Sustainability Financing: Blending Public and Private Finance Well

In my previous article on the sustainability transition, I conveyed its scientific, economic, social and financial aspects in broad strokes. Now, let me focus on its financing. How should national governments cooperating with transnational institutions lead the financing effort since “banks cannot fix the climate crisis alone”, as Tracey McDermott, the outgoing chair of the Net-Zero Banking Alliance, aptly noted? Moreover, how can the financial sector, legacy banks, and neo-banks alike step up so that the private sector can invest in green infrastructure and transform their industries?

 

THE ROLE OF PUBLIC POLICY IN FINANCING SUSTAINABILITY

I agree with the OECD’s view that it is essential to successfully blend public and private financing to overcome the complex challenges of sustainable development. By strategically using public resources to drive private investment, governments can ensure that financing flows to the most needed areas, particularly in low- and middle-income nations.

So what can governments do right in order to foster the financing of sustainability well? I sum it up in three words: Clarity, efficiency, and stability. Realistically, governments may not be able to do it all, yet they can strive for a mix of the approaches I list below:

 

1. Enabling the Right Environment to Attract Private Finance:

A comprehensive approach to addressing climate challenges requires several interconnected strategies. First and foremost, it is essential to strengthen economic fundamentals, with a particular focus on improving business governance practices and implementing effective debt management systems. Clear and consistent climate policies must complement this foundation with well-defined regulations and transparent infrastructure investment pipelines, all of which instill long-term stability and confidence for stakeholders. Climate projects should not exist in isolation but rather be strategically integrated into other key policy objectives, such as enhancing energy security or alleviating poverty. A holistic approach ensures that climate initiatives deliver multiple benefits while building resilience across various sectors of society and the economy.

 

2. Establishing Clear Regulatory Frameworks:

Governments can set binding targets for carbon emissions and sustainability goals, as seen in the European Union’s Green Deal, which aims for a 55% reduction in emissions by 2030 and climate neutrality by 2050. When targets are set in law, governments form a predictable economic setting to encourage investments in green technologies and practices.

 

3. Boldly Creating and Following Through Policy Incentives:
   i) Carbon pricing and pollution taxes: carbon pricing mechanisms, such as carbon taxes or cap-and-trade systems, can push economic agents to internalise the environmental costs of carbon emissions, motivating firms to reduce their carbon footprints and invest in cleaner technologies. Sweden, Germany, and the UK have successfully undertaken such policies.
   ii) Tax incentives and favourable lending: sustainable finance instruments like green bonds, which are debt instruments issued to finance environmental projects, and sustainability-linked loans.
   iii) Flexible regulations to speed up the much-needed development of new technologies to enable cleaner production and supply in critical industries.
   iv) Market interventions to create more competition in alternative markets, break monopolies and encourage entrepreneurship.
   v) Green Investment Banks: Publicly capitalised green banks may attract private capital by carrying some of the economic and political risks that stifle green investments. They tap into domestic and international capital sources to finance climate-friendly projects. Green banks have a strong track record in catalysing new low-carbon markets.

 

4. Blending Public and Private Financing

Blending public and private financing is a powerful tool for governments to de-risk climate projects and catalyse private investments. This can be achieved through mechanisms such as first-loss investments or performance guarantees, which reduce the perceived risks for private investors. By doing so, governments can attract more private investments into climate-related projects, especially in emerging markets where investment risks may be higher. The big caveat here, in both developing and developed countries, is that governments should closely follow through on the viability and execution of projects with the help of their autonomous expert institutions to get efficient and accountable results.

Structured finance is the term used for when governments create conditions to raise long-term funds in areas where private investors are hesitant. Tailored structured finance mechanisms such as feed-in tariffs, quota schemes, and CfDs (contracts for difference) with renewable energy producers can mitigate and allocate risks suitably to stimulate private investments.

 

5. Developing National Green Taxonomies

The World Bank’s Guide on Developing National Green Taxonomies points out the need for clearly defining green activities to attract investments. Creating a national green taxonomy helps clarify what constitutes a “green” investment, guiding financial flows toward sustainable projects. This taxonomy should be developed with financial and industrial experts to make sure it starts with and delivers on market needs and can keep up with international best practices.

