Net Zero Finance: Financial innovation and how to bridge the green investment chasm

clock • 12 min read

Mobilising billions of dollars of low carbon investment is a huge challenge, but it is also a massive opportunity for those financiers willing to innovate in pursuit of net zero emissions

Net zero is suddenly everywhere, from Rishi Sunak's budget to Larry Fink's latest annual letter to CEOs, which declared that "the world is moving to net zero". But amid the pronouncements and declarations of intent, a number of inconvenient truths remain. Chief among them is the huge investment gap that must still be bridged before the destination of carbon neutrality can be reached.

Take the example of the UK, where the government aims to reach net zero emissions by 2050. Achieving the goal will require directing immense capital flows into the development of low-carbon infrastructure. As it stands, these flows are - to put it mildly - too small. Recent analysis from the Green Alliance estimated an annual shortfall of £11.4bn "across transport, buildings, circular economy and natural infrastructure", a gap that the British think tank forecasts will soon exceed £13.5bn. Similar calculations from PWC concluded that more than £40bn of investment will be needed every year in the UK over the course of the coming decade - a doubling of current levels. It is less of an investment gap, more of a chasm.

The broader economic outlook, meanwhile, only darkens this picture. According to the Office for Budget Responsibility, the UK is set to suffer a £372bn deficit in 2020-21 - an economic nosedive that could well impede the required investment into net zero infrastructure. A cold-eyed observer could barely be blamed for asking: is net zero really possible?

Such challenges, however, are only one side of the picture. On the other stands the fact that this immense transformation - "every company, every bank, every insurer, and investor will have to adjust their business models", as Mark Carney put it recently - is "the greatest commercial opportunity of our time", to quote Carney once again. By commercialising new products and services specifically designed to mobilise investment into net zero infrastructure, banks can harness the drive to slash emissions to benefit their own businesses - steering them into a future that is both prosperous and sustainable.

"We need to see the narrative change in the financial sector," Rhian Mari-Thomas, CEO of the Green Finance Institute, told BusinessGreen recently. "It's not about what you can't do - the smart money needs to be figuring out how to make money from this huge transition."

Banking on the opportunities

One bank that has recently reoriented its strategy in just this fashion is NatWest, whose CEO, Alison Rose, called climate change "the defining issue of our generation" when she took the helm at the end of 2019. Shortly afterwards, the bank launched a new corporate strategy with climate change at its core, committing to halving the emissions of its loan book by 2030.

Achieving this goal will require innovation and fresh thinking, as NatWest's head of sustainable finance and just transition Rishi Madlani tells BusinessGreen. "It's no good NatWest decarbonising its portfolio and the carbon intensive assets simply sitting on someone else's balance sheet," he explains. "We have to move the real economy - and this is where championing products and services that can accelerate the speed of the transition is crucial."

In the course of 2020, NatWest launched a range of new products intended to meet just this need. The bank's green mortgage, for example, offers a reduced margin to house-buyers acquiring properties with higher EPC ratings. Similarly, NatWest is providing customers who take out a personal loan to fund green home improvements with a one-off payment of £100. Both initiatives target one of the biggest obstacles facing the UK on its net zero journey: decarbonising the built environment, a goal that will require at least £65bn of investment in energy efficiency upgrades by 2035, according to some estimates.

Another new finance product targets a different net zero infrastructure challenge: electric vehicles (EVs). NatWest has teamed up with Octopus Energy to offer an EV charging and technology bundle, providing retail and business customers with access to discounted EV charge points and installations. 

These new products exist alongside NatWest's huge clean energy investment drive, as the firm pursues what Madlani terms "the darkest green assets". "We hit £12bn last year and are aiming for £20bn of funding and financing by the end of 2021," he explains.

