Real-world impact: The rise of transition finance
Transition finance enables carbon-heavy sectors to cut emissions and encourages innovation in carbon reduction while allowing asset owners to profitably participate in the world’s adaptation to net zero.
‘Green’ strategies, such as ESG-branded assets, are designed to have small carbon footprints. In some cases though, this means they are avoiding carbon-intensive industries, rather than taking meaningful steps to help lower emissions.
Transition finance is about real-world impact. This could be, for example, an investment in the steel industry that is made conditional on the recipient following a responsible path to net zero. It could be investments in the infrastructure we need to shift away from fossil fuels, or in innovative companies or projects that need capital to deliver real-world reductions in greenhouse gas emissions.
Global investment manager Ninety One surveyed 300 senior professionals at asset-owner institutions around the world to explore the outlook for transition finance. The majority (60%) of respondents say fighting climate change is one of their fund’s strategic objectives, while about half (51%) say their fund has emissions-reduction targets in place.
On the surface, these numbers paint an encouraging picture. However, only one in five (19%) say they use transition finance to any extent, and fewer (16%) say that their fund invests in transition-finance assets in emerging markets, which have the highest emissions growth.
The survey shows that asset owners are more likely to be using other investment approaches to incorporate climate change, such as climate-related factor integration and positive screening. So why is transition finance not used more widely?
The framing of sustainability
More than half of asset owners surveyed (55%) say their fund is not focused on any goal beyond the risk-return performance of their assets, while 40% believe that climate-related investing leads to lower returns.
“Most investment professionals have grown up in an era where the framing of sustainability has typically been concessionary,” says Alison Loat, managing director, sustainable investing and innovation at OPTrust, a CA$25 billion Canadian pension plan. “There has been a huge mindset shift, because it is no longer always true, yet the framing still exists for many.”
Faith Ward, chief responsible investment officer at Brunel Pension Partnership, says that policy framework and a clear strategy are key to encouraging asset owners to shift their focus to transition finance. “We need the policy positions, and we need regulations that underpin those,” she says. “There is an opening for blended finance and more collaboration between development banks and investors. Everybody needs to come together, recognising that there will be different solutions in different markets as well.”
Emerging markets need attention
Much more capital must be invested to help emerging market economies decarbonize and shift to cleaner energy. The International Energy Agency estimates that US$4 trillion per year will need to be invested in clean energy projects and infrastructure by 2030 to steer the world back towards a temperature rise of 1.5 °C . This is more than triple existing commitments, and much of the funding is required in emerging markets.
More than half of the respondents to Ninety One’s survey (53%) say that their fund is concerned about the risk-return profiles available in the universe of emerging market transition-finance assets. Some are seeking greater engagement with their consultants to support transition finance investments, particularly for emerging market opportunities.
“It's a different set of skills, knowledge and experience you need for emerging markets,” says a senior leader at a European asset owner. “This creates a barrier for us and makes it appear — incorrectly — as if we intentionally neglect some regions in favour of developed markets where we have more confidence in the advice we can access.”
Asset owners have capital and influence
More than half of asset owners (56%) believe that without greater investment in transition-finance assets, the world will not be able to meet the Paris Agreement goals.
Among asset owners, asset managers and consultants, some say a change in culture or approach may be coming. “I think most people with ‘sustainability’ in their title spend as much, if not more, time on culture change as they do on technical work,” says OPTrust’s Alison Loat.
Asset owners are in a unique position. They have the capital and influence to help the world transform. By allocating capital to the transition, they can help mitigate climate change while profitably participating in the adaptation of businesses and sectors on the path to net zero.
