Dec 23, 2019

Exploring The Capital Market In Combating Climate Change | Christopher Nwuya.

Climate change is a burning issue as it affects virtually all facets of human life. It is regarded as one of the most serious threats to sustainable development, as a result of its adverse effects to the global community. It is common knowledge that the major cause of climate change is the rising concentration of greenhouse gases emitted into the atmosphere[1]. The World Bank estimates that without urgent action, climate change could push an additional 100 million people into poverty by 2030 and by 2050, 143 million people could become climate change migrants[2]. The International Energy Agency (IEA) estimates that an additional USD 1.1 trillion in low-carbon investments is needed every year between 2011 and 2050, in the energy sector alone, to keep global temperature rise below 2°C[3].
The effects of climate change, if not properly addressed, will bring about drastic effects, not just to the environment, but to the world population. The effects are nothing short of catastrophic as they cut across all sectors.
Thus, it is increasingly clear that we cannot continue putting up with our laissez-faire attitude towards our planet. In addressing the issue of climate change, it is worthy of note that there must be a drastic reduction of green-house gas emissions or we'll suffer the adverse effects of this ever-growing menace. The need to reduce the green-house gas emissions then begs the question, how?
In addressing the question, the answer this writer poses lies in the capital market. It is in the interest of the global community to look towards the capital markets in abating the menace of climate change. Substantial reductions in emissions can only be achieved by making significant changes in investment patterns. More prompt collaborative efforts are needed to combat this growing issue.  We shall now look into the ways by which the capital market can contribute to climate change abatement.
Before delving into the nitty-gritty of the matter, it is intrinsic to take note of the potential risks available to investors, if climate change is not curbed.
Climate Risk refers to investment risks resulting from unmitigated climate change. Climate risk involves the uncertain yet possibly severe consequences of climate change on the environment, as well as the economic consequences for failure to recognize the negative effects of greenhouse gas emissions early enough. Investors may therefore face significant climate risk without even realizing it. Organizations such as Mercer[4] and CERES[5] have further characterized the systemic nature of climate risk, by identifying several dimensions through which this risk materializes.
With each passing day, we lose a chance to tackle the drastic effects of climate change. With each passing day, the likelihood of the risks manifesting grows. It is now time for the global community to join hands in abating this global issue by investing sustainably. 

The capital market has a major role to play in the fight against climate change. In addressing this, there's the need for sustainable investment in:
  1. Clean energy
  2. Green bonds, carbon price; and
  3. Carbon tax, which shall be explained below.