Funding this "dark green" infrastructure is only part of the net zero investment challenge, however. Equally important is finding ways of providing finance to existing, carbon-intensive firms so as to help them transform their business models. It is a controversial area, as it can leave banks and investors who have net zero targets facing accusations of financing fossil fuel companies. But at the same time a large number of financial experts fear that starving carbon intensive firms of capital could hamper their ability to develop lower carbon technologies and business models.

"There is an absolute requirement to shift the focus to transition," Madlani argues. "The finance sector has got very good at financing dark green infrastructure: there's no shortage of finance for many renewable assets. The challenge now is how to unpick the trickier sectors that are bound up with higher carbon emissions."

Booming bonds

Another new financial product aims to help achieve this: transition bonds. A sub-category of green bonds, transition bonds aim to provide funding to help high-carbon industries decarbonise. Last year, NatWest worked as a bookrunner on the UK's first transition bond, issued by gas firm Cadent to help fund the upgrading of its networks for the use of hydrogen and other green gases. The bond raised €500m.

Transition bonds have attracted some controversy among campaigners, however, who have alleged that investments labelled 'green' have been used to fund projects in high-carbon industries whose decarbonisation value is unclear. Such concerns over 'greenwashing' are understandable - but advocates of transition bonds counter that high-carbon firms in key industries need to be able to access finance if they're to pursue decarbonisation pathways.

A recent paper from Credit Suisse and the Climate Bonds Initiative aimed to address concerns over 'greenwashing' by proposing a set of standards for the emerging sector. These should require firms to demonstrate that any investments will be aligned with efforts to reach net zero emissions by 2050, excluding carbon offsets, the paper argued.

However, in the absence of such widely accepted standards, some banks are taking their own steps to eliminate risks of 'greenwash' from the projects they finance. One such bank is BNP Paribas, which helped pioneer green bonds and, more recently, has provided sustainability-linked bonds to a range of sectors, from cement to fashion.

"The sustainability-linked bonds we've issued recently have quasi all been using targets certified by the science-based targets initiative (SBTi)," explains Delphine Queniart, head of sustainable finance and solutions at the French banking giant. "We work closely with both corporates on the one side and investors on the other to identify the most suitable performance indicators in their sector. And we recommend science based material targets wherever we can for an optimal deal structure."

Demand for sustainability-linked bonds is surging currently, as corporates that have net zero emission targets in place are attracted by the promise of more attractive terms if they deliver on the environmental goals they have already pledged to meet. Financial institutions are also drawn to the sector given the now ample evidence that companies that deliver on their environmental goals tend to perform better financially.

Beyond issuing green bonds to well-established corporates, BNP Paribas is currently working to develop financial instruments that can support climate action in the developing world. This has involved partnering with development banks, NGOs, and public bodies to generate funding, through an approach known as "blended finance".

One such example is the Tropical Landscape Finance Facility, which combines elements of a grant fund and lending platform. BNP Paribas recently used this mechanism to support efforts to enhance the sustainability of rubber production in Indonesia, working with conservation charity WWF to help Michelin scale up their production of natural rubber on degraded land while protecting Indonesian rainforests.

"Blended finance allows a combination of public and private entities to come up with de-risking financing structures which couldn't happen if they were working separately," Queniart explains. "It enables sustainable finance to come to regions that can be more challenging to operate in."

And the role of state-backed banks in addressing the green investment gap is not limited to developing economies. The UK government's new National Infrastructure Bank may have been criticised in some quarters for not being large enough, but the recent confirmation it is to have a specific mandate to support the net zero transition should provide a major new source of green capital. With £12bn in initial capital and £10bn in government guarantees, the hope is the bank unlocks as much as £40bn of private finance, much of which will be focused at green infrastructure projects.

Green angels

From green homes in in England to rubber plantations in Indonesia: as the initiatives covered so far indicate, perhaps the defining feature that makes the net zero transition both so challenging and so interesting is the immense diversity of the issues it has to wrestle with. In this context, smaller investment firms capable of directing early stage finance into a wide array of different sectors have a critical role to play.

