The big headline for COP28 was announced on the eve of the conference by the UN’s independent High-Level Expert Group on Climate Finance.
The first IHLEG report, published last year, estimated the scale of investment needed in emerging markets and developing countries (EMDCs) outside of China to comply with the Paris Agreement and limit temperature rise to 1.5% above pre-industrial levels. was quantified.
It concluded that approximately $2.4 trillion in investment will be needed each year by 2030.
of Second reportThe book, published on November 30th of this year, was predictably depressing. We’re not even close. Actual investment performance on key climate change priorities at EMDC has stagnated.
“While global efforts to tackle climate change are increasing, albeit unnecessarily slow, EMDC faces setbacks and obstacles on all important aspects of the low-carbon transition,” the report said. ing.
why? Because these countries have too much debt.
“The fiscal deficits resulting from the response to the coronavirus pandemic and the current food and energy crisis have left many EMDCs with significant public debt,” the report said.
And in an era of high interest rates, the cost of servicing and rolling over these debts has skyrocketed.
The IHLEG report finds ways to increase concessional financing by five times, significantly expand the role of multilateral development banks, and increase international private finance flows to EMDCs to combat climate change by 15 times current levels. calls for radical action.
There are issues here that are not being discussed in Dubai. The same issues threaten efforts in developed markets as well.
The day before the IHLEG report was published, Olympia Caladori, Margherita Giuzio, Sujit Kapadia, Diriyala Sarakhova and Katya Vojian presented the report. blog The European Central Bank’s website has more concrete and fundamental proposals to solve the same problem.
The authors highlight an analysis of around 4,000 European companies. Many are privately held and almost all are heavily dependent on bank financing, but together these companies are responsible for more than a quarter of the EU’s greenhouse gas emissions and are therefore eligible for EU emissions credits. It is the subject of a transaction. system.
This is a cap-and-trade system that requires polluting companies to pay emissions allowances. The EU is increasing costs by cutting annual allowances, forcing companies to make tough choices. Investing in cleaner production, which may be more expensive, can also improve shareholder returns. Either that or pay more licenses. Death expenses.
There’s a point to this plan, which boutique investment management firm Osmosis Investment Management discovered early on in the aftermath of the financial crisis. More than a decade ago, the company began tracking the resource efficiency of publicly traded companies by scrutinizing their sustainability reports. Osmosis measured the amount of energy and water consumed and the amount of non-recycled waste produced per unit of revenue.
Companies that invest in more efficient and cleaner production are not just greener;It also improves financial returns
Two things emerged that made up the index for cutting-edge institutional investors, primarily Scandinavian pension funds, who were obsessed with sustainability at the time.
Companies that invest in more efficient and cleaner production are not just greener; They also have higher return on equity, higher operating margins, but interestingly lower leverage and better financial returns.
That may be because by the time the improved resource efficiency scores became apparent to Osmosis, the company had surpassed the initial peak in investment spending required to clean up its operations and was beginning to benefit from improved profitability.
The ECB Blog puts a new perspective on this. Yes, for European private companies, the obvious way to finance climate change investments is through borrowing. However, companies that are already highly leveraged are at a stage where their ability to borrow additionally is limited as they struggle to service and repay existing debt.
These companies may struggle to raise the funds needed to invest in low-carbon technologies.
The authors state: “Up to a certain point, companies that are more leveraged, or have become more leveraged, will significantly reduce their subsequent emissions. They are achieving this without restricting economic activity, and they are creating cleaner We are reducing our carbon footprint through production.”
However, there is a tipping point in the relationship between leverage and green technology investment, known as the inverted U curve.
“Once leverage exceeds approximately 50%, further increases are associated with worse performance in terms of emissions reductions,” they write.
Red flags are now flashing for unrated and below-investment grade borrowers in Europe.
Rachel Ward, high-yield specialist at Aegon Asset Management, sees divergence widening in 2024 and says that while many high-yield companies can weather a mild downturn, defaults will rise. .
“We are seeing polarization across the market, and we expect the gap to widen further in 2024. Weak companies with low profit margins and little room for error are most at risk,” he said. said.
Banks are also tightening lending standards. So how can European companies, already close to the debt ceiling, finance their sustainability investments?
Further improvements to the green bond and loan market, including through greater transparency and international standards, could lead to lower leverage as lenders may believe that their loans will improve a company’s profitability and financial stability. This could be one way for expensive companies to borrow money earmarked for green investments. Medium-term borrower.
However, the author has another, much more radical proposal. The whole corporate culture of financing with debt rather than equity is that debt and interest payments are recorded as pre-tax operating costs, while dividends to shareholders are paid out of the remainder of after-tax profits.
They suggest that the availability of climate finance could be increased through tax changes, “such as applying debt financing tax breaks only to green debt.”
The climate emergency is evident all around us. Addressing it will require far more resources than are currently being mobilized. Drastic action is needed to change that. One of the most radical proposals is published on the ECB’s website with the usual disclaimer that the views expressed are those of the authors and “do not necessarily represent” the views of the European Central Bank.
