Forum Climate Economics 11

The Financial Sector as Climate Protector? The Potential of Sustainable Finance

03 Mar 2022

Virtual Forum Climate Economics 11 on Sustainable Finance brings together voices from research, politics and business

ESG, green bonds or taxonomy act – as a non-expert, it is easy to lose the overview of the abbreviations and technical jargon in the world of sustainable finance, says moderator Conny Czymoch at the start of the Forum Climate Economics 11. Reason enough for the last forum of the Dialogue on the Economics of Climate Change to address the question of the role that the financial sector can play in mitigating climate change. What criteria must the reporting of com­pa­nies in the financial and real economy fulfill in order to sufficiently take climate and transition risks into account? Does disclosure of sustainability information automatically lead to the intended reallocation of capital flows? Are there other barriers to making the necessary investments in green technologies? Answers to these and other questions were hoped for by some 190 participants who followed the 11th Forum via the interactive event platform.

Climate-friendly Technologies are in Particular Depend on Low Cost of Capital

Energy finance expert Prof. Dr. Bjarne Steffen (ETH Zurich) offered a scientific per­spec­tive on the chal­lenges of financing climate-friendly tech­no­logies. The need for in­­vest­­ment in the energy sector in the EU, which is increasing by 30-40 % annually, is explained on the one hand by the high costs of converting the necessary energy infra­struc­ture, and on the other hand by the high capital intensity of low-CO2 technologies.

Although there is no shortage of available capital in Europe, many investors are reluctant to invest because of existing uncertainties - for example, in hydrogen as an energy carrier. In order to strengthen the financing of climate-friendly technologies on a broad scale, a green financial policy could take various measures: A reduction in the cost of capital is expected to favor investments in renewable energies. In addition to the general level of interest rates, key drivers of capital costs are technology-specific interest margins and expected returns, as well as emissions trading schemes. Market initiatives, such as the divestment activities of public pension funds or special support programs of state-owned investment banks, also have an influence on the cost of capital.

Sustainable Finance: not a Green Finance Sector, but a Sustainable Finance System

Kristina Jeromin, Co-Chair of the Cluster for Green and Sus­tain­able Finance Germany, presented a multi-layered picture of sus­tain­able finance. Sustainable Finance is much more than the promotion of sustainable finan­cial products. The goal is a sus­tain­able finan­cial system that supports people and com­panies in the necessary transformation process.

Germany has set the ambitious goal of becoming "a leading location for sustainable finance", but has so far failed to implement the necessary measures to achieve this goal. Besides a high level of ambition, this also requires transparency in the financial system and in financing mechanisms. Kristina Jeromin urged the players in the financial sector to see sustainability not as a niche, but as a systemic field of work. Only in this way, she said, could the sector achieve the innovations needed for change, for example in the area of digital recording and processing of sustainability information. Jeromin expressed criticism towards the current debate surrounding the EU taxonomy, saying that it was diverting the financial sector from its suggested systemic path.

Experts report on exchange between science and praxis in preceding Virtual Roundtable Series

Following the two keynotes, Dr. Kai Lessmann, Dr. Franziska Schütze and Dr. Gunnar Gutsche reported on the series of roundtable discussions attended by about 20 participants each, which had taken place on February 23, February 24 and March 2 on various topics of the background paper for the Forum Climate Economics 11. In their interviews, they briefly presented key results and insights from the discussions:

Key aspects of the Roundtable "Mobilizing Investment: Is the Carbon Price Sufficient to Create Climate-­Friendly Capital Markets?" on February 24, 2022

  • The carbon price is the guiding instrument of climate policy. It drives the transformation of the real econo­my and is the central prerequisite for climate-neutral investments. Uncertainty about the de­vel­op­ment of the CO2 price creates investment risks. Volatile carbon prices were also cited by finan­cial in­sti­tu­tions as a risk and barrier to investment. Similarly, companies emphasized that these increased risks make their transformation towards climate neutrality more difficult. Decisive action by the state was re­peat­ed­ly called for, for example by the public sector assuming part of the risks through guarantees or carbon contracts for difference.
  • Reduced risks lower capital and investment costs in particular. Technologies with high capital intensities would benefit particularly. The adjustment of capital requirements was also discussed as a way of re­duc­ing capital costs. However, this should be done with caution: Instead of lowering them in general, sustainability assessments through ratings should be introduced. The lower risk of sustainable in­vest­ments would lead to lower capital requirements in a more targeted manner via the ratings.
  • For energy- and emissions-intensive companies, high capital costs are less crucial than high input costs. Here, rapidly rising energy costs reduce the scope for financing the conversion of their own processes to climate neutrality from their existing business. From the point of view of these companies, the current CO2 price limits the financial resources for the transformation and endangers their competitiveness during their transformation.

