Role of sustainable finance in accelerating the clean energy transition
Clean energy has emerged as a critical piece of the puzzle as the world races towards a sustainable future. The transition to clean energy sources like solar, wind, and hydropower is essential for combating climate change, reducing pollution, and securing a sustainable future for generations to come. According to Enerdata, the share of renewables in the global energy production mix remained stable between 2020 and 2021 at 28.1%, above 2019 levels (26.3%). The shift to clean energy requires significant investments in renewable energy infrastructure, including the production of solar panels, wind turbines, energy storage systems, power transmission and distribution infrastructure, smart grid technologies etc. Apart from infrastructure development, other investments are also necessary for a successful transition to clean energy, such as behaviour change campaigns to encourage individuals and businesses to adopt clean energy practices, building energy markets that support the growth of clean energy industries, and subsidies & incentives to make clean energy more affordable and accessible. In addition, policies and regulations that promote clean energy adoption and discourage the use of fossil fuels are also essential to accelerate the transition to a clean energy future.
The upfront costs for adopting renewable energy sources are generally higher than those for traditional ones. Therefore, conventional financing models, typically comprised of debt and equity financing, may not be adequate to meet the funding needs of these projects. That’s where sustainable finance comes in. It is the practice of integrating environmental, social, and governance (ESG) factors into financial decision-making to promote sustainable development and mitigate risks. The role of sustainable finance in accelerating the clean energy transition is pivotal. Sustainable finance can be better understood as a combination of traditional financing with philanthropic donations to deliver desired financial returns while also delivering positive social and environmental outcomes. The key participants in the sustainable finance market are capital seekers and investors. The capital seekers, which include companies, governments, multilateral organizations, and banks, either issue securities such as bonds and stocks (issuers) or borrow money through loans (borrowers) for sustainability projects/ activities. The investors on the other hand are buyers of these bonds or lenders of money through loans.
Many large financial institutions have now made commitments to sustainable finance as evidenced by the number of signatories to the Principles for Responsible Investments (PRI-5,000+ signatories), Principles for Responsible Banking (PRB– 300+ signatories) and Principles for Sustainable Insurance (PSI– 100+ signatories). Sustainable finance can help mobilize capital towards renewable energy projects by leveraging innovative financing models like green bonds, green loans, transition bonds, sustainable equity, green index funds, performance-based instruments (sustainability-linked bonds & loans) and other financing options. By adopting this approach, we can build a future that is more sustainable, simultaneously generating financial benefits and positive environmental outcomes, resulting in a win-win situation for both investors and the environment.
According to a report by BloombergNEF, global spending on low-carbon energy transition witnessed a significant increase of more than 25% in 2021, primarily due to the growth of the renewable energy and electric vehicle industries. The report reveals that the total investment reached a record-breaking US $755 billion, marking a 27% surge from the previous year. These investment figures highlight the robust interest of investors in the technologies that play a crucial role in mitigating the adverse impacts of climate change. Sustainable finance has played a crucial role in this growth, with annual green bond issuance breaking the half-trillion mark for the first time, ending 2021 at US $522.7 billion, a 75% increase on prior year volumes. (Climate Bonds Initiative). However, it is also to be noted that incomplete energy transitions due to a lack of strategically designed approaches have little to no effect on net emissions. For example, providing subsidies to buy EVs, but using charging stations connected to the main grid – mainly powered by coal, diesel, and natural gas. It is important to build a circular ecosystem in renewable energy production and utility to minimize inefficiencies and reach scale faster.
There is still a significant financing gap to be bridged to achieve the necessary scale and speed of the clean energy transition. The International Renewable Energy Agency (IRENA) estimates that US $131 trillion of global investment will be required between 2016 and 2050 to achieve the goals of the Paris Agreement on climate change.
To meet these challenges, sustainable finance must continue to evolve and expand, engaging more investors, creating new financial products, and aligning incentives with sustainable outcomes. Sustainable finance solutions like blended finance, impact investing, and public-private partnerships can help to mitigate risks and unlock new sources of capital for clean energy projects, particularly in emerging markets.