The Future of Green Finance and Impact Investment

January 09, 2022

Green finance and impact investment are not emerging concepts, and the study of social responsibility and governance is well established in the investment industry. Following the official announcement of the Chinese government’s peak carbon and carbon neutrality goals (double carbon goals) in 2020, carbon finance concepts are once again receiving widespread attention. This attention has also gradually penetrated into various concepts in the broader ESG investment space.

The Chinese government’s expectations for carbon neutrality are not limited to only the green transformation of China’s traditional industries, but they also include the further industrial upgrading and social modernization that can be achieved by advancing the green transformation of the economy. At the same time, the concept of impact investment is gaining more and more attention as it has had a very positive impact on advancing China’s new economy and high-quality growth goals.

In my view: high quality equals new economy plus ESG.

Firstly, the double carbon goals will bring huge investment opportunities, especially in the transformation of the “brown industry” that accounts for a huge proportion of China’s industrial market.

According to forecasts by the National Development and Reform Commission, Tsinghua University, CICC and Caixin Insight, achieving “carbon neutrality” by 2060 will require more than 140 trillion yuan ($21.9 trillion) in new green investment. By industry, electricity, transportation and construction will have the greatest need for green investment.

Secondly, the carbon emission trading market will continue to grow, becoming one of the main forces in promoting carbon emission reduction and financial innovation.

In 2005, the European Union first announced its Emissions Trading Scheme (ETS), which is a carbon trading mechanism established in accordance with EU decrees and national legislation. Currently, it is the carbon emissions trading market with the largest number of participating countries and the largest transaction volume in the world. In terms of market scale, the carbon trading volume of the EU’s ETS was around 169 billion euros ($193.4 billion) in 2020, accounting for 88% of the global carbon market. In terms of emission reduction effects, the EU’s carbon emissions in 2019 were down 23% from their level in 1990.

China has established eight local pilot carbon trading venues for Chinese Certified Emission Reductions (CCER). In 2021, the country also set up a unified national Chinese Emission Allowance (CEA) market with a dual trading center structure in Wuhan and Shanghai.

The carbon finance market system is similar to that of traditional financial markets, in that it includes trading, financing and support systems, and the trading system also consists of both primary and secondary markets. It is worth looking forward to the programs and initiatives that will be introduced in terms of compliance management and product innovation.

Thirdly, green investment should be combined with research into carbon-negative technologies to help cultivate low-carbon industries.

One of the core objectives of carbon neutrality is to promote the development and application of carbon-negative technologies. The route to “carbon neutral” technologies is made up of two technical paths: “subtractive” and “additive.” The first refers to the reduction of carbon dioxide emissions (supply-side emission reduction and demand-side emission reduction), while “addition” refers to increasing the amount of carbon absorbed by CO2.

These different technological routes are widely seen by the scientific and investment communities as evolving as the corresponding technologies mature. In the next decade, clean energy and electric vehicle applications will dominate development of green technology, followed by energy storage and hydrogen. In the decade after that, cutting-edge technologies such as carbon capture, utilization and storage (CCUS) and bio-energy and carbon capture and storage (BECCS) will be rolled out commercially.

Research into the application of low carbon technologies for specific industries, and the development of industrial low carbon knowledge graphs will be critical in the future. They will become an encyclopedia to guide the direction of investment in the future. This will require the intervention of many cross-disciplines, including sciences of science, industrial economics, social-economics, anthropology and artificial intelligence.

We have recently noticed that a number of local governments have already started working with data providers to establish local green investment project databases, structuring the data about these green projects into categories such as region, technology, capital amount and cooperation needs, so as to facilitate project screening by investment institutions, which is a very useful effort.

In line with the general pattern of new technology development and adoption, venture capital and private equity institutions will need to have a longer-term investment horizon and a more objective and pragmatic approach when investing in green technology startups.

Fourthly, in addition to active investment, ESG investors should make more use of passive investment tools to give long-term support to listed companies in green industries.

Passive investment strategies based on ESG factors should become the mainstream capital management strategy in the era of carbon neutrality.

Currently, the global ESG investment portfolio size has risen from $18.3 trillion in 2014 to $40.5 trillion in 2020, an increase of 122%. This compares with a rise of just 36% for other categories of investment over the same period.

Because achieving the dual carbon goal involves a systematic, comprehensive and long-term transformation, a passive investment strategy oriented toward a basket of assets and based on ESG performance can better simulate the general trend.

ESG performance-based passive portfolios are public-service oriented in nature and better reflect the simple logic of short-term investment for long-term returns on topics such as carbon neutrality, especially for pension funds and government public investment institutions, a product category worthy of attention and distribution.

Finally, it is important to emphasize that carbon reduction is in the common interest of all humankind, and therefore carbon issues should not be used as a diplomatic tool.

We note that recently, mature carbon markets such as Europe and the U.S. have been discussing and launching initiatives such as “carbon tariffs” and ESG reviews of supply chains in developing countries. While these are efforts to advance the global goal of carbon neutrality, they should be pursued together with equal respect for the rights of people in all countries to live and develop. It is also in the fundamental interest of developed countries to give greater recognition as well as technical and financial support to developing countries in their efforts to reduce carbon emissions.

If the subject of carbon is used to set financial and commercial cooperation thresholds, forming a new diplomatic tool, it would be a complete departure from the original intent of the emissions reduction issue.

It is worth looking forward to the development of carbon finance as a broad, international financial cooperation mechanism and an important part of building a community of human destiny, because of the borderless nature of the carbon neutral cause.

By Gao Erji, Vice President of Caixin Media

Gao Erji is a vice president of Caixin Media in charge of the group’s capital operations and strategic development. He is also executive president of Caixin Insight, Caixin’s data and research arm.

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