At the outset of the One Planet Summit in Paris last December, U.N. Secretary General António Guterres outlined many of the grave challenges posed by climate change. Then the world’s top diplomat offered what was, coming from him, an unexpected solution, one that wasn’t directly related to strengthening political will or environmental regulations, technological breakthroughs or alternative energy sources.
“Finance,” Guterres said, “could be, should be and will be the decisive factor — the difference between winning and losing the war [on climate change].” The financial system, he went on to say, is “awash with funds.” The opportunities within finance are “not scarce,” he said, but “vast.”
Indeed, there is some $200 trillion invested in global capital markets. Harnessing not only the capital within the sector but also the innovative tools it creates to spur investment into the areas of greatest need could rapidly turn the tide, saving us from a dire and ever growing threat.
And the needs are acute: The International Energy Agency estimates it will take an average investment of $3.5 trillion a year for the next 30 years to contain the rise of global temperatures to a minimum of 2 degrees Celsius. The current rate of investment in combating climate change comes to just $1.8 trillion — less than half the necessary average to contain a catastrophic temperature rise. The World Bank estimates that between now and 2040, we also collectively face an $18 trillion infrastructure investment gap to address what will be necessary for growth — and, in the long run, save money, lives and many of the world’s ecosystems — in a rapidly changing planet.
This gap, between the money that’s available for investment (hundreds of trillions of dollars) and the money actually invested in combating climate change (a fraction of that), points to the inadequacy of today’s global financial system to tackle the world’s most urgent challenges.
Take, for example, the world’s multilateral development banks, including the World Bank, which were conceived in the wake of World War II, when there was a flurry of new ideas and initiatives to create a global financial architecture that would avoid the devastations of war and meet what were then the world’s global development needs.
More than half a century has since passed, and the world has changed dramatically. The business models of multilateral development banks no longer fit the same institutions’ stated purpose. The boldness and new thinking that led to the banks’ conception must now be turned to reforms that will address the challenge of climate change.
One such reform would be to shift the World Bank and other multilateral development banks from their traditional function as the providers of capital (lenders) to the mobilizers of private investment (catalysts). When multilateral development banks were first formed, it was a lack of capital that critically constrained development goals. Accordingly, nations raised billions in public funds to capitalize multilateral banks so they could achieve the highest credit ratings possible, which would in turn allow them to raise money for development as cheaply as possible, as well as lend money for development.
Today, capital is no longer the critical constraint. Last year, as the World Bank dispensed $61 billion in loans and investments into developing countries, more than $1 trillion went to emerging markets from private investment groups. That’s $900 billion more than the World Bank has doled out in its entire history.
Multilateral banks must massively increase their risk tolerance while lowering expectations for market-rate returns.
The challenge today is that money isn’t going where it needs to go to meet the 2-degree target. The reason is simple: Too many of the investments that might directly curb temperature increases are viewed as overly risky. Here is where multilaterals must step in, as mobilizers of private capital vs. lenders. They can do this by reducing the risk of these investments for private investors. There are a broad set of proven financial tools that multilateral banks can use such as the provision of guarantees to make what were once risky bets far more palatable to commercial investors.
To do this at scale, multilateral banks must massively increase their risk tolerance while lowering expectations for market-rate returns — seismic shifts in both the business models and the culture of these institutions. These changes will be difficult, but essential.
New investment products that address climate change
Finance is nothing more than a tool to meet our human needs. Our challenge today is that mainstream investment products haven’t been designed to address the rapidly changing climate. Just as the multilateral banks must revamp the role they play, we need to revamp our mainstream investment products and vehicles as well. The channels through which money flows must be widened to address climate change.
There are examples of such a widening: insurance products for the preservation of the world’s coral reef systems, for example, that reduce the impact of violent storms on coastal communities. There are also investment funds that restore ecosystems and rehabilitate degraded land to ensure food security. It isn’t impossible to see how a healthy reef acts like a sea wall, or that healthy soil is vital in the production of healthy food, but without this broadening in our view — that preserving our environment is preserving our continued existence on earth — we won’t create the types of channels necessary for the money to flow in and address this need.
When an investment is viewed as attractive, people invest. Fossil fuels have long been an attractive investment in large part because, globally, an estimated $425 billion in taxpayer money goes toward making them attractive, via subsidies. That’s more than three times the equivalent in subsidies for renewable energy sources, and a staggering 22 times more than is currently being channeled toward adaptation and resilience to the impacts of climate change.
It’s time for the markets to readjust, address a dire need, and win us this war.
Lorenzo Bernasconi is senior associate director at The Rockefeller Foundation, responsible for the Foundation’s innovative finance and impact investing portfolio. Follow him on Twitter @BernasconiKohn.