Triggering a critical mass of sustainable investment: How can Europe do it?

Written by Kirsten Dunlop, CEO, EIT Climate-KIC. Originally published in EurActiv

The European Commission’s HLEG Working Group on Sustainable Finance released its long-awaited final report on 31 January. More than two years after the Paris Agreement and implementation of the Sustainable Development Goals, Europe looks ready to put finance to task, leveraging its structural potential in helping a green economy bloom.

The report proposals – including a taxonomy to provide market clarity on what ‘sustainable’ is; clarification of investor duties in considering sustainability in investment decisions; improvement in disclosure; and an EU-wide label for green investment funds – have been broadly welcomed in banking and policymaking circles.

The proposals aim to get to the heart of finance and change behaviour by targeting the incentives that matter to investors like capital requirements and investment mandates. But will these proposals drive change in finance sufficient to meet the complexity of decarbonisation projects and the scale of transformations needed to stay on track with current climate targets and a 2ºC pathway?

Europe has done well at stimulating renewable energy infrastructure, and market opportunities that are vertical and aligned with traditional business perspectives seeking growth and return on investment. This model, however, does not incentivise financial flows to projects and actions vital to a low carbon development path, for example in retrofitting Europe’s building stock or integrated energy-mobility-dwelling models.

Unlike renewable energy, transport and deep retrofit require engagement with myriad stakeholders with an array of interests. Such a heterogeneous landscape may deter investments. The next wave of climate innovation will be based on the internet of things, including distributed ledgers and digital intelligence, resulting in the increased selling of services rather than products and greater transparency in value chains.

To encourage investment in such projects, public finance has a responsibility to explore how best to take the first loss risk and develop a track record to incentivise private sector investors to manage the associated risks.

Effective business models that manage to blend concessional finance with private finance and can address the demands of the multiple stakeholders involved are desperately needed.

So, how can traditional investment appetite be changed? The answer lies in diversity and in the introduction of a resilience and renewal logic to the strategic allocation of capital – capital directed at ‘hedging’ or rather ‘underwriting’ business model renewal in the face of disruptive change. Working with a spectrum of risk and opportunity appetites, a range of financial partners, sectoral specialisms and techniques and a portfolio approach designed to learn can help create an ecosystem of finance partners working in a more patient, considered and democratised way.

This ecosystem might include national banks, philanthropic funders, impact investors, local credit unions or crowdfunding mechanisms, convened together with mainstream finance players. Creating a platform for this financial co-creation of investment solutions could help trigger a breakthrough in the critical mass of sustainable investments across Europe.

One less discussed proposal in the HLEG report that supports this is a proposal to create ‘Sustainable Infrastructure Europe’. This capacity building hub would facilitate a transfer of lessons learned and insights from across the European, national and local level to help develop and implement projects as testbeds for change contract effectively with private sources of capital and give advice on how to reduce uncertainty in a patchwork of regulatory environments.

This is something that can be built on. To meet the EU’s broader environmental and sustainability goals, the bottlenecks constraining investment in sustainable infrastructure on both the demand and supply side must be addressed.

Some of these bottlenecks on the supply side will be generic to the targeted industrial activities, while others may be related to specific environments where activities occur. Different regions will have a varying institutional capacity to absorb finance.

As the report authors emphasise, access to capital is not so pressing as project development capacity. Many large-scale private funds are ready and willing to invest but are unable to identify attractive investment opportunities, not least because of poor enabling environments.

Such a body must be a platform where a diverse finance ecosystem can co-develop projects, share funding information, best practices and methodologies, and make vital connections between project demand and supply.

This will be crucial to the understanding of how to generate an enabling environment – institutional capacity, labour market skills, and policy frameworks – as well as providing the financial sector with better tools for assessing climate-related risks and for investing in strategic innovation options capable of generating renewal and economically viable transformation.

 

Climate-KIC’s Decision Metrics and Finance team works with our network of partners to develop the metrics and financial mechanisms to redirect and mobilise the finance needed to quickly scale up climate action.

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