Ciao!

Benvenuto alla quinta ed ultima edizione di questo anno accademico di "Report Review" la newsletter uffciale dello Starting Finance Club Statale.

Il report di questa settimana analizza l’importanza e gli effetti della “Green Finance“ sul mondo degli investimenti.

Green Finance

We have recently seen a growth in the trend of sustainability and environmental protection. The topic of environment and climate change is the center of all the economic and policy reforms. These new policies are being implemented across all industries and sectors. In this scenario, it becomes obvious that the financial industry can’t be left behind. The financial sector is crucial for all policy forms, including environment-preserving policies. Finance is a key factor in shaping economies. When it comes to financing the markets for implementation of green policy, it steps forward with the proposal of ‘Green Finance’.

Green finance is a term recently gaining as much attention as any other segment of finance, the following image shows the increasing size of the economy. Before exploring its significance, let us try to understand what it means. Green finance can be described in many ways. Many research papers explain it as the financial investments incurred to combat climate change. This can include credit and other forms of financial help provided to the firms and industries to comply with environment-protecting policies and objectives such as net-zero carbon emissions. Others simply understand it as the investment made for the preservation of the environment and combating climate change. Therefore, Green finance should be understood as a concept and not a term. 

If we must generalize this concept, we can describe it as direct private and public investment for the management of environmental goods and services and the prevention and minimization of the damage caused to the environment and climate. It also includes financial instruments such as Green Bonds and Green Climate Fund which have specific aims for protecting the environment and preventing climate change. Green finance makes the foundation for long-term sustainable growth. It is not only a crucial tool in achieving the goals of a green economy but also essential for firms to combat the market failures occurring due to climate change.

In this report, we will try to shed light on the rise of green finance, its impact, and what challenges it is facing at the moment. This would help us understand the implications of green finance and how it yields positive results for producers, consumers, and the economies.

Why is green finance important?

Green finance is a crucial element for maintaining a sustainable level of economic growth. Sustainability requires a lot of financial investment but there is a large share of economies that struggle to finance green activities. Therefore, in these cases, green finance is pivotal in determining the level of sustainability in developing countries. The following are other relevant reasons why green finance is important.

1. Allocation of Capital - Green finance directs funding to projects with positive environmental impacts or promotes the shift to a low-carbon economy. This ensures that financial resources are utilized for sustainable development and addressing pressing environmental challenges like climate change and biodiversity loss. Capital investments in clean energy technologies and sustainable agriculture also drive innovation and technological advancement. This leads to the development of cost-effective solutions, making renewable energy sources more competitive and enhancing productivity in agriculture while minimizing environmental harm.

2. Mitigating Risks: Green finance helps mitigate risks associated with environmental degradation and climate change. Investing in resilience-building measures reduces vulnerability to physical damages, supply chain disruptions, and liability claims from extreme weather events. Incorporating environmental, social, and governance (ESG) factors into investment decisions enhances financial stability. By managing risks associated with unsustainable practices and promoting long-term sustainability, green finance improves resilience to market disruptions and regulatory changes.

3. Contribution to a Prosperous and Sustainable Future: Green finance aligns financial flows with sustainability objectives, fostering economic prosperity, social equity, and environmental stewardship. It plays a crucial role in achieving global sustainability goals and building a resilient, inclusive, and prosperous future for generations to come.

Furthermore, green finance can enhance financial stability by promoting long-term sustainable growth and reducing systemic risks associated with unsustainable practices. By incorporating environmental, social, and governance (ESG) factors into investment decisions, financial institutions can better assess and manage risks, improving their resilience to market disruptions and regulatory changes.

Instruments of Green Finance

Green finance can be traced back to the late 20th century, when the idea of green economies first came into being. When Western countries started experiencing environmental degradation due to rapid industrialization, a need to mitigate these effects was felt. The need for mitigation led to several measures on the part of governments across countries at national levels. The first concrete international resolution toward the green economy was The Paris Agreement of  2015. In this agreement ‘The Green Climate Fund’ was established that served the purpose of a financial instrument for progressing toward a green economy. The Green Climate Fund is the world's largest climate fund, which aims to support developing countries in raising and realizing their nationally determined contributions to reduce their greenhouse gas emissions.

Since then many new instruments for the green revolution have come into being and we have seen many initiatives from governments all across the world in developing various other means for sustainable finance.

As reported by Green Finance Platform, 124 green finance legislations were implemented globally in 2021, representing a significant increase. This indicates that governments across the world recognize the fact their policies must be in line with net-zero goals. The increased number of green finance measures has been driven by renewed international cooperation, as evidenced by the re-establishment of the G20 Sustainable Finance Study Group and the updated climate pledges announced in the run-up to the COP26 UN Climate Change Conference in Glasgow in November 2021.

These governments use a combination of green instruments to achieve their goals. Some of these instruments are discussed below:

· Green Funds: can be described as mutual funds and investment tools that only invest in companies that show concern about the environment and/or consciously try to promote emotional responsibility. The portfolio of these funds is largely based on environmental, social, and governance criteria. The image below shows the data on ESG funds in Europe.

