Location and granularity may be the new mantra in assessing climate risk.
That was among the top takeaways from a conversation at Climate Week NYC hosted by MSCI that convened key leaders from across capital markets to examine a series of critical issues in the transition to a low-carbon economy.
The conversation, which was governed by Chatham House rule to encourage candor, unpacked how investors are financing the shift to a clean-energy economy, considered how AI can accelerate climate finance and revealed why the road to net-zero runs increasingly through private markets.
Transition finance in focus
Financing the transition to a low-carbon economy means different things depending on whether institutions are investing in transition solutions or driving high-emitting companies and sectors to decarbonize.
- “We have not signed a net-zero pledge because of the shift from portfolio decarbonization to real-economy decarbonization,” observed one panelist. “Merely decarbonizing our portfolio does not affect the real-world risks that impact all the investments in our portfolio.”
- “We are working on the transition across asset classes,” another commented. “We made net-zero commitments because we believe the transition presents a historic transformation that will impact how we deliver returns.”
- “The way we approach the transition is asset specific,” explained a third panelist, noting that even within infrastructure investing, the transition means one thing for utility-scale renewables and another for ports and airports, for example. “It’s very specific for each asset type,” he said.
Opportunities in fixed income
“We see lots of opportunities in public fixed-income markets to invest in the transition,” said one panelist. “We see a lot of value in working with issuers to structure new and innovative impact bonds that provide transparency, based on direct, measurable impact.”
- “We approach it from a return perspective first,” another panelist echoed, adding that his institution had developed a mandate for bonds that are earmarked for transition finance. “The idea is to finance the shift, which will also mean increasing the supply of energy,” he noted. “Even if we can scale up renewables, we need fossil fuels that currently provide the bulk of energy, but we also need to help companies that rely on them to reduce the carbon intensity of their business.”
A pivotal role for private assets
Panelists agreed on the growing importance of private assets in financing decarbonization and the energy transition. “We need more transition capital,” one noted. “The move will be messy and complicated. There might be a transition fuel from coal to renewables that differs across regions. Private capital is the creative capital that can be there.”
- “We’ve spent years educating portfolio managers, getting them comfortable that the low-carbon transition is material to their investment portfolios, and to help them incorporate climate risk,” another panelist stated. “It’s harder to do in the private markets but very important such as in real estate for example.”
- “Private markets offer the opportunity to front-load net-zero commitments,” one panelist suggested. “You can use corporate credit and other assets to incentivize companies in the mid-market, for example, to accelerate decarbonization in the near term.”
- Private capital is increasingly financing opportunities for decarbonization and climate solutions that are unavailable in the public markets, said panelists. “Transition is not a dirty word anymore,” one opined.
- The data suggests as much, added Abdulla Zaid of MSCI ESG Research, who noted that exits from renewables by private-capital groups have yielded higher returns than exits from oil and gas every year between 2016 and 2023. “In private funds with a climate focus, we’re seeing more exposure to renewable energy compared with such funds in public markets, which invest more heavily in information technology, highlighting the role that private capital can play in financing decarbonization,” he added.
Strategies unique to private markets
Panelists agreed on the importance of fundamentals whether investors are financing the transition via public or private markets.
- “Not all solutions will come through the public market,” said one panelist. “Our definition of private credit is predominantly investment grade. If an investment is going solely into a climate fund, the question is why. It has to be good enough for any fund. You need to bring in your entire investment team.”
- “We’re investing in solar, wind and electric vehicles through the public markets, and in carbon sequestration and nuclear in places where private capital is really needed, through our private portfolios,” explained another. “This can’t just be a niche thing on the side.”
- “Having transition themes be part of the opportunity in private markets are making the market grow,” one panelist noted. “We see that in companies coming to us for growth financing that are advertising their science-based net-zero targets.”
- “Different funds are doing different things,” Zaid observed, noting that infrastructure funds dominate investment in renewable energy, while buyout and venture-capital funds, respectively, lead in investments in both green mobility and energy storage. Differences among regions have emerged as well, he added. “You can’t compare a venture fund in APAC with a buyout fund investing in North America.”
- “Some sustainability teams are going to have to get comfortable speaking with counterparties they’ve not traditionally spoken with,” commented one panelist. “Energy companies with the most capital are investing in carbon capture and are the most investable from a credit-risk standpoint.”
Challenges
Geopolitics presents a key challenge, one panelist noted, citing as an example competition between the U.S. and China for rare earth metals. “We’re seeing parallel development of technologies but unwillingness to share technologies,” he said.
- Dealmaking has slowed, shared another. “We’re seeing about half the value of deals this year than we did in 2020 and 2021, and deals are taking twice as long to close,” he noted.
- Policy adds to uncertainty too, added another. “We were happy to see the Inflation Reduction Act passed but we need to see similar policies in every economy where you have a need to decarbonize.”
- A rise in physical risk creates its own kind of uncertainty, one panelist commented, citing how changes in weather that diminish the availability of hydropower can slow efforts by some utilities to eliminate coal from their energy portfolio.
The outlook
Panelists agreed that the sheer scale of the low-carbon transition creates opportunity. That includes investment from investors whose strategies may not explicitly address sustainability.
- “Climate-minded investors who are quick to the draw have even greater opportunity because the transition will represent such a massive flow of capital,” one noted. “You will see a huge wave of interest and activity coming from investors, including in emerging markets. I feel excited about that.”
- “We are seeing how the transition is permeating companies,” shared another. “From top to bottom, from operators to senior management, people are contributing to this.”