Clean energy infrastructure is essential in reducing greenhouse gas emissions. With renewable power still only representing 20% of world electricity supply, the majority of which is hydropower, there is enormous scope for increased investment in the renewable sector.[6] Investors should consider reorienting their portfolios towards low carbon energy by replacing fossil fuel stocks with energy efficiency and renewable energy instrument[7]. For a transition to a low-carbon economy, a great deal of investment would be required.
International Energy Agency estimates that a global need of $53 trillion in cumulative investment up to 2035 in low-carbon energy supply and energy efficiency to avoid catastrophic climate change[8]. Climate finance flows reached a record high of USD 612 billion in 2017, driven particularly by renewable energy capacity additions in China, the U.S., and India, as well as increased public commitments to land use and energy efficiency. This was followed by an 11% drop in 2018 to USD 546 billion[9]. These figures are an indication that countries have made steps in transitioning to a low carbon economy. According to the International Energy Agency (IEA) estimates, investment in low-carbon energy sources must more than double by 2030 if the world is to meet its Paris Agreement climate goals. The IEA further estimates that an additional $1.1 trillion in low carbon investments is needed on average every year between 2011 and 2050, in the energy sector alone, to keep temperature rise below 2°C.[10]. Investments in clean energy still fall far short of this estimate.
Also, worthy of note is investment in energy efficiency, otherwise referred to as the "fifth fuel". It is regarded as the cheapest energy choice in a sustainable world. IEA estimates fuel expenditure may even be reduced by 2020, if the right energy efficiency improvements in the transport sector are implemented[11].
For a smooth transition to a low-carbon economy, investors need to tap the potential existing in low-carbon transportation. Also, there has to be investments in clean energy as it is an essential component of sustainable urban development.
1.1.      Incentives for De-Carbonization
A major factor behind the growth of renewable generation was tax incentives. One example is solar energy generation in the US. The Energy Policy Act of 2005 created a new tax incentive (30% tax credit for investment in commercial and residential solar energy systems) which, in 2008, was extended for another eight years. This led to investment of $66 billion in solar energy since 2006 (out of a total of $100 billion invested in clean energy over the period).[12]
Tax incentives can also be used to bring about a reduction in CO2 emissions. By creating incentives, manufacturers are more likely to invest in technology that will result in lower carbon emissions[13]. The costly nature of carbon technologies today will only make tax incentives more appealing to the investor’s eye.
Simply put, green bonds are investment instruments that raise capital for environmental and sustainability purposes. The emergence of green bonds has been recognized by the United Nations as “one of the most significant developments in the financing of low-carbon, climate-resilient investment opportunities.”[14] Green bonds can raise large amounts of financial resources to support environmental projects and can facilitate the establishment of public-private partnerships to accelerate green investments.[15]
Green bonds provide investors with a way to earn tax-exempt income with the benefit of personal satisfaction, knowing that the proceeds of their investment are being used in a responsible, positive manner[16]. In 2008, the World Bank became the first entity to issue green bonds, and since then, they have issued over $3.5 billion in debt designated for issues related to climate change[17]. Development banks such as International Bank for Construction and Development and the German Kfw Development Bank have followed this initiative.[18]
The issuance of green bonds to make infrastructure and capital projects climate resilient should be in line with the international guidelines brought out by the International Capital Market Association (ICMA) for green bonds, called the “Green Bond Principles” (GBP). These were first drafted in 2014 and have since gone through periodic updates[19].
For the growth of the green bond market, transparency is critical. Investors need to have complete trust in the environmental credentials and performance of the bonds.
Setting a higher price for carbon-intensive energy use can achieve the desired outcome of mitigation against climate change. Increasing the cost of fossil fuel for consumers will cause them to seek cheaper alternatives and / or change their consumption mix. In doing this, aggressive low-carbon policies would reduce the need for fossil fuel energy in the medium to long run. In consequence, fossil fuel assets would lose their value and become stranded assets.
Furthermore, putting a price on carbon creates (dis)incentives for producers and consumers to reduce emissions by internalizing the cost of future damage caused i.e. carbon emitters should bear the liability for the outcome of their actions. Scholars have also argued that pricing carbon can act as an insurance policy against catastrophic climatic conditions that could occur in the future.
As it stands, there are two main approaches to the carbon price. One is the emissions trading system, otherwise referred to as “cap-and-trade”. In this system, the total allowable emissions in a country or region are set in advance (‘capped’). Permits to pollute are created for the allowable emissions budget and are either allocated or auctioned to companies[20]. This system caps the total level of greenhouse gas emissions and allows those industries with low emissions to sell their extra allowances to larger emitters[21], thereby creating a market for emitters.
The second approach is the carbon tax. The aim of carbon tax is the reduction of greenhouse-gas emissions. Thus, carbon fuel users are charged at an explicit tax rate depending on how much carbon they emit when burned[22]. By this, carbon fuel users will pay for the damage caused to the atmosphere. If the rate is high enough, it could drive them away from carbon fuel usage and motivate them to explore opportunities in clean energy.
Research shows that carbon taxes effectively reduce greenhouse gas emissions[23]. It has been argued by economists that carbon taxes are the most efficient way to curb climate change, with the least adverse effects on the economy[24]. It is thus hoped that more countries will join in the fight against climate change by enacting carbon taxes within their respective jurisdictions.
1.0  CHINA
The finance industry of China has been taking giant strides in abating climate change. In September 2017, the China Development Bank issued the first retail green bond for individual investors and non-financial institutional investors.[25] Furthermore, China are a leading market for solar panels, wind and electric vehicles, and accounts for two-thirds of solar cells installed worldwide,[26]and the wind power capacity accounting for one third of the world’s total.[27]This is considerably remarkable considering China are one of the world's largest emitters of CO2.[28]
In the US, the trend away from coal as a primary fuel source is beginning to reduce the power generation industry’s reliance on fossil fuels; the share of which reduced from 72% in 2007 to 67% by 2014. Of this figure, coal’s share of US power generation declined from 49% to 39%, being replaced by natural gas and wind as the preferred alternatives. The reliance upon gas, wind and solar as the dominant generation types is expected to continue for several years until storage technology can be economically scaled up. The state of New York has passed a bill to eliminate carbon emissions by 2050, while the city of San Francisco already gets 60% of its power from renewable energy.
The British government has set itself a legally-binding target of hitting net zero emissions by 2050. Since 2013, the United Kingdom has maintained a carbon tax. It is sometimes called a “top-up” tax because the intendment of the tax was to top up European carbon prices. It functions as the minimum price that fossil fuel producers pay to emit CO2[29]. This resulted in the drastic reductions of CO2 emissions since 2013. The United Kingdom has also advanced plans for a carbon free environment by launching an initiative in 2015 to test prototype for driverless cars[30], which are set to be on the roads by 2021.[31]
Ireland is one of the pioneers in the implementation of the carbon tax. It was enacted in 2010 and it covers nearly all of the fossil fuels used by homes vehicles and offices[32]. This move almost immediately spiked the prices of oil, natural gas and kerosene[33]. This resulted in a 15% drop in the emissions since 2008. Also, Ireland enacted vehicle Registration Tax, which is partly emissions based. Ireland has also issued its first green bond, and has raised over $5billion from the sale of bonds[34].
As part of the plan to transition to a sustainable economy by 2050, Ireland plans to spend a total of €23bn on green projects between 2018 and 2027.[35]
5.0  FRANCE.
As part of the EU policies, France has submitted a long term emissions development plan to the United Nations Framework Convention on Climate Change (UNFCCC), and has a strategy for near zero energy buildings.[36] France also has a carbon tax, which is currently charged at €44.60 per ton[37]. France has also been at the forefront of greenbond issuance this year. .With more than €15 billion worth of green bonds issued since January, France has become a leader of green finance.[38]
Today, climate change is one of the most deadly threats to human existence. All over the world, countries are experiencing first-hand, the effects of climate change. Now is the time for urgent action. It is the time to invest sustainably in the environment. Investors need to do away with short term thinking, and focus on environmental sustainable investment. There's a need for capital, so as to reach the goals of the Paris Agreement. To get this capital, there should be investment in clean energy, with disincentives for fossil fuel usage. Green bonds also provide a lucrative opportunity for investors and climate activists. By investing in a green bond, the proceeds would be used solely for environmental/climate related projects. Carbon pricing and carbon tax also provide a huge opportunity for the abatement of this menace. It aims to clamp down the on CO2 emissions, by making defaulters pay.
Countries such as Ireland, China, France, and UK have taken giant strides in saving the earth. Urgent action needs to be made. All hands need to be on deck. Other countries should borrow a leaf from the books of the aforementioned countries, so we can effectively and efficiently curb this menace.

