The path to net zero: why financial firms need to change the way they invest

Financial institutions have a vital role to play in helping the world reach net zero, but adapting market structures and accelerating funding for green innovation is a major challenge

Financial firms hold the purse strings to the planet’s future. Without the support of the finance sector, there is no road to net zero. Businesses in almost every sector of the economy need funding to adapt to cleaner, greener ways of operating and manage the risks associated with a warming world. Innovations that could help to keep carbon emissions below 1.5C also require major investment, along with new sustainable services and products for consumers.

As well as funding the transition to net zero, financial firms need to shift investment away from heavy polluters too. One recent report from the CDP revealed that financed emissions are a staggering 700 times larger than financial firms’ direct operational emissions. As well as addressing their own carbon footprint, financial companies need to measure and disclose the environmental impact of their portfolios, and fully incorporate environmental costs into their investment decisions. 

Given the imperative nature of climate change, it’s perhaps not surprising that one of COP26’s primary thematic streams focuses on the green economy. Establishing a truly sustainable global economy is a huge challenge, of course, but it shouldn’t be seen as a burden. In fact, as Mark Carney, former head of the Bank of England and now a UN Special Envoy for the US, has suggested: “The transition to net zero is creating the greatest commercial opportunity of our age.”

There are trillions of dollars to be made from the right investments in renewable energy, green housing and alternative food sources. Thanks to strong returns, solar and wind energy have already become staple parts of investment portfolios, for instance. But when it comes to emerging technologies, the sketchily defined pathway to net zero complicates matters.

Investments in promising areas like carbon capture and green hydrogen might not deliver good returns for some time. And while low-carbon retrofitting is an essential part of reaching net zero, it’s often challenging to undertake.

That’s a particularly acute problem for big investors like pension funds, which seek predictable, consistent returns over a long period. But reaching net zero is such a huge task that government cannot fund every new technology or retrofit on its own. “By necessity, it requires private sector finance or some combination of government and private sector finance,” says Jim Coleman, head of economics at WSP.

Governments can help to mobilise private finance by sharing the initial investment risk in green infrastructure and promising new technologies, or by guaranteeing certain returns. Such arrangements already exist for off-shore wind, for example. “But it might also have to exist for some of the newer technologies or more nascent things,” says Coleman. 

The UK’s National Infrastructure Bank could potentially play a role here. Along with a UK green taxonomy to tackle greenwashing and green sovereign gilts, it’s one of several measures designed to help the UK reach net zero by 2050. Is London set to become a global hub for green finance?

All the trillions of capital that’s out there – at the end of the day that’s our money, not the fund managers’ or the chief executive of the banks’. And people are now starting to say ‘I want something different. I want my money to act in a way that’s aligned with my values and the things I want for future generations’

It certainly looks that way to Louise Wilson, co-founder of Abundance Investment, which helps people to make ethical and socially beneficial investments that contribute to a green economy. She says that if the UK doesn’t become a leader in sustainable finance, it would be a major missed opportunity. “The City of London is keen to do it, the Treasury is keen to do it,” she says. “It makes sense as we’ve got so much to offer.”

Although the UK appears to be moving in the right direction on green finance, more financial instruments that combine public and private investment would undoubtedly be welcome. That goes double for nations in the developing world, where the shift to a more sustainable economy has barely got underway. As such, Coleman believes that financing the shift to net zero must be a truly global effort.

He says: “Even if we were really successful here in the UK, if no one else has managed to do it then it doesn’t really matter. We’re still going to suffer the negative consequences. So there has to be a level playing field globally for these kinds of funding mechanisms.”

More long-term thinking and political consensus around regulation would also help to create a more predictable investment environment. “Even if it was relatively tight regulation but you knew it was in place for a long time, then you could adjust to it and deal with it somehow,” says Coleman.

However, while big investors would undoubtedly welcome more regulatory certainty, they still need to act now regardless. “There are always uncertainties, so you need to live with that,” says Coleman. “Don’t wait for this regulatory certainty to happen.”

One regulatory change that has already happened is the EU’s new Sustainable Finance Disclosure Regulation (SFDR), which requires fund houses, insurers and pension funds that provide financial products or services in the European Union to disclose their true sustainability credentials. It aims to prevent financial firms from capitalising on increased demand for sustainable investment by greenwashing their products, and instead drive investment to firms that offer genuine alternatives.

Abundance Investment is one such firm. Wilson, who left mainstream banking after she became frustrated with its response to climate change, says the burden of proof currently falls upon firms that are trying to do good: “Actually, what we need to do is level the playing field, and disclosure reporting will do that.” 

Other levers that could be deployed to speed the shift to a green economy include stricter emissions criteria for investees. Financial firms could insist that companies in their portfolio work toward net zero goals, for example, and make it clear that if certain targets are not hit, support may be withdrawn. But this all depends upon good ESG data from those seeking finance.

Although we’re still very much at the beginning of the path to net zero, there are signs that the financial industry knows it needs to change. Industry groups like the Glasgow Financial Alliance for Net Zero (GFANZ) aim to encourage firms to shift funds from high-carbon investments to low-carbon infrastructure and technologies, for example. But while lenders such as Standard Chartered, HSBC and Barclays have all made public commitments to reach net zero targets by 2050, the fact that they have not yet stopped financing fossil fuel companies shows more action is still needed.

Activism from shareholders and the wider public can help to keep the pressure on firms that are yet to fully commit to the green economy. In fact, a survey by PA Consulting of 3,500 consumers found that 93% expect sustainable finance to be the norm in future.

“If you look at why the finance sector is already changing, it’s because people are increasingly demanding that it changes,” says Wilson. “All the trillions of capital that’s out there – at the end of the day that’s our money, not the fund managers’ or the chief executive of the banks’. And people are now starting to say ‘I want something different. I want my money to act in a way that’s aligned with my values and the things I want for future generations.’”