How Risk, Regulation and Technology are Forging a New Climate Economy

The convergence of key technologies, the existential global risks that climate change present as well as fast emerging government policies are creating a new climate economy. What does this mean? The climate economy means companies creating goods and services which drive decarbonatization. Climate will become the new lens through which all activities are viewed and sustainability will disrupt virtually every sector and industry from manufacturing to transport to energy.

The most obvious example of the climate economy are the wind turbines which increasingly dot the seas, oceans and hills across the globe. But the climate economy is far wider than just renewables, it means any goods and services that reduces greenhouse gas emissions or addresses the impact of climate change. This could mean companies that produce more efficient engines for trucks to firms focused on protecting global forests

The climate Economy is broadly connected to the rise of Environmental, Social and Governance (ESG) investing. The ESG movement attempts to tackle with the broader non-financial risks and opportunities of investing. Currently most economic activity in the modern world is entirely dependent on energy which is primarily supplied by carbon emitting fossil fuels. However, times have changed and now renewable energy can compete with fossil fuels on price, consumers increasingly favour climate friendly companies and government policies across increasingly seek to reduce emissions.

The New Drivers of the World Economy

The next few decades will see climate (decarbonisation) and more broadly sustainability (ESG) become the new driving force of the global economy. All business will eventually have to embrace decarbonisation and sustainability. Three main trends will drive this: technology, renewable energy is cheaper than ever and continues to become more efficient, but also other new technologies such as artificial intelligence (for more efficient decision making), growing meat in a lab and industrial batteries will all drive decarbonisation.

A wave of new legislation and regulation designed to encourage decarbonisation such as the Task Force for Climate Related Financial Disclosures (TCFD), the EU Sustainability Taxonomy as well as national level legislation to fulfil climate targets will shift vast amounts of capital away from carbon intensive activities. Much of this climate will need a new home, which is where new wave of innovative companies in the climate and clean tech fields will emerge as well as existing firms with the ability to pivot to the new reality.

Perhaps above all the climate economy will be sparked by the unfolding reality of climate change, each unpredicted wildfire, each temperature record broken, each mm of sealevel rise will force change onto society and inspire new companies in the Climatetech space and force governmental and geopolitical shifts.

A Grand Opportunity

As the global economy shifts toward decarbonisation the opportunities for Climatetech firms will emerge rapidly. Some parts of the world with more favourable regulatory regimes and a technological edge will become leaders in Climatech. China despites its record emissions is a leader in the Climatetech field. Many US firms so often leaders in innovation have taken up the challenge to decarbonise.

Perhaps the key firms in building the climate economy are those which are still emerging. Start-ups could in time become key drivers decarbonisation through innovation and imaginative use of technological solutions. The new wave of climate investment is looking beyond renewables to transform agriculture, food, mobility and much else beside. For example firms such as Beyond Meat, Impossible Foods and New Wave Seafood are offering plant based meat and seafood substitutes which reduce demand for carbon emitting and deforestation causing meat ocean ravaging seafood.  

Technology Rules

Solar energy has dropped 89 percent in cost over the last decade and wind power has declined by 70 percent in the same period of time. This demonstrates the power of applied technology which is a key element to the success of many Climatetech firms. The climate economy is very much tied to the so called Fourth Industrial Revolution. Like previous revolutions before it promises major improvements in efficiency and huge upheavals in society.

The Fourth Industrial revolution promises a dramatic leap forward in the application of robotics, artificial intelligence, quantum computing and energy storage, as well as the mass connection of society and businesses through the internet of things and 5G.

These new developments bring huge global risks such as the increasing exposure of infrastructure to cyberattacks. But also major benefits, more efficient storage and distribution (through smart grids) of energy makes renewables more hugely more attractive, overcoming their traditional limitations such as windless days and night time. Artificial Intelligence advances can help humans monitor climate change risks such as deforestation as well as providing more detailed and accurate predictions and simulations of climate change.

Other new technologies will also prove vital in the decarbonisation. These include industrial batteries for storing energy, energy efficiency measures (such as more efficient home appliances), cutting edge energy such as hydrogen as well as the electrification of cars, planes, trains, ships all of which will ease the move towards decarbonisation.

Services that employ technology such as those which measure climate risk, carbon trading platforms, measurement of ESG risks and measures will all have a part to play helping service the climate economy.

The New Regulatory Framework

The EU has led the way in providing a regulatory framework for decarbonisation, countries that follow can grow and nurture the climatetech firms of the future.

