We already have indexes that pick green stocks, and rank nations by their policies. The Global Green Finance Index (GGFI) ranks the world’s financial centres – London, New York, Singapore, Shanghai, etc. – by the policies and support they give to green investments. Old ways of valuing assets, particularly in fossil fuel companies, are being questioned say Mike Wardle and Michael Mainelli of the think tank Z/Yen, one of the creators of the index. That’s why financial centres need new types of analysis and financial instruments which realistically account for the transition’s effect on returns, and also help meet our climate goals. As the GGFI comes up to its first year in operation, they note how smaller centres, like Amsterdam, Copenhagen and Luxembourg, are finding a niche market in developing green finance.
Green finance – that is any financial instrument or financial services activity which results in positive change for the environment and society over the long term – is a growth area. The challenge of climate change has provided an impetus to the development of new forms of finance, which drive sustainability.
The scale of the need is huge. The International Energy Agency (IEA) estimates that $26 trillion of additional investment is needed just in renewables and energy efficiency between 2015 and 2040 to achieve the 2°C climate change target laid down in the Paris Agreement – around $1 trillion a year – not including the large amounts also needed for climate mitigation.
The shift in value for fossil fuels may depend on whether this need is long-term or acute. The political environment seems to be moving towards acute. UN Secretary-General António Guterres remarked in September 2018, “Climate change is the defining issue of our time — and we are at a defining moment. We face a direct existential threat.”
Old ways of valuing assets are not working
The shift towards sustainable financing and development means that the market valuation of existing assets, particularly in fossil fuel companies is unstable. In 2011, Carbon Tracker, a London-based financial services think-tank, published ‘Unburnable Carbon’. This ground-breaking piece of research calculated that all proven fossil fuel reserves owned by governments, and public and private companies were equivalent to 2,795 gigatonnes of CO2.
The report noted that if the world was to meet the objective of keeping global warming below 2°C, the total amount of CO2 which could be released globally could not exceed 565 gigatonnes for the 40 years to 2050. The market valuation of fossil fuel company stocks is tied to their reserves. If 80 per cent of these reserves had to remain in the ground, the value of fossil fuel stocks would require readjustment. With some of the world’s leading stock exchanges having a significant fraction of their market capitalisation and revenue connected to fossil fuels, this has raised the spectre of an unsustainable carbon bubble.
This analysis makes the issue of disinvestment from fossil fuels a significant consideration for fund managers across the world. The shift required in capital flows towards green financing offers opportunities for new types of analysis and new kinds of financial instruments which focus returns on outcomes.
Measuring depth and quality of financing
Against this background, the Global Green Finance Index (GGFI), produced by Z/Yen in partnership with Finance Watch and sponsored by the MAVA Foundation, is designed to measure the depth and quality of the green finance activity being undertaken in the world’s financial centres. Depth refers to the proportion of a financial centres’ business which is sustainable. Quality refers to the way in which the financial centre approaches green finance and the quality of its green finance offering.
Global Green Finance Index:
Depth refers to the proportion of a financial centres’ business which is sustainable.
Quality refers to the way in which the financial centre approaches green finance and the quality of its green finance offering.
There are other indices and datasets on sustainability and finance produced by a range of research groups and inter-governmental agencies. Many of these focus on country level data, or on specific aspects of investments and instruments. For example, the EY Renewable Energy Country Attractiveness Index provides an assessment of the attractiveness of a range of countries’ markets in relation to investment in renewable energy. The GGFI by contrast focuses on individual financial centres, rather than country level; and seeks to measure the range of green finance activity in that centre. The basic thinking is that there is much that financial centres can do via policy and nurturing to develop thriving green markets.
Some big players are lagging behind: Singapore, Hong Kong, New York
The leading centres in the green finance index are shown in table 1. Not all the GGFI top ten would feature in a list of the top ten centres overall for the quality of their financial services, as Singapore, Hong Kong and New York do; but these three do not feature in the GGFI top ten either. This suggests that smaller centres have been able to find a niche market in developing green finance, for example, the development of green loans in Amsterdam, green bonds in Luxembourg, or Guernsey, where the regulator has set green fund standards to enable its Guernsey Green Fund initiative.
We can also look at the relationship between depth and quality in the index. Figure 2 plots the centres in the index for depth and quality. Those centres below the trendline score better for quality than depth. Many of the centres above the line have put time and effort into developing their green finance.
As green finance develops, we expect to see continued competition among financial centres looking to steal a march on their peers and snapping at the heels of larger, more established markets.
What drives green finance? Policy, regulation and investor demand
What is driving green finance development? According to our research for the GGFI, the drivers for green finance most often mentioned in survey responses are policy and regulatory frameworks and investor demand.
In terms of policy and regulation, there are numerous examples of how regulatory systems are pushing towards green finance. Several jurisdictions require extensive disclosure by listed companies of their exposure to climate risk. In the UK, the Bank of England has adopted the recommendations of the Taskforce for Climate-Related Financial Disclosure (TCFD). The fact that prudential regulation of banks in the UK reflects the TCFD approach has helped ensure that climate issues are seen as vital to financial services’ success.
On the demand side, disinvestment from fossil fuels has been a key battle ground. Supported by the NGO 350.Org, pressure from students and academic staff initially convinced a number of small liberal arts colleges in the US to divest from oil and coal. Larger academic institutions began to follow suit.
Today, nearly 1,000 institutional investors with $6.24 trillion in assets have committed to divest from fossil fuels. These include a partial disinvestment by Norway’s huge $1 trillion sovereign wealth fund, and complete disinvestment by the Republic of Ireland, which became the world’s first country to sell off its investments in fossil fuel companies by its €8bn national investment fund. Over the past year, several major banks, including the World Bank Group (WBG), have also made high-profile decisions to stop financing new fossil fuel projects.
By continuing to shine a light on green finance measurement, the GGFI will lead to a further greening of the financial system as financial centres engage in a race to the top; and lead to the financing of the future.
Mike Wardle is Head of Indices at Z/Yen Group.
Professor Michael Mainelli is Executive Chairman of Z/Yen Group.