We are mapping how and why a collaboration between the public and the private sector can contribute to preventing global warming.
Climate finance made easy by Homaio.
In this edition :
🔥 The Story: Why private wealth is Climate Change's main battlefield
🎙️ The Testimonial: A lesson by an INSEAD Impact Investing professor
💹 Keeping up with carbon pricing: Invest in carbon markets.
Global warming is a financial problem.
The World Bank has stated that an annual investment of $5 trillion by 2030 is crucial to reach the international climate objective of reaching net-zero carbon emissions. In France alone, achieving the National Low Carbon Strategy would require approximately €15 billion in additional investments, every year.
That wealth lies with the private sector. BlackRock, Microsoft, Bank of America, and Elon Musk hold the necessary funds. And so do you. According to the World Inequality Report, the most comprehensive benchmark document on global wealth and inequalities across academia and institutions, " nations have become richer, but governments have become poor."
Over the past five decades, public wealth has declined. Public wealth is the assets of local and central governments - public hospitals, roads, bonds of publicly owned companies, etc. Private wealth is what individuals hold in the form of firms, corporate bonds, savings, or real estate. And national wealth is the sum of the two.
Currently, in Europe, public wealth constitutes only 2% of national wealth, while in the United States, this disparity is even more pronounced: There, public wealth is at -6% of national wealth due to the substantial public debt.
Contrastingly, private wealth has been consistently on the rise since 1970 and inequalities have been increasing. The top 1% of the world's wealthiest individuals have claimed 28% of all additional wealth accumulated since the mid-1990s. In contrast, the bottom 50% of the global population has only captured a mere 2% of this wealth. This disparity has intensified during the Covid-19 period, marked by governments borrowing from the private sector the equivalent of 10% to 20% of global GDP.
And so, it is the private sector possesses the financial resources. Yet, it lacks the organizational structure, democratic legitimacy, and the economic incentive to effectively address global warming. Although the private sector holds the keys to the capital, the current system provides no compelling reason to unlock the necessary climate investments.
The core reasons is because climate change is an externality. It is a large but indirect effect of private transactions, whose damage is not priced in. This IMF article explains it in simple terms. Managing this externality requires governments need to intervene in the economic sphere. It is up to the public sector to create the normative infrastructure to allocate capital effectively.
The most effective way to tackle climate change is bridging the climate funding gap by aligning economic interests. Beyond the moral perspective of "the mean multinational polluters" versus "your friendly neighborhood green startup", all entities are rational economic actors responding to incentives. They maximize their profit in the current competitive and regulatory landscape. And so, it is only with the right regulatory environment that negative externalities can be managed.
This IMF article explores how a strong carbon price can provide a global economic incentive to shift towards a more sustainable world. It incentives private actors to massively invest in decarbonation solutions. The article also highlights that “A carbon price also generates more than enough budget revenues to support vulnerable groups. Around 20 percent of carbon pricing revenues can more than compensate the poorest 30 percent of households.”
That is why putting a price on greenhouse gas emissions is not only the most efficient, but also the fairest mechanism to reduce emissions on a pace and scale consistent with the Paris Agreement.
For example, in 2017, the EU Emissions Trading Scheme (ETS) yielded €5 billion, and by 2022, this figure escalated to EUR 30 billion. Over the period from 2013 to 2022, a substantial 76% of total EU ETS revenues were used for climate, renewable energy efficiency or other energy efficiency related purposes. And since earlier this year, 100% of EU ETS revenues are earmarked for climate investments.
While the EU ETS is the pillar of Europe's climate strategy, it is widely unknown, severely lacking the attention it deserves. Yet it is the silver bullet in our arsenal to fight global warming. It encourages the private sector to wield the capital needed to decarbonize the economy.
Let's unleash the potential of climate markets.
Meet Prof. Singh, INSEAD's expert in Impact Investing
Currently serving as a Professor of Strategy and the Paul Dubrule Chaired Professor of Sustainable Development at INSEAD, Prof. Singh's expertise spans in areas such as Sustainability Strategy, Inclusive Business, Innovation, Impact Entrepreneurship, Impact Investing, and Impact Evaluation.
With a doctoral degree in Business Economics (Strategy) from Harvard Business School and a master's degree in Economics from Harvard University, he also holds a BTech from IIT Delhi and a dual MS from Georgia Tech.
In his article "ESG is not impact," Professor Jasjit Singh emphasizes how important it is to combine regulatory frameworks and business investments. According to him, we should systematically incorporate ESG and climate impact considerations to financial decisions in order to seek societal progress.
We are very grateful for Prof. Singh's time in responding to Homaio's questions and generously sharing his academic expertise.
Homaio: ESG and impact investing at the center of your academic career. Why?
Prof. Singh: At INSEAD, I am completely focused on studying and teaching about issues at the intersection of business and society, and ESG/Impact Investing represent some of the most critical debates in this space today. So it is natural for me to be involved in this space. The good news is that this is also of increasing interest to students.