Nations like Russia are likely to favour a rearguard action and continue backing oil, gas and coal for as long as possible in the hopes that the shift to renewables will be slower than hoped. Others like Saudi Arabia can hedge their bets – able to host vast solar arrays in empty deserts and even become an innovative exporter of blue hydrogen while remaining a major oil producer.

The Task Force for Climate Related Financial Disclosures is designed to push Banks into diverting financial resources into climate safe investments. By identifying the assets at most risk from climate risks in terms of either physical or transition risks banks can avoid projects exposed to climate change. The G7 recently moved towards making TCFD reporting mandatory.

This mass movement of capital will impact over time oil and coal producers who will be unable to access capital as it becomes clear that investing in these industries is not only environmentally damaging but also financially unsustainable. The launch of the TCFD has given rise to a new similar piece of regulation which attempts to measure the financial impact of biodiversity loss.

The EU has recently published its long-awaited sustainability taxonomy which will clearly define which economic activities contribute to decarbonisation. This will make it clear to investors which companies are backing climate friendly projects and which favour carbon intensive activities.

Carbon pricing or emissions trading is another instrument of change. Putting a price on carbon encourages polluters to reduce emissions. The EU is planning to extend its scheme beyond large firms to buildings and transport. This does risk a backlash if users are landed with big bills to reflect the cost of change.

Geopolitical Winds of Change

China’s Belt and Road Initiative (BRI) was built partly so China could secure oil, gas and raw materials such as iron ore, all key to Chinese economic development. The rise of the climate economy could mean geopolitical battles for materials such as cobalt, copper and lithium all vital to develop electronics, batteries and cleantech (A wind turbine uses 4.7 tonnes of copper). This will be mirrored by the fall in use for fossil fuels and materials associated with that industry.

The Next Wave of Government Action

The United States has new impetus with a major decarbonisation plan for the US aiming at a 50 percent reduction on 2005 levels of carbon and international financing for decarbonisation of developing countries is underway. This legislation alone may spur other countries onto more ambitious plans. Perhaps the most critical achievement of the plan will be the demonstration effect.  

The US and other climate action leaders need to show and prove that societies and economies can continue to thrive in spite and because of decarbonisation. The success of these plans will help dispel doubts and excuses for countries still planning a fossil fuel future who can take up new targets with confidence of a positive outcome.

China Laggard and Leader

China is home to 40 percent of solar capacity and roughly one third of global wind power. Its bus fleets are nearly all electric and it is a world leader in terms of electric vehicles being sold. Solar prices have dropped 80 percent wind turbines while lithium batteries have dropped one sevenths of the cost compared to a decade ago. On these terms China is global climate leader.

This claim comes with a major caveat: China is doing little in the short term to decarbonise. The country remains hopelessly hooked on coal and oil imports to power an economy rapidly rebounding from the shock of Covid. China has promised to cap carbon emissions by 2025 but for this to happen needs to rapid uptake of renewables, energy efficiency measures and a major unprecedented scaling down of coal use.

Countries that fail to embrace the climate economy will face a number of risks: failing to keep up with international regulation like the TCFD and EU Taxonomy leaves them open to transition risks. Continued focus on fossil fuels for countries like Indonesia, Russia, China and Iran make the shift to renewables harder and more painful when it does inevitably happen.

The Shift has Started

There is a long road ahead before the climate economy is a reality. The companies and countries that forge ahead with change now are likely to be the winners. Companies that fail to embrace new green regulation, ignore public sentiment and growing climate risk and geopolitical change will see themselves fall behind and increasingly out of sync with fast changing times. For start-ups and new ventures focused on decarbonisation the next decade will be a golden era for growth as the climate economy picks up momentum.

Quick Guide: The EU Taxonomy on Sustainable Finance & why it is Important

Why Create a Taxonomy?

The 2015 Paris Agreement and 2030 Agenda for Sustainable Development were created to tackle the major global risk – climate change. But these agreements created a problem. Plans to decarbonise economies had to actually be put into action. So the EU Commission developed the Action Plan for Sustainable Development and then the Technical Expert Group (TEG) on Sustainable Finances to tackle this issue.

The TEG set to work and developed the Taxonomy on Sustainable Finance. The Taxonomy creates a shared language, a lingua franca for investors, governments, policy makers and anyone else interested in defining sustainable activities.