· Green Credit: is an innovative tool used by governments across the world to incentivize voluntary environmental actions across diverse sectors by various stakeholders like individuals, communities, private sector industries, and companies. Countries like India use this instrument to encourage environmentally beneficial activities.

· Carbon credits:  Green credit is often accompanied by carbon credits. Carbon credits are tradeable certificates or permits that set a maximum level of carbon emission for industries, companies, or countries. The global carbon credit market growing steadily. According to Technavio, the market is estimated to grow by USD 1437.52 bn from 2024 to 2028. The image below shows the data estimation.

· Green Bonds: are gaining more and more popularity with the rise of green finance. These are a type of mixed-income investment used to fund projects with a positive environmental impact. They offer a stated return and a promise to use the proceeds to finance or refinance sustainable projects.

· Green Banks: are financial institutions created with the purpose of accelerating the shift to clean energy and net-zero emissions. They help in financing a wide variety of projects that aim to lower carbon emissions by using public money to leverage private capital. They act as a bridge between private capital and the demonstrable public interest in clean energy and sustainable development.

Challenges for Green Finance

Green finance has emerged as a critical tool for addressing pressing environmental challenges and driving the transition to a sustainable global economy. However, despite its potential to bring about positive change, the field of green finance faces numerous challenges that hinder its effectiveness and scalability. Understanding these challenges is essential for developing strategies to overcome them and unlocking the full potential of green finance. Listed below are some of the biggest challenges faced by green finance in today’s time:

· Limited Availability of Investment Opportunities: Despite growing interest in green finance, there's often a limited supply of investment-ready projects, especially in certain regions or sectors. This scarcity can hinder the deployment of capital towards environmentally beneficial projects, slowing down the transition to a low-carbon economy. Along with this lack of standardization and transparency there is another crucial aspect that is the lack of standardized metrics and reporting frameworks for assessing the environmental performance and impact of green finance investments. This opacity can undermine investor confidence and make it difficult to compare and evaluate different investment opportunities, leading to market inefficiencies.

· Financial Viability and Return on Investment (ROI) Concerns: Some investors may perceive green finance projects as riskier or offering lower returns compared to traditional investments. Concerns about the financial viability and ROI of green projects can deter investors leading them to traditional low-risk methods of investments despite the potential long-term benefits for both the environment and financial performance that can result from green investment.

· Policy and Regulatory Uncertainty: Inconsistent or evolving policies and regulations related to environmental standards, carbon pricing, and renewable energy incentives can create uncertainty for investors. This uncertainty may increase perceived risks and deter investment in green finance projects, particularly in the absence of clear and stable regulatory frameworks. The green finance landscape is complex and fragmented, with a multitude of stakeholders, initiatives, and financial products. This complexity can pose challenges for investors in navigating the market, understanding different investment options, and assessing their environmental impact, leading to inefficiencies, and missed opportunities for sustainable investment.

To address the challenges that are faced by green finance, a multifaceted approach is needed. This involves raising awareness through education and outreach campaigns to promote the benefits of sustainable investing. Standardization efforts should focus on developing common metrics and reporting frameworks to facilitate transparent assessment of green investments. Financial incentives, such as tax breaks and subsidies, should be aligned with sustainability goals to attract more investors. Collaboration among stakeholders is essential to streamline efforts and avoid market fragmentation while improving data availability and quality. Additionally, policymakers must provide clear and stable regulatory frameworks to reduce uncertainty and encourage long-term investments in green projects. Investing in technological innovation and research can drive the development of clean technologies, further enhancing the attractiveness of green finance opportunities. By addressing these challenges collectively, green finance can be cultivated into a robust and integral component of the global financial system, driving positive environmental and social impacts.

Conclusions

Green finance stands at the forefront of a transformative shift in the global financial landscape, embodying the integration of economic growth with environmental stewardship. Its importance cannot be overstated, as it channels much-needed capital into projects and initiatives that combat climate change, promote renewable energy, and foster sustainable development. By leveraging a variety of financial instruments—such as green bonds, green loans, green funds, and carbon pricing mechanisms—green finance not only facilitates the transition to a low-carbon economy but also drives innovation and resilience across sectors.

However, the journey towards mainstreaming green finance is fraught with challenges. Standardization and harmonization of green finance definitions and methodologies remain critical issues. The lack of comprehensive and transparent data hampers effective decision-making, while regulatory complexities and market fragmentation pose significant barriers to widespread adoption. Additionally, the perception of risk associated with green investments continues to deter some investors.

Despite these obstacles, the momentum behind green finance is undeniable. With concerted efforts from policymakers, financial institutions, investors, and other stakeholders, these challenges can be addressed, paving the way for a robust and inclusive green finance ecosystem. The potential of green finance to reshape the future of global finance and contribute to a sustainable and resilient world is immense, making it imperative that we continue to innovate, collaborate, and push the boundaries of what is possible.

Autore: Kaur Arashpreet - Caporedattore: Tommaso Topa