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Blog Post 12 November 2020

What is green finance?

They say money makes the world go around. But when it comes to saving the planet, does it really all come down to finance?

If we are to successfully transition to a green economy, it’s going to cost and so naturally the issue of how we pay for the transition is a key topic at every level of the debate. In this article we look at green finance and whether it holds the key to delivering our sustainable, low carbon future.

What is finance?

To understand the importance of green finance, it’s worth taking a step back to consider just how important finance is to our lives and to the economy as a whole.

Finance lies at the heart of how the economy functions at every level – for individuals, businesses and nations, for example:

  • when you want to buy a house, you’ll probably take out a mortgage
  • you may use a personal finance deal to buy a car, make home improvements or afford holidays and so on

If you have money to invest:

  • you may buy companies’ stocks and shares
  • you’re likely to pay into a pension to save for your retirement

If you want to start a business, or invest in equipment or technology:

  • you’ll take out a business loan

At a national level:

  • when a government needs to invest in new infrastructure – they may issue a new bond on the global finance markets
  • when a developing economy needs to develop a new power plant, it may borrow from a development bank set up for that purpose

What makes finance green?

To put it simply, green finance is just finance, but where the house, car, company, infrastructure or power plant being invested in are green.

If you buy an electric vehicle using finance – that’s green finance. If you take out a loan to improve the energy efficiency of your home – that’s green finance. If you invest in an investment fund that supports green technologies – that’s green finance. When a company takes out a loan to invest in efficient machinery or a developing country takes out a loan to develop renewable energy facilities – that’s…well, you get the picture.

The examples above are generally badged as green, but not all green finance is explicitly labelled. For example, if you have a pension plan, it’s inevitable that your fund will include investments that support the transition to a green economy. So you are probably already investing in green finance without knowing it, especially as technologies like wind and solar become part of the mainstream of the energy and investment worlds.

Green finance isn’t a magic wand

Given the importance of finance across the economy, if we want to tackle climate change, it’s clear that finance is going to need to be increasingly re-focussed toward greener outcomes; for example, financing low carbon homes, electric vehicles, shares in clean-tech companies and renewable energy infrastructure instead of their carbon intensive alternatives. Green finance is vital, hence the huge focus on its availability.

But it’s important to remember that finance alone cannot drive the transition. A large proportion of the UK population could borrow enough money to buy an electric vehicle – there are plenty of finance options out there – but just because they could doesn’t mean that they will.

A high profile example of the limits of green finance was the Government’s Green Deal. This was a scheme based on the premise that if finance was readily available to homeowners then they would take up cost effective measures such as new boilers and insulation in droves. The reality was a bit more complex.

The demand didn’t materialise and take up of the scheme was described as ‘woefully low’ by a House of Commons Select Committee. Just because people could pay for measures, didn’t mean that they wanted them. One barrier was removed but others still remained. The recently launched UK Government Green Homes Grant scheme, which offers vouchers to homeowners in England to make energy saving home improvements, may have more luck – but that remains to be seen. Green finance is important – but it is not a silver bullet.

Government or private?

The Green Deal and Green Homes Grant scheme are examples of government led green finance initiatives, but green finance can come from both private or government sources and, often, a combination of the two. The vast majority of finance for wind turbines, for example, comes from the private markets. Wind turbines are an established technology and the market for investing in them is mature, so there is less need for governments to intervene.

However, where governments perceive that there is insufficient private finance to deliver the necessary change, they may decide to step in and loan government money in order to advance green policy objectives.

This was the case in 2012, when the UK Government set up the Green Investment Bank to fill some of a renewable energy investment gap. However, in this case, it wasn’t long before the private capital markets had caught up and private investment in to the renewable energy sector was plentiful. So, having filled an initial gap, the Green Investment Bank portfolio was sold to the private Investment group Maquarie in 2017 (generating a profit for the exchequer in the process).

Because government loan funds are often investing in newer or more challenging types of project, it is quite common for them to be accompanied by support programmes to build a pipeline of good projects. An example of this is the UN Green Climate Fund. Here, developing economies are supported with every aspect of developing green projects right through to the implementation, recognising that finance alone won’t ‘green’ the economy, and that wider support is needed. It’s clear that there is a role both for governments and markets in the green finance space and finding the right balance between the two will be critical.

The political position

The UK Government launched its Green Finance Strategy in July 2019. The strategy supports the UK’s economic policy for strong, sustainable and balanced growth, the delivery of a modern Industrial Strategy, as well as domestic and international commitments on climate change, the environment and sustainable development.

Importantly, the strategy recognised the role of the financial sector in delivering global and domestic climate objectives. A review of the progress against the aims and objectives of the strategy is expected in 2022.