How can investors best position their portfolios to take advantage of the historic transition from fossil fuels to renewable energy? That was the question at our recent Capital for Climate Action EMEA Conference, which gathered owners and managers of assets, lenders and companies to address both the opportunities and ongoing challenges that define this critical moment in the low-carbon transition.
Discussion centered on assessing the readiness of companies for a net-zero economy, the growing role of private assets in financing the transition, and the promise of artificial intelligence (AI) to accelerate climate finance and investment. Here are some of the biggest takeaways from the conversation, which highlights that climate is no longer just a risk for the future but also an opportunity to invest now.
Financing decarbonization and financing the transition
Investors and financial institutions are investing in the climate transition and scaling sustainable finance, participants stressed, noting there is real money to be made (or lost) right now. Utility companies in the U.S., for example, are on track to install more capacity to produce power from low-carbon sources than natural gas by the end of this decade.
- The market for green bonds, meanwhile, “is larger than the U.S. high-yield market,” noted David Oelker, BlackRock’s head of ESG investment for fixed income in EMEA, who cited estimates of a USD 7 trillion annual gap in climate finance. “It’s truly enormous,” he observed, adding that “fixed income has a tremendous role to play.”
- Net-zero means different things to different investors depending on their strategies and aims, observed Jenn-Hui Tan, chief sustainability officer at Fidelity International. They may be looking to reduce real-world emissions, to influence the pace of private-sector decarbonization, to reduce their exposure to high emitters in their portfolios on an absolute basis, or, most commonly, to integrate climate physical and transition risk, he noted. “All are valid reasons to see a net-zero objective in your portfolio, but they are not the same thing,” Tan explained. “Managing climate risk is not the same as managing climate impact.”
- Tan’s observation echoes recent research by MSCI that shows how a blend of decarbonization and transition-financing strategies will be instrumental for investors aiming to meet their climate objectives without sacrificing financial returns.
The power of incentives
Though change will not happen overnight, “we need to make sure that it’s in our enlightened self-interest that we finance business and industrial strategies that can sustain themselves because climate and the degradation of nature is impacting our economy,” stressed Dr. Rhian-Mari Thomas, OBE, CEO of the Green Finance Institute, in a keynote conversation.
- Thomas outlined a series of mechanisms for spurring deployment of capital for climate action. “You start off with a carbon price,” she suggested. “If there were a green bullet it would be pricing carbon correctly.” Still, the imperative to address climate change is not going away, she noted, outlining a series of priorities that include clearing regulatory barriers to investment, developing policy such as the U.S. Inflation Reduction Act that incentivizes private investment in low-carbon infrastructure and clean technologies, and encouraging creativity, citing the hiring of engineers by insurance companies to improve the insurer’s understanding of climate risk. “As we start seeing the realities of a changing climate, we are going to have to act, so it’s in our own self-interest to get ahead of that,” she said.
- “I’m hopeful nobody leaving this room needs to ask whether there is a trade-off between climate and making money,” suggested Vikram Raju, head of climate investing for private credit and equity at Morgan Stanley, noting that the fee he and his colleagues earn for operating their climate private equity strategy comes half from the ability of the fund’s portfolio companies to remove greenhouse gas emissions from the atmosphere and half from making money. “That is the litmus test,” he added. “Someone should want to buy the product irrespective of the green label.”
- “We have to bridge between the financial-return story of renewables and the story of climate impact,” agreed Abdulla Zaid of MSCI Research, citing his recent finding that exits by private equity groups from renewables have yielded higher returns than exits in oil and gas in seven of the past eight years. “This incentivizes both climate-focused investors and investors with no climate mandate, thanks to the financial return.”
- “Net-zero in most cases makes good business sense because the marginal cost of renewables is many times lower than the cost of fossil fuels,” Tan noted, emphasizing the power of incentives in the stewardship of portfolio companies.
- At the same time, “as an investor, the risk you will take is the risk you are paid to take,” he observed, adding that “high carbon emissions can actually be a good financial investment because of the broader environment we find ourselves in.”
- “As countries work this year and early next to update their national climate plans, they have an opportunity to lay out ambitious plans that will help provide clarity, reduce uncertainty and attract investment to their countries,” said Nigar Arpadarai, UN Climate Change High-Level Champion for COP29, who in a recorded message noted that regional platforms for climate projects are designed to catalyze both public and private investment.[1]
The power of data and the importance of private assets
“Forceful stewardship,” underpinned by data, is absolutely critical, Thomas stressed. “I would ask that we bring this down to a tangible requirement: Just how much capital expenditures and R&D are actually aligned with a below 2-degree trajectory,” together with a review of companies’ lobbying “to address the divergence between words and actions.”
