Finance

If environmental challenges are to be tackled effectively, private finance and capital markets will have a major role to play. Finance is essential to the transformation to a sustainable economy that protects the health of the natural environment.


The operation of the financial markets is an important leverage point despite the finance sector itself having relatively little impact on the natural environment. Finance is the means of allocating resources and determining the conditions under which individuals and organizations earn and invest. It therefore affects where capital flows to and what projects are undertaken. It shapes the direction of development and long-term growth and can drive innovation and new technology.


Finance operates in a number of different forms, each of which can impact on the natural environment. For example how debt finance (loans from banks, project finance and bonds) decides which activities to lend to can lock in a carbon-intensive economy, say in the area of energy production, by investing in a coal-fired power station with a 30 year life. Or through its lending terms, can make it expensive for a mining company to ignore its environmental impacts.


Investor (e.g. mutual funds) decisions on which companies to buy shares in affects the value and growth options for these firms. And through their share ownership, investors can influence how companies address the environment. Insurance companies can incentivize environmentally responsible behaviour by making insurance policies cheaper for companies that better manage their environmental footprint. Finance can also drive new markets and products. Sustainable forestry, energy efficiency, wetlands, extreme weather events and carbon have all been the focus of recent financial innovations.


The finance sector is also beginning to understand how the health of the natural environment matters to it. This is often discussed in terms of risk and materiality. Risk is the potential harm to financial value that may come from a future event; incurring a cost or failing to obtain some benefits (a state of uncertainty is a risk). Materiality is a common term in finance for issues that make a real difference to the financial bottom line.


For instance insurance companies are developing a greater understanding of how they are exposed to environmental risks, which they need to factor in to the prices of the insurance policies they offer. Investors such as pension funds, which invest for the long-term are increasingly concerned by climate change because of its ‘material’ impact on the global economy as well as on individual assets.


The risks and ‘materiality’ of biodiversity are also becoming an issue for finance providers. Many of the businesses to which finance is provided are dependent on biodiversity and ecosystem services (such as wetlands cleaning water or forests absorbing carbon from the air), or impacted by them in other ways. This dependency is a potential source of risk for finance providers as changes to the natural environment can create loss and uncertainty. As an example, the reduced availability of raw materials is a risk for investors in the pharmaceutical industry and the affect on pollination of a declining bee population increases the costs of agri-business.

US$500 billion – investment required per year by 2030 needed to assist developing countries adapt to climate change while powering low carbon growth. (World Bank)


86% - percentage of this total investment required from private sector. (United Nations Framework Convention on Climate Change)


€29-€74 billion – the estimated economic value of the pollination of cultivated plants by bees. (Bund Naturschutz)

Stats + Figures

Resources

Translator: Adam Ognall (London, UK), Deputy Chief Executive, UKSIF - The Sustainable Investment and Finance Association

Finance + The Environment

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