This emerged into a pack including the EU Taxonomy Climate Delegated Act which came into force in April 20201 as well as a Corporate Sustainability Reporting Directive, These along with another a further delegated act will define the technical criteria for identifying the economic activities which contribute to climate change mitigation.

The Green List

Described as a “Green list” or classification scheme for sustainable activities as well as a pioneering piece of legislation. The Taxonomy will create a common language and principles for firms and investors around green investing. It will be a living document designed to change overtime to adapt to new circumstances. The Act is part of efforts to enact the EU’s Green New Deal which promises to shift the EU to a more sustainable future.

The Taxonomy dodges (for now) some critical issues such as nuclear power, natural gas and the climate impact of agriculture. Despite these shortcomings it represents a major milestone in driving Environmental, Social and Governance (ESG) driven investment. It is also likely to influence other nation’s legislation and standards as well as being used by investors across the world as a reference point and guide for their own investing plans.

The Taxonomy lists six environmental objectives which economic activities must help achieve:

1. Climate change mitigation (aka reducing greenhouse gas emissions).

2. Climate change resilience & adaptation (helping the world adapt to a changing climate).

3. Sustainable use and protection of water and marine resources.

4. Transition to a circular economy, waste prevention and recycling.

5. Pollution prevention and control.

6. Protection of healthy ecosystems.

An activity must contribute to at least one of the above points and do no harm to the others in order to be eligible for the criteria. Interpreting the full text of the legislation is likely to keep ESG financing experts, lawyers and environmental specialists busy for a long time.

Who should Use the Taxonomy?

The Taxonomy will be used by banks, insurers and other financial institutions that want to invest in sustainable activities and companies.

How will Users adopt the Taxonomy?

  1. Identify the activities conducted by the company, issuer or covered by the financial product (e.g. projects, use of proceeds) that could be eligible.

2. For each activity, assess whether the company or issuer meets the relevant criteria for a substantial contribution e.g. electricity generation <100g CO2 /kWh.

3. Verify that the Do No Significant Harm (DNSH) criteria are being met by the issuer. Investors using the Taxonomy would most likely use a due-diligence like process for reviewing the performance of underlying investees.

4. Conduct due diligence to avoid any violation to the social minimum safeguards stipulated in the Taxonomy regulation (article 13).

5. Calculate alignment of investments with the Taxonomy and prepare disclosures at the investment product level.

What Information do investors need

Investors will need data about company or issuer performance on the Taxonomy activity criteria for the taxonomy to operate. Data markets will take time to develop as issuers and ESG research and rating companies gather information and data. The data will need to include:

A. Revenue breakdown by Taxonomy – eligible activities, or expenditure allocation to each Taxonomy criteria.

B. Performance against the technical screening criteria, or environmental management data where this is an acceptable proxy for compliance with the technical screening criteria – including DNSH assessment.

C. Management data on social issues: Labour rights policies, management systems, audits, reporting.

Asset managers will then use this investment to create sustainable products and portfolios which will be able to state their levels of sustainability

Sustainable Finance Disclosure Regulation

This information can then be used to demonstrate which products are “light green” (partially sustainable development as objective) or those which are “dark green” – investments contributing to an environmental or social investment.

What do Companies Receiving Investment have to do?

Large or listed firms will have to report on their sustainability risks, the impact of their business on climate and the impact of climate on their business. Firms will have to report what percentage of their future revenues and current activity is aligned with the Taxonomy.

This information will go to investors (see above) who can then use the information to develop financial products and identify in a transparent manner how green firms and financial products really are. This in turn will help the buyers of financial products, shareholders and other stakeholders to get a firm grip of how green their portfolio is.

What Comes Next?

Now the Taxonomy has been published it will come under a great deal of scrutiny as it is a major tool in delivering the Green New Deal. Firms have to start publishing their percentage of their activities which are Taxonomy aligned as soon as 2022.

Doubtless there will be arguments on what should and shouldn’t be included (for example there is a relatively relaxed view on burning wood). The true test will be how much it encourages investors to back sustainable investments. In order to meet the target of carbon neutrality by 2050, there needs to be roughly EUR 1 trillion in sustainable investment a decade. The Taxonomy needs to help investors by establishing a transparent sustainable finance market, free of greenwash for this to be achieved.

The other major achievement may be geopolitical. The Taxonomy could provide an impetus and model for other countries to create similar or complementary legislation, this could be neighbouring UK, the USA, China and Japan. If other countries follow suit this could give sustainable finance the boost it needs to help to truly decarbonise the global economy.