One such organisation is the Green Angel Syndicate, a "classic angel syndicate" according to its founder, Nick Lyth, which invites its members to buy equity in start-up and early-stage companies. "In order to stop emissions we need granular level innovation that deals with the minute details of what is produced," Lyth says. "A multitude of tiny innovations need to be developed - and those innovations then have to be scaled to a global level. This is precisely why it's such a fantastic investment opportunity."

Applications for finance are assessed by a core group of associates, selected from the Syndicate's 240 members for their expertise in the field in question. If they approve it, the applicant can pitch their proposal to the Syndicate's wider membership. If enough support is offered - "usually around £100,000," Lyth says - the investment can go ahead, and a suitable person from the Syndicate's membership team is placed on the company's board.

Recent beneficiaries amply demonstrate the capacity of this investment model to fund a wide diversity of technical innovations. One example is British cleantech innovator Rovco, which has developed a system of subsea monitoring with potential applications ranging from assessing the state of coral reefs to helping maintain offshore wind farms. A second is domestic battery storage firm Powervault, while a third is eco-tech start-up Nature Metrics, which is developing technology capable of quickly assessing the plant and animal population of a given area, helping facilitate the regeneration of ecosystems.

Such a diversified portfolio has helped propel Lyth's firm to the cutting-edge of the UK's decarbonisation efforts. Chris Stark from the Committee on Climate Change recently placed it at "the fulcrum of the change we need" to reach net zero.

Democratising finance

Alongside banks, financiers, and angel investors, there is one more significant source of finance which green investment innovators are targeting: the general public.

"I've always been very interested in democratising finance," says Bruce Davis, founder of online platform Abundance Investment.  "And I saw there was a big gap for ordinary people who wanted to invest directly in renewable energy."

To pursue this interest, Davis set up Abundance and began developing financial products aimed at enabling ordinary people to invest in the green economy. Chief among these products is the Innovative Finance ISA (IF ISA), a special ISA wrapper for crowd-funded investments which, like a conventional ISA, allows individuals to invest up to £20,000 a year without having to pay any tax on returns. "About 50 per cent of our money comes directly from our innovative finance ISA," Davis explains, estimating that the firm has injected around £110m into the green economy - around a sixth of which has financed the UK's growing tidal industry.

Alongside promoting innovative savings mechanisms such as the IF ISA and a green-tinged self-invested pension product, Abundance is currently focused on repurposing an older financial product for the green industrial revolution: Community Municipal Investments. The firm has so far worked on two such products, with West Berkshire and Warrington Councils, each worth £1m and both financing solar generation. These bonds offered an interest rate of 1.2 per cent - a low-return but, since local councils should not go bust, a very low-risk arrangement that, Davis argues, is perfect for people new to investing, or green technologies, or both.

Indeed, Davis stresses that now is the perfect moment to encourage ordinary people to invest in green technologies. The restrictions of the coronavirus lockdown has left some people sitting on an unusually large pile of accumulated savings, estimated in the UK to amount to £250bn. "If that all goes into consumer spending, it will be bad the planet and could cause inflation," Davis says. "Instead, we should be incentivising people to put that money to work in the green economy."

With tens of billions of pounds needed every year for decades ahead, there's no denying that the level of investment required for the UK's net zero transition is intimidating. But as this brief survey of the green finance landscape suggests, if the spending power of the British public can be combined with that of angel investors, retail banks, green financial innovators, crowd-funding platforms, and the world's investment giants, generating such financial flows is far from an impossible task.

"We've got every reason to be optimistic," says Rhian Mari-Thomas from the Green Finance Institute. "We're not seeing the floodgates open yet - but I'm pretty confident we will."

Want to find out more about Net Zero Finance and the green investment trends that are impacting businesses and investors of all types? Then join us at the Net Zero Finance pathway event, as part of the Net Zero Festival 2021, which will take place online on March 16th. You can request an invitation to the event here.

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