- The growth of more demanding climate disclosure is helping banks sharpen their deployment of capital, reported Caroline Haas, head of climate and ESG capital markets at NatWest. “It means we are looking at our own assets very differently and have much more knowledge to track the impact and have much more sustainable finance,” she noted.
- Investors in private assets “are seeing positive steps in terms of data availability though disclosure still lags significantly behind the public markets,” noted Michael Viehs, global head of sustainable investing at Partners Capital, adding that developments like the ESG Integrated Disclosure Project and providers such as MSCI play a constructive role.
- In private markets, “disclosure is the elephant not in the room,” Zaid agreed, citing data from MSCI showing that just 2% of companies in private-capital funds reported their Scope 1 and 2 emissions as of the second quarter of last year.
- Franck Rizzoli, head of ESG financing advisory at BNP Paribas, noted that he and his colleagues advise private companies to prioritize disclosure of data that holds relevance for investors. At the same time, “the data needs to be relevant to the investor but also to the issuer,” he said.
- Green bonds, by design, yield data that informs decision-making, noted BlackRock’s Oelker, describing transparency that includes “the amount of insight into projects that you get from issuers and reporting of how money has been spent.”
- Oelker and his colleagues “look for similar factors that an equity investor might look for, including transition plans” together with factors that influence borrowing costs. “Green bonds allow us to look at the project level and differences in warming among assets,” he added.
- Raju stressed the value of clarity, citing his fund’s strategy of investing in growth-stage companies that will seek to collectively avoid or remove one gigaton of greenhouse gas emissions from the date of investment through 2050, adding that the fund encourages investors to independently evaluate the amount of emissions reduced. “Limited partners don’t have to take my word for it,” he said.
- Zaid reported that a recent review by MSCI Research of funds with climate-themed names found that investments in technology companies dominated public-company funds while their private-company counterparts invested more heavily in renewables. The findings highlight differences among funds with similar names and “demonstrates the role that private capital could play to close the financing gap in the energy transition,” he noted.
The promise of artificial intelligence
The biggest challenge for AI in climate finance and investing comes down to reliability, quality and trustworthiness of data, according to a poll of the audience, 70% of whom said they are “cautiously optimistic” about the financial sector’s ability to leverage AI this decade.
- Though AI remains in an early phase that suggests caution in using the technology in investment decision-making, the use of generative AI itself is producing efficiencies, stressed Budha Bhattacharya, head of systematic research at Lombard Odier, citing AI’s ability to lower the cost of functions ranging from customer relations and sales to marketing, as well as the value of machine learning and regression analysis in gathering information. “We also get a lot of investment signals from using AI for extracting data,” he noted, citing its use in extracting data from publicly available documents that can illuminate decisions on whether to buy bonds issued by a sovereign.
- AI lends itself to tasks such as extracting data from text, but the technology has yet to find its footing in causal reasoning, explained Markus Leippold, a professor of financial engineering at the University of Zurich, senior chair of the Swiss Finance Institute, and a part-time visiting researcher at Google DeepMind. “AI can do common-sense reasoning, but causal reasoning still requires a human,” he noted.
- Leippold cited a series of open-source prototypes developed by him and his colleagues that illustrate how AI can help with both extracting data and combating misinformation: ChatClimate, a conversational AI prototype that uses information from the latest series of reports by the UN Intergovernmental Panel on Climate Change to provide timely access to reliable information; ChatReport, which uses generative AI to analyze the data in corporate sustainability reports; a tool that uses AI to assess the credibility and ambition of corporate climate plans; a cheap talk index that quantifies the share of superficiality in companies’ climate commitments; and Climinator, which is designed to combat misinformation by fact-checking claims.[2] “Generative AI is both a blessing and a danger in its ability to generate and present information,” he said.
- Bhattacharya predicted that concerns over data quality would resolve over time and said he anticipates that AI will add nuance and accuracy to predictive analytics such as models for quantifying catastrophic risk and illuminating areas in climate finance such as private companies “that we need light shed upon.”
- “I see MSCI being the flag holders of change for this new world,” he added. “You are sitting on the data. You can provide us with insights that will be truly game changing.”