H: Why is everyone interested in "ESG investing"? Is it just a trend? An obligation?
JS: Most of ESG investing is driven by a view that, even for achieving solid risk-adjusted financial returns, considering ESG factors is becoming more and more important. However, we should be realistic about what ESG can achieve if completely non-standardized and voluntary: a large fraction of the mainstream investors would not care about societal impact beyond the point till when it is good for their bottom-line.
H: What is needed to make more companies and investors interested in achieving positive societal impact?
JS: The hope is that as stakeholder pressures – such as those from regulators, customers, employees and communities – continue to increase, even purely money-minded companies and financial institutions will have to care more and more about society too.
H: What are the biggest risks when it comes to ESG investing?
JS: The thing we need to look out for is that, to the extent that ESG remains voluntary, it risks degenerating into green-washing/impact-washing. People are also pointing out a systems-level concern that it can crowd out other – and sometimes more effective – kinds of societal action on certain issues that require faster or deeper change.
H: What is the difference between ESG and impact investing? Why does such a difference exist?
JS: Unlike ESG, impact investing pursues more clear impact strategy and impact management towards measurable goals. Impact investing, however, is relatively small compared with ESG investing. The reason is that the non-concessionary segment has limits on how many “win win” opportunities truly exist to hit market returns while making substantial impact (especially if you also require additionality of the investment), while concessionary funding has limits to scaling as it has a component of philanthropy need built in.
H: Can climate investing be entirely voluntary and autonomous from any sorts of regulation?
JS: It is a myth to think that ESG or impact investing, or indeed any kind of market mechanism, can exist in a vacuum without a regulatory framework that sets rules of the game in the first place. Regulation is in the background. For example, the threat of climate change is leading ESG investors to anticipate, among other things, a rise in carbon prices, and that in turn is nudging them to move faster on climate action (e.g., setting an internal carbon price).
H: You just said that we need some regulatory framework in order to have effective climate investing solutions. But you also say that "Policy solutions are rarely perfect" . Is a combination of those aspects (regulation and free market dynamics) the best solution?
JS: Policy solutions are rarely perfect, indeed. Politics by definition involves compromises to get enough support to pass any regulation or get to any agreement. Real life rarely mimics “first best” from economics textbooks or scientific recommendations (e.g., from IPCC). This is as true at the regional and national level as at the international level (e.g., think of the painfully slow progress being made through the annual COP conferences and resolutions). Policy solutions, just like business solutions, also often have unintended consequences. So we cannot expect that either just business or just governments can fix society’s grand challenges. We need both of them to do their part. There are no magic bullets!
H: Are carbon markets an effective impact investing tool? What is your opinion on the voluntary and the compliance carbon markets?
JS: Carbon markets are indeed part of the overall climate solution as not every organization or sector can quickly reduce its emissions down to acceptable levels. The real issue is that, in a majority of settings today, carbon markets are voluntary, the level of verification is less than ideal, and fundamental issues like additionality, permanence and leakage are often not given adequate consideration. There are in fact many scientific studies showing that carbon offsets that are certified even by prestigious ratings agencies often have a real impact that is much smaller than is claimed. So we need to make a lot more collective progress on this within countries as well as internationally. We need carbon markets based on stricter standards and regulations, and should make sure that voluntary carbon markets have really good verification mechanisms that also cover issues like additionality, permanence and leakage.
2024 will be an exciting year both for carbon markets and for Homaio. Here is what is likely to affect EUAs in the months to come:
🏛️ Climate regulation. In the weeks to come, there will be significant policy announcements from the EU Commission regarding its climate targets. They will share insights on the region's objectives to combat global warming with a 2040 horizon. The level of ambition in these targets can have a direct influence on EUA price levels.
⚖️The EUA supply. There are 2 opposing forces when it comes to the EUA supply in 2024.
On the one hand, there is the Linear Reduction Factor (LRF). Every year, the EU commission decreases the carbon allowance supply. From 2024 on, the pace at which it does so increases (it was previously 2.2% per year, now it is 4.3% per year). This means less EUA issued by authorities.
On the other hand, there are some emergency measures put in place in order to help Europe respond to the energy crisis after the start of the war in Ukraine. A temporary increase of EUA supply has been one of those measure. This means more EUA issued by authorities.
🌐 The Carbon Border Adjustment Mechanism. Introduced in 2023, the CBAM aims at keeping European competitiveness. The idea is not to make European industrials pay too much for carbon while one can import “cheaper polluting goods” from outside of the Union.
We expect this mechanism to have an impact on carbon pricing globally. It is anticipated to make non-European countries also introduce Emission Trading Schemes. This can push carbon prices higher at an international level, also impacting EUAs to the upside.
In this edition, we saw how critical it is to leverage investing as a tool to combat climate change.
The Compliance Carbon Market encapsulates well the discussions we've had with Prof. Sight - he explained how crucial is the collaboration between financial markets and regulatory authorities.
Now, it's your turn to take action. Homaio has unlocked the European carbon market, making it accessible for everyone to invest.
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