Using private capital for public good

corporate

Using private capital for public good

On 16th September 2021, Hubert Keller, Senior Managing Partner at Lombard Odier, took part in an online event organised by Onward, a think tank dedicated to strengthening economic opportunity and communities throughout the UK. Hubert was joined by host Will Tanner, director of Onward1, and fellow panelists the Rt Hon. Kwasi Kwarteng MP, the UK’s Secretary of State for Business, Energy and Industrial Strategy, and Rhian-Mari Thomas, Chief Executive of the Green Finance Institute, for a conversation around the event’s theme: ‘Private Capital for Public Good’. Together, the panelists talked about what the financial industry and policymakers must do to pave the road to net zero with green capital.

“If we need a range of technologies to achieve net zero, then it doesn’t make sense to have just one source of capital”, shared Kwasi Kwarteng MP.

…the panelists talked about what the financial industry and policymakers must do to pave the road to net zero with green capital

Three challenges for the investment sector

The investment sector, which manages around $120 trillion of capital, is increasingly committed to net zero, and a number of industry players have already pledged to deploy capital with a net-zero mindset. However, the industry still faces a number of challenges in this area.

The first challenge is that of climate-related financial exposure, which comes in a variety of forms, depending on the climate-scenario considered. In a best-case scenario where the world moves rapidly towards achieving the Paris Agreement’s goal of limiting global warming to 1.5–2 °C, transition exposure across all industries will be significant as they transform their business models to make themselves fit for the move to an economy that is Circular, Lean, Inclusive and Clean—the CLIC™ economy. Conversely, in a worst-case scenario where the world takes inadequate action, rise in global temperature could exceed 3–3.5°C. In this case, there will be less transition exposure as fewer companies adapt for net zero, but the physical and litigation risks will be much more significant, creating other problems for the global economy.

The second challenge is that climate is an incredibly complex topic, and we have yet to build the expertise we need to tame that complexity. As an industry, there are many difficult questions that we need to answer, such as what kind of emissions to focus on and how to address avoided emissions and carbon offsets. Unfortunately, we still lack a common framework that could serve as a guiding principle for allocating capital with a net-zero mindset. Even the EU Taxonomy is not particularly helpful here, as it fails to capture the need to support those companies that are transitioning from brown to green activities and, therefore, taking us closer to net zero.

The final challenge is around how, as an industry, we fulfil our role of funding the real economy while also helping the world move towards net zero. Right now, the real economy is not even close to being aligned to the Paris Agreement, let alone net zero. This gap between ambition and the real economy creates the problem of how exactly our industry is to deploy capital at scale with a net-zero mindset.

This gap between ambition and the real economy creates the problem of how exactly our industry is to deploy capital at scale with a net-zero mindset

At Lombard Odier, we believe that we need to rethink our approach by focusing on two things we need to address these challenges.

First, we need to move away from the simple exclusion approach, particularly when it comes to sectors that currently have large carbon footprints. We recognise that it is especially in sectors that are high emitting today where much of the transition will play out, where transitional finance may be most needed, and where significant climate leaders are already emerging.

We recognise that it is especially in sectors that are high emitting today where much of the transition will play out

Second, we need to focus much more on understanding each company's transition trajectory, which includes both what it intends to do to half the economy’s emissions by 2030 and also how it will be aligned to net zero by 2050. Only with this understanding in hand can we begin to quantify and assess the financial impact of that transition and make climate-related financial exposure our guiding principle for allocating capital in net-zero investment strategies. This is how, as an industry, we will fulfil our commitment to net zero and help the rest of the economy move in the right direction.

“We need to focus much more on understanding each company's transition trajectory, which includes both what it intends to do to half the economy’s emissions by 2030 and also how it will be aligned to net zero by 2050”, said Hubert Keller

Supporting technology for net zero

When we’re talking about sustainable finance, we have to distinguish between ‘greening’ existing capital and funding green investments.

The first of these is the more significant challenge, because there is around $120 trillion of capital that must be redeployed in a way that is aligned with the challenges and opportunities of the environmental transition. This is a massive task when you look at the transition through a net-zero lens. And, crucially, you cannot mitigate systemic risk simply by divesting from hard-to-abate sectors. Instead, we must use the stewardship responsibilities that come with asset ownership to ensure that companies are being held to their transition strategies and that they are funding the innovation necessary to achieve them. This is the role of investors: to fund the real economy in a way that accelerates our progress toward our climate goals.

This is the role of investors: to fund the real economy in a way that accelerates our progress toward our climate goals

When it comes to the question of funding green investments, there are many different options. For instance, there are increasing numbers of opportunities in the area of natural capital and the new technologies, infrastructure and assets it will require. All of these are interesting to the finance industry and represent investable opportunities. That said, green investments – i.e., investments in specific enabling climate solutions – will always account for a small proportion of that $120 trillion.

“The challenge of investing in early-stage technology is the challenge of how to appropriately deploy public and private capital to optimise risk,” said Rhian-Mari Thomas.

…there are increasing numbers of opportunities in the area of natural capital and the new technologies, infrastructure and assets it will require

We should also remember that it isn’t appropriate for most financial institutions to invest in early stage innovation and technology, because this is not what their risk mandate has been created to do. Take, for example, the success of offshore wind in the UK, which now accounts for around 40% of global offshore wind capacity. While this is now a global success story, we still needed the green investment bank to invest in what, at the time, was still an unproven technology. But once we had a blueprint for how to do it, the public sector was able to bring in institutional investors which now fund offshore wind in the UK in its entirety.

In short: the challenge of investing in early-stage technology is the challenge of how to appropriately deploy both public and private capital to optimise risk. And this is a generalisable lesson. When it comes to net zero, neither investors nor policymakers can go it alone.

 

1 https://www.ukonward.com/

Important information

This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier.

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