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There is a huge financing gap between what is needed to mitigate the worst effects of climate change and what is being spent, with recent analysis suggesting that annual expenditure must increase from $1.3trn to over $10trn between 2031 and 2050 to limit global temperature rises to 1.5°C.
Trillions more will be needed for climate adaptation and tackling nature loss, yet the political and regulatory environment is preventing institutional investors from rising to the challenge.
The risks of inaction are also misunderstood by banks, insurance firms and pension funds, with research indicating that they could be underestimating investor losses from climate change by as much as 70%.
Professor Aled Jones is director of the Global Sustainability Institute at Anglia Ruskin University, which is renowned for its research into climate science, policy and climate finance. He has also been highly commended in the sustainability professional category of the Green Gown awards.
Here, he tells IEMA’s policy and engagement lead for climate change and energy, Chloë Fiddy, what can be done to tackle the systemic challenges that are blocking finance for climate and nature.
Are financial institutions and the companies they invest in doing enough to report their impacts and risks relating to climate and nature?
The reporting gaps are more to do with indirect risk versus direct risk. Large companies have to disclose some element of climate risk, but it is not real financial risk – it’s what they can understand and measure. They might report on how they have regenerated a bit of biodiversity for nature, or done some carbon capture and storage near a factory, without really reporting on the upstream or downstream impact, which is societal collapse at one end.
Nobody is including societal collapse as part of their business management process, or thinking about how their investments could lower that risk. Some big pension funds and insurance companies can’t protect themselves from the wider economy – which is why we have the universal owner hypothesis – but some only ever think about what their returns on investment are going to be over the next 12 months.
Who is responsible for that way of thinking?
It’s almost as though the system is running itself. It is not managed by any one individual, especially where you have shareholders. Nobody has the ultimate decision-making power and nothing ever happens that is radically different. And then there’s competition between insurers and pension funds, where if one does something different they lose out on market share in the short term.
Is this where the idea of divestment comes in?
We’ve looked at some interesting case studies in the past around tobacco and pension funds, especially the really large ones that were teachers’ pension funds, which refused to invest in any tobacco products. They knew it would cost them money, but they took an ethical stand, and it was member-led. It’s been more difficult to do that more widely – to say we won’t invest in fossil fuels – although that is starting to happen, especially around universities. But you need everybody to divest to make it work and really increase the cost of capital for polluters.
Wouldn’t divestment from polluting industries and investment in green solutions and climate finance ultimately save money?
Divestment will save them money over the long term, but in which year? When will the fossil fuel industry collapse? In the conversations I’ve had with pension funds, it’s like they’re all in it together, therefore none of them will make an individual decision to do something differently.
Like lemmings, as long as they all carry on running towards the cliff, they’re all happy, and if they all jump off the cliff together, they’re probably still happy, whereas obviously we want them to stop running and to do something different. But there is no reward for them standing alone and they might even lose money in the short term.
So we’re approaching climate change finance with the western capitalist viewpoint of how things work, which is that the markets should solve everything, even though the markets have helped create the problem?
It’s exactly that, and part of the problem is the return-on-investment period, which for infrastructure is often around seven years. If it costs more because you have to put in a flood defence, then there might not be a return on investment in those seven years. If you stretch the investment period to 100 years, the investor in the asset doesn’t benefit from that adaptation. So if it’s a flood defence, you need to be able to monetise the defended properties, capture that value and feed it back to the infrastructure.
That’s really difficult to do, especially when you’ve got private sector or private assets in there. It’s easier to do it if it’s public sector investment, because you can justify it from the public’s perspective by lowering overall risk in the future. But then that’s public money, and that needs to go through a whole other range of justifications. The challenge when you’re looking globally is that the necessary volume of investment is so big you need private capital.
Are public/private sector partnerships the answer to mobilise the climate finance that we need?
Co-investment is happening in some countries, such as in Kenya with solar farms, where the government takes a stake alongside the private sector, which takes a bigger stake. The public sector is almost a guarantor; default is less likely to happen because they’ve understood it and done the due diligence.
They understand the network and the metrics and the regulation within the country. It does lower the overall risk of losing on the return so the private sector can crowd in quite a lot of capital. But one of the key issues is using public money to protect private investment.
Is this what we mean by ‘socialising the risks and privatising the profits’?
Exactly. I get so frustrated when the private sector says ‘we want the public sector to take all these risks and then we can put money in’. The argument for the private sector being a good thing is because it takes risks, and it can be more innovative, can create more solutions, it’s quicker and more efficient – isn’t that the whole point of capitalism?
They are saying the opposite; that the public sector should take all the risks and the loss, and that the private sector is really conservative and doesn’t want to do anything. If you don’t want capitalism, shall we just nationalise everything?
In Florida, you get private sector insurance, but when climate change makes extreme weather and flooding happen so often that the insurance is no longer viable, they can’t put the premiums up. If a major event happens, it’s not that they just let everything collapse; the state of Florida or the US government declares a federal emergency, and they pay for the rebuilding. So the public sector becomes the insurer of last resort and no one has any incentive to do anything about the risk, because the government will foot the bill.
What would your policy recommendations be?
I can’t see a way of creating the right incentives in a purely private market to deploy the climate finance we need, which is why I think that the key thing is regulation. We need to get much bolder at banning doing the wrong thing, or putting standards in place for building infrastructure. So if we build on a floodplain, the person building has to take responsibility for managing that floodplain, and regulation needs to have real teeth and be quite long-term.
Financial institutions might also be disclosing climate risk, where they say that if we get to 4°C we lose a few billions off global GDP. That doesn’t translate into real, immediate loss for them, where they can justify making a different choice, unless it’s a regulatory mandatory choice. Carbon pricing is also really difficult to implement at the right scale because it’s very political.
We’re getting less cross-party consensus on climate change and regulation than a decade or so ago. How can we depoliticise them?
It was quite easy to push through the Climate Change Act 2008 and to agree targets for 2050 but we’re now having to translate it into short-term action, and the difference between the political parties is much more obvious. There is also an increase in climate scepticism.
Doing the right thing currently makes a lot of money on the renewables front. The Inflation Reduction Act in the US has created a manufacturing boom and employment. If a country wants to capture a market, and growth will be in renewables and energy efficiency over the next few years, an investment strategy is a strong political argument and will have high public support.
