SAN MATEO, CALIFORNIA – The atmosphere at the end of the United Nations Climate Change Conference (COP27) last November in Egypt was sobering. The Russian invasion of Ukraine forced countries to switch back to thermal coal and other fossil fuels for energy needs, and this is likely to lead to postponing the transition to a net zero emissions economy; but COP27 also highlighted the need to harness public policy, regulation, and technological innovations to achieve a climate-secure future.
It is now abundantly clear that supporting climate-related projects around the world at the scale required will require an immense amount of capital. According to estimates by the International Energy Agency, the transition to clean energy alone will cost trillions of dollars a year (even without considering loss and damage, especially in developing countries). The all-important deal reached at COP27 to create a fund to help low-income countries deal with the worst effects of climate change suggests that world leaders are aware of the situation.
But the capital coming from donations and from the multilateral development banks will not be enough, the private sector must also participate. So far there is no clear path to unlocking the vast potential of the world’s capital markets. There are, however, good reasons to remain hopeful.
First, governments have made significant progress in ensuring better quality data. In March, the US Securities and Exchange Commission proposed requiring some companies to disclose information related to the risks they face from climate change, in line with last year’s global directive from the European Union, which refined the framework you have been using for a long time. The China Securities Regulatory Commission proposed similar measures a few months later. High-quality climate data from the three largest economic blocs would allow investors to assess the inverse relationship between risk and return of sustainable technologies.
But while those analytical tools play a critical role, investors also need incentives. This is where carbon pricing and taxes come into play. Even though this is a European measure, the recently agreed EU carbon border adjustment mechanism is likely to have a global impact, as countries that export goods and services to Europe will soon realize that reducing its carbon footprint will be beneficial to trade. While the new Inflation Reduction Act does not itself impose a carbon tax, it pushes the United States in the direction of carbon pricing by providing incentives for clean energy and climate-related spending (such as carbon capture). , carbon use and storage).
These positive developments – the result of cooperation between policy makers, asset owners and investors – will accelerate the growth of local and global carbon markets. Although their markets currently cover less than 25% of global emissions, the Africa Carbon Markets Initiative launched at COP27 is another major development, as are the national carbon markets implemented in countries like China and Singapore.
The conversion of investors to the climate cause offers another reason for hope. Asset owner coalitions, such as Climate Action 100+, and asset manager alliances, such as the Net Zero Asset Managers initiative, represent nearly $70 trillion in assets. And more than 600 investors (of which we are part), with more than 40 trillion dollars in assets, signed the Global Investor Declaration at COP27 to promote policies that allow a just transition to a low carbon economy.
This increased activism among investors reflects a goal that we all share, regardless of our nationalities or political affiliations: financial profitability. It is in the interest of all parties involved to capitalize on the growth potential of climate solutions, which is why recent efforts to politicize environmental, social and governance goals have proved so counterproductive. Sustainable investing is not about defending certain values, but about creating value.
When investors have useful information and the right incentives, we can let the capital markets do what they do best: allocate capital at scale; But first, policymakers need to focus on the extremely real business opportunities for climate solutions, rather than specific agendas based on outdated terminology. The recent decision by the US Department of Labor to reverse restrictions that prohibited retirement trustees from considering environmental, social and governance (ESG) criteria is a step in the right direction.
The powerful combination of sustainable finance and rapid innovation in climate technologies could accelerate the transition to carbon neutrality. If we finance nuclear, wind, solar and geothermal energy, as well as clean energy storage technologies – such as reversible hydroelectric plants and thermal storage – we can achieve that the production of electrical energy – which currently represents more than a quarter of greenhouse gas emissions – be more sustainable. And by accelerating the development of green hydrogen technology we can solve the problem of intermittent renewable energy and avoid the need to improve electricity grids.
Although the war in Ukraine hampered the transition to a low-carbon economy, it also highlighted the need for energy and food security. Shutting down an oil or gas pipeline, after all, is much easier than preventing the sun from shining or the wind from blowing. But to create sustainable and resilient systems, countries and companies must invest in energy efficient infrastructure and sustainable agriculture. Of course, some of these climate solutions are still not cheap, but with time and support from governments, and with growing interest from the capital markets, the technologies can be scaled up and become more affordable.
The challenges ahead may seem daunting, but there are reasons to be hopeful. Global climate investment is on track to exceed $915 billion this year, up 13% from 2021. By continuing to activate capital markets, we can allocate resources where they are needed most, achieve a net-zero economy, and mitigate the worst effects of climate change.
*Chris Bradley is a Director of the McKinsey Global Institute and a Senior Partner at McKinsey & Company in Sydney and Marc Canal Noguer is a Fellow of the McKinsey Global Institute in Barcelona.
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