- “Despite the political rhetoric in the U.S., we know what needs to be done,” one panelist commented. “I am hopeful that companies will continue to shift toward the transition, and that we can drive capital in a way that’s beneficial for our stakeholders while addressing the critical issue of climate change.”
Physical risk in focus: Location matters
Investors, bankers and insurers are all increasingly using location-specific data to sharpen their view of climate-related physical risk, stressed panelists, who discussed the value of geospatial asset intelligence.
- “We care about location because it means we can price risk appropriately,” explained one panelist. “The more data we have about the uniqueness of a place, the more we can assess the risks and opportunities associated with it.”
- “Risk varies whether you’re talking about properties or people,” stressed another. “Insurers want to understand wildfire or flooding risk. We can use data to account for and price these risks.”
- “As soon as we bring nature into the conversation, location matters tremendously,” observed one panelist.
- “The overlap between climate and nature is important,” another noted. “Sequestering carbon in the Amazon rainforest differs from sequestering carbon in Scotland.”
Granularity and uncertainty
Location especially matters in assessing flood risk, panelists agreed. “Flooding is spatially complex, which means you can be wet here and dry over there. You need to know the flood risk at both ends of an Amazon warehouse,” one explained.
- Because all flooding is local, the modeling itself demands high-precision data, the panelist added. “That’s why flood-modeling has historically lagged analysis of other exposures,” he noted.
- Geospatial data “is accelerating the nature element of the metrics we need to sharpen a portfolio view,” added another. “You can’t have a climate plan and a nature plan. They have to be one plan.”
- “You can’t think about the carbon-credit market without granularity,” someone added. “MSCI is assessing carbon credits, for example, based on geospatial data and satellite imagery.”
- “The challenge is to be transparent about uncertainty in building models, so you can understand why models will give us different answers over time,” one panelist noted.
- “Get comfortable with uncertainty,” another panelist agreed. “No matter how good the models are, you still need a probabilistic answer to climate risk.”
How AI is accelerating climate finance
“We are seeing the power of AI to accelerate action and unlock new ways of processing data,” said Naomi English, MSCI’s head of climate strategy, who moderated the panel, noting that MSCI is using AI to build datasets, assess the integrity of carbon projects and measure emissions across asset classes.
- “AI is helping us analyze data for corporate finance and easing our ability to generate and distribute data,” said one panelist, who added that AI also allows his firm to “make the volumes of research we publish digestible to someone who may not be an economist by training.”
- “AI changes by an order of magnitude the efficiency of extracting decision-useful climate data,” observed Pooja Malpani, MSCI’s head of ESG and climate engineering, who explained that AI comprises machine learning (including natural language processing), deep learning (finding patterns in vast amounts of data) and, at its core, generative AI, which refers to unsupervised learning by a machine to generate new content.
AI’s contribution to climate solutions
Generative AI is helping banks incorporate companies’ sustainability performance into decisions about creditworthiness, shared one panelist, who described how prospective borrowers answer questions about sustainability that augment the information contained in credit ratings. “AI allows for consideration of more unstructured data for insights,” she observed.
- AI is also helping banks who want to finance decarbonization assess, for example, the carbon footprint of farms using geospatial data that can surface opportunities to reduce emissions from agriculture, the panelist added. “The information provides insights for the farmers, while informing the bank’s assessment of both its financed emissions and opportunity,” she explained.
- “It’s early days for AI impacting climate finance in ways that will be transformative,” suggested someone else. “If you believe that we have solutions that we just need to deploy, then AI can do a lot,” he said. “But if you think we need a step change in technology, I don’t think AI is ready for that.”
- MSCI’s GeoSpatial Asset Intelligence leverages AI and the Google Cloud to provide location-specific data on 70,000 listed and unlisted companies with more than one million asset locations, Malpani noted.
- AI holds particular promise for both the energy grid and for repricing assets to reflect climate risk, panelists agreed. “AI will be important for getting the grid capable for renewables and storage,” one stated.
Responsible (and environmentally sound) use of AI
While the European Union regulates the use of AI, the U.S. and other countries currently do not, participants noted, leaving companies to develop policies for using the technology responsibly.[1]
- “Our clients are articulating a risk appetite,” shared one panelist. “Some institutions have no-fly zones — such as don’t use generative AI without humans in the loop — with clear governance,” she noted, citing opportunities for firms to integrate responsible use into risk management, policies governing data and culture.
- Panelists expressed varying views on the impact of power-hungry data centers. “I worry there’s an element of alarmism here,” said one, predicting that demand for clean power will accelerate decarbonization. “For technology companies, AI is all of a reason to spend money on mitigation and absorb the green premium,” he suggested. “I agree that AI can be used to identify climate solutions but today the reality is that it has a disproportionate environmental impact,” observed Malpani.
- “We have means of managing the energy demands of data centers,” one panelist claimed. “One is to recognize that we don’t need AI for every task,” she offered, suggesting that everyone think about the data they actually need to keep. “We can use the data we have more efficiently.”
- Panelists offered their advice for leveraging AI to accelerate climate finance. “Experiment a lot,” Malpani advised. “It’s too early to get married to a single model or company.” “Train people to be fluent in using generative AI,” proposed another panelist. “The younger people in our firm are the ones who are suggesting the most innovative ideas,” noted another. “Be open to them.”
Conclusion
Investors say they are seeing the power of location-specific data, AI and private assets to drive decarbonization and accelerate action. Action (and more of it) will be urgently needed if society is to tackle the climate crisis which, as the conversation at Climate Week NYC reaffirms, is triggering what may be the largest reallocation of capital and repricing of assets in history.