Interview with Dr. Kai Lessmann (PIK Potsdam) on the results of Roundtable 1

Key aspects of the Roundtable "Taking a Look Ahead: Forward-Looking Reporting as Trailblazer for a Climate-Neutral Economy?" on March 2, 2022

  • The discussion has shown that while more and more sustainability reporting is taking place, it is often still highly inconsistent, unverifiable, and in some cases only qualitative and selective. Studies show a positive effect of mandatory reporting on the emission reduction of companies. The standardization of sustainability reporting that goes hand in hand with mandatory disclosure could be a valuable lever for reaching companies that have so far been performing relatively poorly in this area.
  • More and more companies from the financial and real economy are committing to the goal of climate neutrality, but many still lack a strategy and a concrete idea of what risks, opportunities and investments this entails. This partly stems from the fact that there has been a lack of suitable scenarios for use in a company-specific context to date, and politics has thus far failed to provide the necessary certainty about future regulatory conditions. The available scenarios, for example by the Network for Greening the Financial System (NGFS), do not sufficiently differentiate between regional and sectoral aspects. An alliance of governmental and nongovernmental actors is needed to support the business community in designing company-specific transition plans. Therefore, it is important to improve forward-looking indicators of sustainability reporting. Following this, there is a need to verify transition plans during the implementation phase.
  • Overall, a forward-looking approach to sustainability reporting has the potential to reach a much larger portion of the business community with sustainable financing tools, including those aligned with en­vi­ron­men­tal criteria. This will particularly benefit companies in sectors facing the greatest trans­for­ma­tion tasks, such as industrial heavy manufacturing.

Interview with Dr. Franziska Schütze (DIW Berlin) on the results of Roundtable 2

Key insights from the Roudntable "Sustainability in the Private Portfolio: Is Transparency the Key to more Sustainable Investment Decisions?" on February 23, 2022

  • Investors are increasingly interested in sustainable investing, but often have little or no knowledge about sustainable investments. However, transparency, while desired, is not the biggest barrier to sustainable investing, but rather its complexity. The time required to find adequate sustainable investment products is perceived as too high. In principle, current political approaches (e.g. within the framework of the Markets in Financial Instruments Directive (MiFID) II, the Disclosure Regulation, the EU taxonomy, or the introduction of state sustainability labels) are suitable for overcoming these hurdles.
  • From the point of view of the consulting practice, the question of sustainability preferences of investors in investment advice on sustainable investments, as stipulated by MiFID II, still has many weak points: Its implementation would have to be coherent in terms of both the timing and the content of the measures. As the discussion on the EU taxonomy makes clear, there is no uniform understanding of sustainability, not even on the part of investors. The resulting increase in complexity in the already time-consuming consulting process could lead to a fundamental reluctance to recommend sustainable products. Moreover, neither financial advisors nor software systems are currently in a position to im­ple­ment the planned measures.
  • Minimum standards and labels could be of particular help to investors who do not seek investment advice from the bank, as they increase both transparency and the confidence of investors. In fact, investors have strong preferences for labels, while the level of knowledge about their content is rather low. For consumer protection reasons, investors should be warned against blind trust in sustainability labels. There is a risk that investors will link them to other financial aspects, such as the lower risk of labeled products. As discussed in the background paper, investors may also use such labels as heuristics if the investment process is too complex - but disregard other investment objectives and important aspects of investing (such as fees).
  • In summary, transparency is important, but must be designed in a meaningful way.  Overly detailed and complex information that confuses both the advisory and demand sides is not desirable. First of all, it is more important to increase the knowledge about sustainable investments, the so-called sustainable financial literacy, both among investors and financial advisors.

Interview with Dr. Gunnar Gutsche (University of Kassel) on the results of Roundtable 3

Panel discussion: What can the financial sector contribute to climate protection?

In the final panel discussion, keynote speak­ers Bjarne Steffen and Kristina Jeromin were joined by representatives from the financial sector and the manufacturing industry. Head of Sus­tain­ability at the capital management company BayernInvest, Wiebke Merbeth point­ed out at the beginning that existing political uncertainties require an even strong­er dialog between all stake­hold­ers involved. Christoph Reißfelder, energy and climate policy expert at the chemical company Covestro, also considers the simultaneous change in political and macroeconomic conditions to be a very big challenge for the preparation of long-term investment plans. Here, he sees a close link between companies in the financial and real economy, which requires mutual trust in possible transformation paths.

State support, for example in the form of public-private partnerships, can be a valuable instrument for achieving progress in terms of sustainability. One example, Reißfelder added, is the establishment of circular production processes, the costs of which are still substantial. He was supported in his view by Bjarne Steffen, who believes that the greatest challenge lies in the transformation of industries for which no competitive alternative processes or technologies are yet available. In this context, Steffen said, it is also necessary to build up expertise within the financial sector in order to be able to adequately solve these industry-specific challenges. All panelists were optimistic about the prospects for success of the necessary economic transformations. Even if this change is sometimes unpleasant and uncomfortable, they believe that the players in their industries are on the right track.