View from UNEP: Aligning the financial system with sustainable development

Estimates for achieving the Sustainable Development Goals range up to $7 trillion a year. Where will it come from? According to two senior experts from the United Nations Environment Programme, the funds are there, and the real question is how they can be channelled from damaging investments towards sustainability.

Nick Robins, Co-director of UNEP Inquiry, believes the bulk of funding for the SDGs will need to come from private sources – “individuals, households, enterprises and investors”. With low or negative interest rates in many countries, there is a lot of private capital waiting on the side-lines. “Meanwhile we have huge sustainable development and infrastructure needs,” said Robins. “We have to think about how we’ll mobilise the financial system. It will require a clear focus on how we get the financial rules and incentives aligned so that pension funds and other sources of capital naturally invest in sustainable development. There are a number of ways we can do that.”

The first ingredient to encourage sustainable investment is policy clarity. “Pension funds are cautious investors,” said Robins. After all, they have to make sure they can pay their pensioners over decades. “People have been burnt in the past with policy change,” said Robins. “People expected carbon prices to be rising, but they’ve fallen after the financial crisis; people expected solar incentives to stay, but they’ve been cut. What governments can do is make clear that when they make a commitment they stick with it, because investors really value that long-term certainty.”

Second, there is an important role for the watchdogs and facilitators of the financial system to play. Regulators, stock exchanges, central banks and finance ministries can encourage or even require investors to take the environmental and social impact of investments into account. “Often people say, ‘we’d like to do this’, but our regulator isn’t telling us to do it, and until they do we’ll keep business as usual,” explained Robins.

Many emerging economies are leading the way, according to Robins. “Brazil has become the first country to require all banks to incorporate environmental and social risk into their governance process; China has led a green finance task force, and green finance is now part of its 13^th five year plan; and Bangladesh is taking a lot of action - all banks in Bangladesh need to allocate 5% of their loan book to green finance.”

A third area is market innovation, notably in the area of green bonds. Kicked off by development banks several years ago, they now raise $40 billion a year for green activities from retrofitting buildings to renewable energy. These make financial as well as environmental sense: they can help reallocate pension funds’ assets which are exposed to climate risks (such as increased regulation of dirty industries), and can benefit from tax reductions.

Well-established projects such as public transport infrastructure and clean energy systems are natural candidates for green bonds. Innovative technology and start-ups looking for solutions to climate change, on the other hand, need another route towards private funding.

This is where public money can play an important role, making riskier green investments attractive to cautious private investors. A range of development banks run schemes in which they take the initial losses on a green investment, enabling investors mandated to buy only the highest-rated securities to get on board.

Hear about how EU support helped bring in private capital for solar cell producer Exeger, winner of a European Commission LIFE award for its innovative indoor solar technology.

However, channelling money towards green investments will not be enough on its own. In Robins’ view, the financial formula needed is very much like a diet. “You can eat your greens, but unless you cut out the carbs you won’t achieve your diet goals,” said Robins. “As well as positive greening, there’s recognition of the need to reduce the negative impact of finance.” The carbs in this case are high-carbon, resource intensive sectors and environmentally-damaging subsidies.

“There are so many ways money is invested every year, and a lot of it is wasted, unfortunately,” said Steven Stone, Chief of UNEP’s Economics and Trade Branch. “The classic case is thermal power production, coal-fired power plants or even oil or diesel-burning power plants, which are still being constructed all around the world.”

Subsidies for fossil fuels are in the order of $5 trillion a year, including subsidies for exploration, producers and consumers. They come with high environmental and health costs.

“So the question is not how will we finance the SDGs, but how do you shift that huge amount of money that’s out there towards sustainability. And I think the answer lies in how do financial markets perform – what are the rules of the game that govern capital allocation, and what are the price signals that consumers, investors and producers are perceiving.”

For Stone, one of the most urgent signals to change is on carbon emissions – 90% of which are not covered by a trading scheme or carbon price. “Until we start putting a price tag on things we don’t want, polluters won’t have a strong incentive to move away from them,” said Stone.

UNEP and others are working with pension funds and other investors to remove high-carbon, resource-intensive sectors from their portfolios. Members of the Portfolio Decarbonisation Coalition have already committed to decarbonize $600 billion of their assets under management.

A slow transformation towards a greener financial system is underway. Private financial institutions are recognising that the transition to a low-carbon green economy is in their long-term interests. Standard-setters including the Financial Stability Board are homing in on climate disclosure. And policy-makers are focusing on inclusive wealth - how to create jobs, human and social capital without depleting natural capital.

According to Robins, the frameworks laid out in COP21 and the SDGs were “unthinkable two or three years ago, and were fantastic achievements. Now the hard work begins. The European Union has been the leader in many of the sustainable finance innovations we’re seeing – and now’s the time to develop a strategic roadmap, joining the dots and showing how sustainable finance can contribute to long-term economic recovery and job creation.”

Further reading

UNEP Inquiry: The Financial System We Need

UNEP Inquiry: Building a Sustainable Financial System in the EU

Voices & Views

A New Approach to Finance for Development

Leveraging Private Sector Participation for Development

Blending: An Increasingly Useful Tool for Tackling Poverty

This collaborative piece was drafted with input from Yves Ehlert from DEVCO, with support from the capacity4dev.eu Coordination Team.