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February 15, 2024

How the world can fund the trillions needed for net zero

The eye-popping costs of achieving net zero represent a major challenge and opportunity for the financial services sector.

In the news

The world invested a record $1.8 trillion last year installing renewable energy facilities, purchasing electric vehicles and deploying other green energy transition technologies—a 17% jump from 2022, according to research organization BloombergNEF. The achievement befits a year that the World Meteorological Organization calls the hottest on record “by a huge margin.” The rising investment shows the green energy transition has increasingly strong winds in its sails (or maybe in its turbines).

But it isn’t enough. The reported climate finance investment amounts to some 1.7% of global GDP; contrast that with the 7.1% of GDP spent on fossil fuel subsidies in 2022. BloombergNEF believes the clean energy transition will require global investment of $4.8 trillion annually between now and 2030 to put the world firmly on the pathway to net zero.

Even that amount doesn’t cover all the angles. According to the central scenario published in a recent report on climate finance by independent not-for-profit Climate Policy Initiative (CPI), the world currently requires $8.1 trillion per year in climate finance—and that needs to increase to $9 trillion by 2030, then to $10 trillion between 2031 and 2050. That’s the year countries have pledged under the UN Paris Agreement to reach net zero.

This amount would cover not just the transition to clean energy sources but also all forms of mitigation (actions to slash emissions) and adaptation (initiatives to prepare the world for consequences of climate change, such as more frequent droughts and storms).

All this money needs to come from somewhere. In 2021-2022, 51% of climate finance came from public sector institutions, such as national development banks and state-owned enterprises, whereas 49% came from private institutions—corporations, banks and institutional investors.

The Cognizant take

Climate finance is an enormous opportunity for the financial sector and is likely to attract increasing interest from fund managers, insurers and banks in coming years. That will create strong pressure to better harmonize currently fractured sustainability disclosure standards.

As we recently discussed, it will be vital for banks to calculate their financed emissions (those linked to financial companies’ loans and investments) to eliminate those emissions, which poses a formidable challenge. Doing so demands close coordination between financial sector players and invested companies, and between these and their own value chain. Overcoming these barriers will only be possible with ambitious use of technologies such as Internet of Things sensors and data-crunching AI.

Another major challenge is balancing the geographical concentration of climate finance flows. East Asia and the Pacific, the U.S. and Canada, and Western Europe received a combined 84% of all global finance in 2021-2022, according to CPI. The World Bank believes the private sector needs to contribute 90% of climate finance to developing countries (excluding China), but risk sources in these regions can make international investors wary.

An idea gaining prominence in international forums is the Bridgetown 2.0 initiative. This program would involve a new and more ambitious role for the IMF and multilateral development banks to address the currency risk that undermines climate investments.

Other possible solutions may be put forward in the near future. Blended finance, in which private and public investors join forces to back climate-related projects, is also set to increase in coming years.

The world has the financial resources it needs to reach net zero and prepare for the unavoidable consequences of climate change. Using these funds well is a major challenge that requires new thinking—but will create major opportunities for the financial sector and communities around the globe.

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