NB Financial Health
The 7 Trillion Dollar Question: Can Sustainable Financial Products Close the SDG Financing Gap?
Policy debates on climate change and sustainable development routinely cite the massive numbers needed to achieve the United Nations Sustainable Development Goals (SDGs): an additional $1 trillion annually in clean energy investments to limit global warming to below 2 degrees and $5 trillion-$7 trillion a year to achieve the SDGs. These numbers are overwhelming – but there is good news. When put in context with broader economic activity, these are far more manageable than they first appear.
The trillions needed for the SDGs and a low-carbon future seem more within reach when we consider that the global economy, as measured by gross world product, was almost ten times these amounts in 2016 (approximately $75 trillion). Investing in the SDGs is also expected to help further grow the global economy – the Business & Sustainable Development Commission estimates that the SDGs will help generate at least an additional $12 trillion in market opportunities as governments and companies increase investments in energy, cities, food & agriculture and health & well-being. Drilling down further into these numbers, in 2016, banks helped their clients raise $7 trillion in the global debt capital markets and another $655 billion in the global equity capital markets. These figures don’t include bank lending, which totaled an additional $2+ trillion in commercial and industrial loans outstanding for U.S. banks alone. When you do the math, the numbers are no longer so intimidating – the money is there, but we need to steer it in the right direction.
The challenge is that current investment levels in the types of development and climate-positive activity needed remain far below what is required. This is cause for concern, since delays can drastically increase the costs of taking action and, related to climate change, as we inch closer to the 2-degree mark, it becomes more difficult and expensive to prevent and mitigate the impacts.
Fortunately, many existing financial products, including bonds, securities and hedges, are already being re-tooled to meet the growing demand for green and social investments. Thematic bonds – including green bonds, sustainability bonds and social bonds – whose use of proceeds is directed toward environmental and social initiatives represent a growing portion of the capital being raised. The green bond market, in particular, has seen rapid growth, more than doubling in 2016 to $95 billion. Governments, led by Poland and France, have also started using sovereign green bonds to raise capital to meet the climate mitigation and adaption targets that they have set for themselves as part of the Paris Agreement.
Some banks are also looking into green loans for clients, particularly for those that don’t have access to capital markets. Another innovation relates to the securitization of loans for residential energy efficiency projects. In 2015, Citi pioneered the use of term asset-backed securities for energy efficiency by creating a new class of securities backed by unsecured installment loans to finance energy efficiency and water saving improvements; this same approach is also being used for distributed solar. Other innovations in sustainable finance include banks such as Citi stepping in as an intermediary to develop power purchase agreements to support the financing of renewable energy projects and provide savings for energy customers. Through these innovations and more, approximately $288 billion in total was invested in clean energy last year.
These developments are cause for optimism, but the figures still fall far below what is needed, as these sustainable financial products are underutilized. Although there has been strong investor demand for green bonds, corporate issuances remain limited. While the Climate Bonds Initiative estimates that the green bond market could raise $1 trillion per year by 2020, to do so will require a more diverse array of issuers from both the public and private sectors. Green bonds can be used to finance a wide range of environmental projects – from renewable energy and clean tech to energy efficiency and green building to water quality and the circular economy – but we have barely scratched the surface of their potential.
Beyond green bonds, we have seen recent issuances of sustainability and social bonds for a broad range of social issues (education, health, housing, gender and inclusive business), which have come from a diverse set of issuers including the corporate sector (Starbucks), nonprofits (International Finance Facility for Immunization), subnational governments (Land NRW) and development banks (IFC, NAFIN and TSKB). These are a promising start, and Citi is committed to bringing more of these bonds to market. As a financial institution that serves as a facilitator between clients, capital markets and investors, Citi is partnering with our clients to explore opportunities to issue green, sustainability and social bonds.
On the clean energy side, we’ve also seen an acceleration. In fact, global renewable generation capacity rose by 9 percent in 2016 (a fourfold increase from 2000) and for the second year in a row, renewable energy accounted for more than half the new power generation capacity added worldwide. Offshore wind in particular, which holds great promise as a source of renewable energy, has seen noticeable growth, with capital commitments growing to nearly $30 billion in 2016, up 40% over the prior year. Citi helped finance the first offshore wind farm in the United States, the Block Island Wind Farm, and we are excited to see other offshore wind projects under development.
There are many points of ongoing discussion and debate. How much of our sustainable finance is truly going to new, additional projects versus refinancing existing work? Do we need new and innovative financing products to meet the SDGs, or do we already have the tools that we need and just need to focus on maximizing what we have? And perhaps most importantly, how can we look at the interconnectedness of the SDGs so that we are tackling these global challenges in a comprehensive way, for example leveraging biodiversity work to tackle climate change, or addressing gender equality to deliver on economic growth?
Much attention has been paid to the SDG financing gap, and this focus on the finance sector is appropriate. You can follow the money and see how much progress has been made, but also see the daunting gap that remains. Current trends are heartening, however – existing financing tools are being adapted to sustainable ends, and this is an area where we can expect to see further innovation. At this juncture, we need to have a dual focus on maximizing the potential of our current financial instruments, while also creating space for the next wave of innovations for sustainable growth. With the combination of motivated clients, demanding investors and a robust set of financing options, we may be able to close the gap and help create the future we want.
This post was originally published on the World Economic Forum. It is republished with permission from the author.
Valerie Smith is director and global head of corporate sustainability for Citi.