commitment to Net-Zero”.

About 200 representatives from the global sustainable finance community, including academics, industry leaders, policymakers and regulators, financial institutions, and legal experts, gathered at the event to discuss strategies and challenges in meeting net-zero targets by 2050.

In his welcome remarks, SGFIN’s managing director Professor Sumit Agarwal urged the finance industry to help avert irreversible climate damage by reconfiguring economic and financial systems as well as conceptions of fair use of resources.

“The traditional value principles, with which our existing financial systems have delivered superior financial returns and profit maximisation, have proved painfully inadequate at nurturing economic development without damaging our environment and ecosystems,” he said. “We must pivot our financial systems to prioritise environmentally sustainable economic growth.”

Prof Agarwal said that the transition to clean energy is complex, with winners and losers in the transition, and some companies will have to wind down if they cannot successfully pivot and transform.

Companies making the transition from environmentally damaging resources to more sustainable practices will have to balance stakeholder demands for a faster transition with the economic requirement for a smooth and managed phase-out.

In addition, sustainability-linked transition projects are undermined by a lack of trust in the data behind them, a product of inconsistent standards for monitoring, reporting, and evaluating such initiatives. Geopolitics adds another layer of complexity to the discussion, as many aspects of the energy transition will require countries to cooperate and coordinate their efforts.

Market failures hinder the energy transition

From an economics perspective, market failures are at the heart of the global energy challenge, which is a broader discussion that must be addressed in the climate change conversation, said keynote speaker Professor Michael Greenstone, who is the Milton Friedman Distinguished Service Professor in Economics as well as the Director of the Energy Policy Institute at the University of Chicago (EPIC).

“An isolated focus on climate change misses the full picture and, in many ways, makes it difficult to make progress on that,” said Prof Greenstone. “Instead, what we should be focused on is the global energy challenge, (which) recognises at its core that when we make choices about energy… what we are really doing is making decisions about three things that directly impact human well-being.”

The global energy challenge is the quest to find energy solutions that meet three main goals: providing affordable and reliable energy, minimising air pollution – which Prof Greenstone noted is the single greatest external threat to human health globally – and minimising the damages from climate change.

This challenge is especially difficult for developing countries, which have limited resources and must increase their energy consumption to grow their economies. Yet, these countries are the same ones who will need to cut their carbon emissions the most significantly if the world is to achieve the goal of limiting the global average temperature increase to 2 degrees Celsius – a tension that Prof Greenstone describes as the “cruel arithmetic of the global energy challenge”.

The market failures he identified as obstacles to the global energy challenge lie in energy pricing, innovation, and information. Financial markets are directly involved in the first market failure, as energy is currently priced at the cost of production without regard for the cost to human life and the environment.

In order to phase out fossil fuels, energy markets will need to incorporate the social cost of each type of energy into their prices. For instance, natural gas and coal would cost much more than they currently do if their prices included the higher mortality rates and decreased quality of life caused by the air pollution they generate.

Raising energy prices to appropriately reflect the emissions damage, however, will be a major feat, considering that the current average carbon tax globally is US$6 per ton, compared to the latest estimates of climate change damages of US$225 per ton. Prof Greenstone believes that while existing carbon taxes are a step in the right direction, the world needs to take more drastic action to hasten the transition to clean energy.

Governments of wealthier countries must step in to address the second market failure of innovation, which includes technical and policy innovation, because their discoveries will be crucial to managing emissions growth in developing countries that are poised to increase their energy consumption, Prof Greenstone said.

For instance, research in the US revealed that households were proactively making their homes more energy-efficient, rendering a government policy focus on the same issue redundant. Other governments can use such findings to guide their policy design and optimise government spending.

“Policy innovation is a public good just like technical innovation is, because governments that do the experimentation of finding how to make this policy work are going to incur all the costs by themselves, but once it’s discovered, it’s going to benefit governments all around the world,” he said, noting that recent research has estimated that the benefits of such research can exceed the costs by a factor of 17 to 1.

Finally, addressing information gaps will aid in decision-making and driving behavioural changes, which governments can leverage to help their countries deal with climate change challenges. For example, studies have found that informing people about the health impact of air pollution motivated them to purchase N95 masks to protect themselves, and more accurate monsoon forecasting enabled farmers to adjust their farming patterns and achieve better results.

Promoting greater collaboration

Prior to the event, a Memorandum of Understanding (MOU) was signed between NUS and the University of Chicago through SGFIN and EPIC respectively. The MOU outlined the intention of the two institutes to jointly develop research collaboration and initiatives in sustainability, stimulate cross-pollination of ideas on development and sustainability policies and regional green finance frameworks, as well as develop collaborative educational initiatives and curricula on climate, development, and green finance.

Speaking at the event as Guest of Honour, Deputy Prime Minister and Coordinating Minister for Economic Policies Heng Swee Keat encouraged SGFIN and other finance industry leaders to leverage technology and analytical tools to direct more capital towards supporting the climate transition.

“The financial sector plays a critical role in mobilising finance to invest in addressing the challenges of climate change,” he said. “To do so, the sector must continue to invest in deepening sustainability-related skills and capabilities, forge closer collaborations with academia and industry, and position itself to pursue innovation with impact and at scale.”

Citing the MOU signed between NUS and the University of Chicago, Mr Heng urged the sustainable finance community to continue working together on solutions that will facilitate critical energy transitions and support national and regional pathways to net-zero.