The transformation to a low-carbon economy, highlighted at this month’s COP27 meeting in Sharm el-Sheikh, will require a global capital commitment of at least $4-6 trillion a year. Much of this is expected to come from private investments.
Delivering such funding will require a swift and comprehensive transformation of the financial system and its structures and processes, and engaging governments and institutional investors, said the official statement following COP27.
“The problems are not insurmountable if we ensure that finance is being directed to the areas which most urgently need it,” according to Hanneke Smits, CEO of BNY Mellon Investment Management.
“But the investment community cannot do it on its own. We have to collaborate with government and policymakers to ensure that the right incentives and frameworks are in place.”
BNY Mellon recently published a report showing that the world might need something in the region of $100 trillion to achieve the goal of net zero by 2050.
“That’s a lot of money," said Smits, but she believes that over the course of the next 28 years, it is achievable.
At COP 27, UN secretary general António Guterres said private financial institutions “must now fully facilitate investments for a renewable energy revolution, and proactively work with international financial institutions to address issues of cost of capital and risk perceptions; namely, the cost of capital in the developing world is something that worries us a lot.”
Global private equity and infrastructure firm KKR is already heavily committed to sustainable investing. “What’s exciting about today’s world is there are great opportunities to invest in this ‘brown to green’ transition,” said Joseph Bae, the firm’s co-chief executive officer, at the Hong Kong global leaders' summit earlier this month.
For the world to really make progress on decarbonisation, Bae said Asia needs to be a leading force.
“With China and India among the biggest emitters globally, this is going to be an enormous challenge for Asia, but also an opportunity for investment. I’m optimistic that regulators, governments, and the private sector will find a way to work together and I think that’s something that will happen in a reasonably short period of time.
“The really hard work is deciding what are the strategies to materially decarbonise and improve your business. As investors, that’s where the focus needs to shift. Let’s not just get the reporting right, but what does it mean to be a responsible owner of a business — what are the right targets?”
“In order to do this, we must not shy away from allocating to those companies that need to align themselves to net zero, including energy and utilities companies,” said Smits. “Given those opportunities to invest, we must engage with them and support them in their reallocation of capital towards a greener world.”
For actual reductions in carbon emissions to occur, “it requires more than simply divesting and reducing the carbon exposure of an individual portfolio," Chris Trevillyan, director of investment strategy at Australian asset consultant Frontier Advisers, told AsianInvestor. “Therefore, investors will need to invest in high emitters, but with a clear plan and direct actions to reduce the emissions in those businesses.”
While engagement and consultation on energy transition is seen by asset owners as the correct strategy in most cases, an institution’s passive investments are another matter. The NZ Super Fund, for example, has recently shifted about 40% of its overall investment portfolio to market indices that align with the Paris Agreement on climate change. The changes apply to the fund’s index-tracking reference portfolio benchmark and its corresponding $25 billion of passive investments in global equities.
While Asia is behind developed markets in Europe and the US, in terms of sustainable investment practices, Smits said the region is catching up. “We are seeing, from an investor perspective, an increased need for sustainable investment options as they evolve their portfolios."
Asia needs about half of the $100 trillion total requirement to get to net zero by 2050, said Smits, because the economies here are growing faster. "They are energy dependent and therefore need even more capital than in developed markets, to get to that greener future.
“I also think there is a great opportunity here from an investment perspective to leapfrog some of the carbon-intensive technology that we have seen in developed markets, in much the same way as mobile phones leapfrogged the laying down of landlines in rural India.”
Bae agreed that there’s a lot of progress being made in Asian sustainable investing, but pointed out there is a two-speed market.
"The situation in the smaller markets, in terms of access to capital, is very different from China and India. There needs to be a recognition that where private capital can add value is in some of those gaps."
One of KKR's largest investments is in the Philippines power company First Gen.
"They produce almost 20% of all the electricity in the Philippines, and it’s almost all renewable. Geothermal, hydro, wind and solar," said Bae.
"But the Philippines is not a market where a lot of international capital flows. There are real gaps in terms of availability of funding. So that has to be a big part of the solution."
At the Hong Kong summit, Jin Liqun, president and chairman of the Asian Infrastructure Investment Bank (AIIB) explained one of the benefits of working with a multilateral development agency such as AIIB or the Asian Development Bank.
“Investing in infrastructure naturally has a long gestation period, with associated regulatory and macroeconomic risks. Your due diligence on a project may be very good, but you perhaps didn’t know about the macro or geopolitical storm brewing.”
Individually, it will be more difficult for private investors to be assured of their success, he said. “I hope the investors who work with us will not expect us to close the gap of risk-adjusted returns. I don’t think we can do that, but because we have maintained a dialogue with the host country governments, we can ensure, as far as possible, that the regulatory policies are in good order and if necessary we can try to change them for the better."