[4] The risks include the physical risks, reputation risks(for companies that are publicly criticized for their high emission rates), competition risk(for companies that do not take pro-active measures in reducing the climate risk) and even litigation risk(industries producing large amounts of GHG could face a law suit)
Climate Change Scenarios - Implications for Strategic Asset Allocation”, Mercer 2011,
[5] “Navigating Climate Risk”, CERES, Sep 2013
[6]GSBGEN 390: Climate Change and Capital Markets
[7] As above
[8]Climate Bonds Initiative July 2014 The “2014 Green Bonds Final Report
[9] Global Landscape of Climate Finance
[12] Graduate School of Stanford Business: Climate Change and Capital Markets
[13]Also, a competitive edge could be created for renewables by lowering the tax incentives that currently benefit the traditional oil and gas industries. As above
[14]Climate Change Support Team of the UN Secretary General, Trends in private sector climate finance, (October 9, 2015,
[16] How Green Bonds Are a Cornerstone of Responsible Investing
[17] As above.
[18] Green Bond Market: Who are Its Protagonists?
[19]Federal Ministry for Economic Cooperation and Development, Germany, Green Bonds- ecosystem, issuance process and case studies, January 2018
[20] "What is a carbon price and why do we need one?"
[23] As above
[25] (Hong Kong Exchanges and Clearing Limited, Green bond trend: global, mainland China and Hong Kong, 2018)
[29] As at 2016, the rate was 18 pounds per ton. Carbon Tax Center -
[32] As at 2012, the rate was 20 euros per ton, and it remains that way till date. Carbon Tax Center -
[33] Elisabeth Rosenthal, ”Carbon Taxes Make Ireland Even Greener”