Green finance provides linkage between the financial industry, protection of the environment and economic growth. Simply speaking, green finance refers to use of financial products and services, such as loans, insurance, stocks, private equity and bonds in green (or eco-friendly) projects. Green finance, which has grown by leaps and bounds in recent years, provides public well-being and social equity while reducing environmental risks and improving ecological integrity. For example, global interest in green energy finance is increasing at a rapid pace – in 2015, investments in green energy reached an all-time high figure of US$ 348.5 billion, which underscores the significance of green finance.
Potential and Promise
Environmental sustainability, climate change mitigation, resource conservation and sustainable development play a vital role in access to green finance. During the past few years, green finance (also known as climate finance) has gained increasing relevance mainly due to the urgency of financing climate change mitigation and adaptation efforts, and scale of sustainable development projects around the world.
The impetus has been provided by three major agreements adopted in 2015 – Paris Agreement on climate change, a new set of 17 sustainable development goals (SDGs) and the ‘financing for development’ package. The implementation of these agreements is strongly dependent on finance, and realizing its importance the G20 nations established Green Finance Study Group (GFSG) in February 2016, co-chaired by China and the UK, with UNEP serving as secretariat.
According to Sustainable Energy for All, a global initiative launched by the UN Secretary-General Ban-Ki Moon, annual global investments in energy will need to increase from roughly US$400 billion at present to US$1-1.25 trillion, out of which US$40-100 billion annually is needed to achieve universal access to electricity. On the other hand, around US$5-7 trillion a year is needed to implement the SDGs globally. Such a massive investment is a big handicap for developing countries as they will face an annual investment gap of US$2.5 trillion in infrastructure, clean energy, water, sanitation, and agriculture projects. Green finance is expected to fill this gap by aligning financial systems with the financing needs of a sustainable or low-carbon economy.
Bonding with Green
An emerging way to raise debt capital for green projects is through green bonds. Green bonds are fixed income, liquid financial instruments dedicated exclusively to climate change mitigation and adaption projects, and other environment-friendly activities. The prime beneficiaries of green bonds are renewable energy, energy efficiency, clean transport, forest management, water management, sustainable land use and other low-carbon projects.
A record US$41 billion worth of green bonds was issued in 2015 which is estimated to rise to US$80 billion by the end of 2016. Notably, the World Bank issued its first green bond in 2008, and has since issued about US$8.5 billion in green bonds in 18 currencies. In addition, the International Finance Corporation issued US$3.7 billion, including two US$1 billion green bond sales in 2013.
Green bonds have the potential to raise tens of billions of dollars required each year to finance the global transition to a green economy. According to International Energy Agency, around $53 trillion of energy investments are required till 2035 to put the world on a two-degree path, as agreed during the historic Paris Climate Conference COP21. The main drivers of green bonds for investors includes positive environmental impact of investments, greater visibility in fight against climate change and a strong urge for ‘responsible investment’.
Many developing countries experience hurdles in raising capital for green investment due lack of awareness and to inadequate technical capacities of financial institutions. Many banks, for instance, are not familiar with the earnings and risk structure of green investments, which makes them reluctant to grant the necessary loans or to offer suitable financing products. With rising popularity of green finance, it is expected that financial institutions will quickly adapt to funding requirements of environment-friendly projects.