 

6. Providing Green Subsidies

Governments can stimulate demand for sustainable products and services through subsidies as well as tax incentives. For example, Germany’s substantial investment in EV infrastructure and subsidies for EVs has significantly boosted the adoption of green technologies. Similarly, feed-in tariffs in Vietnam have led to a dramatic increase in rooftop solar installations. Incentives for environmentally friendly practices, such as renewable energy and energy-efficient technologies, would speed things up.

The subsidy approach requires the public’s scrutiny and follow-through, not only of successive governments but also of the press and the NGOs. Subsidies had better be issued on merit, drawn back if companies step out of line, and abusing the system with subpar or illegal practices must not be tolerated.

 

7. Enhancing Public Procurement Practices

It is an excellent idea for governments to become good buyers themselves. Strict green criteria in public procurement can drive demand for sustainable output. This not only reduces the carbon footprint of the public sector but also encourages suppliers to adopt greener practices. Training and measuring the performance of public procurement officials in sustainable practices is essential for this idea to work at all.

 

8. Fostering Innovation through R&D Investments

Direct public investment in research and development can spur innovation in sustainable technologies. Governments can fund research institutions and private firms to develop transformative technologies in renewable energy, carbon capture, and waste management, thereby enhancing the overall capacity for sustainability transitions.

 

THE ROLE OF FINANCIAL INSTITUTIONS

 

Legacy Banks: Large, established, global financial institutions are working in tandem with the private sector to lead sustainable financing that makes economic sense. There’s a need to widen the use of new financing instruments to fill the financing gap. Green finance is the term referring to any structured financial activity that’s been created to ensure a better environmental outcome. It entails green bond issuance capability with associated assets and agreements as well as green lending. In bond issuance, two methods come to the fore:

1. Sustainability Linked Bonds (SLBs) may be more appropriate for a majority of companies since only meeting some criteria is sufficient to issue them: They are often based on carbon footprint (SLBs) and tie interest rates to sustainability performance.
2. Use-of-proceeds Instrumentation stands for actual green bonds, which will increasingly become the norm. Their issuers must use the funds given by investors to achieve predefined sustainability goals. As of early 2023, the cumulative global issuance of green bonds had reached approximately $2.5 trillion. In Europe, Germany and France are leading, and the issuance increase is multiplying in Italy. Emerging markets recorded 81% growth in 2023.

The distinction between “brown” and “green” firms is becoming increasingly relevant in the context of securing lending. Brown firms, which do not prioritise sustainability, may face stricter lending conditions as green firms benefit from more favourable financing terms.

 

The Rise of Neobanks and Fintechs in Sustainable Finance

 Neobanks and fintechs are emerging as key players in bridging the sustainability funding gap. These digital-first financial institutions are uniquely placed to drive sustainable finance forward due to their innovative streak and their appeal to younger and more environmentally conscious consumers, also their connection with SMEs. So, what are they up to with regards to sustainability financing?

 

1. Green Bonds and Loans: Neobanks like Stripe and Atmos and fintechs like Clim8 are pioneering digital platforms for issuing and trading green bonds, making sustainable investments more accessible to retail investors. At Stripe, corporate customers can automatically deduct a portion of their income to finance advanced technologies that lower GHG emissions.
2. Crowdfunding: Fintech platforms enable direct investment in sustainable projects through crowdfunding, democratising access to green investments. You can invest a minimum of £25 in solar loans in Sweden’s Trine.
3. AI-Driven ESG Analysis: Fintechs like CarbonChain of the UK are leveraging artificial intelligence to provide more accurate and comprehensive Environmental, Social, and Governance (ESG) ratings for companies, helping investors make informed decisions about those companies.
4. Blockchain for Transparency: Some neobanks use blockchain technology to ensure transparency in sustainable investments, tracking the impact of funds from source to project implementation.
5. Personalised Sustainable Banking is an emerging trend. Neobanks are offering personalised banking products for customers that align with their sustainability goals:
   1. Carbon Footprint Tracking: apps that calculate the carbon footprint of each transaction, helping users understand their environmental impact.
   2. Sustainable Savings Accounts: accounts where deposits are exclusively used to fund sustainable projects, often offering competitive interest rates.
   3. Green Credit Cards: Cards made from recycled materials, with rewards programs tied to sustainable purchases or carbon offsets such as TreeCard or Tred.

6. Empowering Small and Medium Enterprises (SMEs): Fintechs play a growing role in financing the sustainability transition of SMEs. For example, in sustainable supply chain financing, fintechs offer preferential rates to suppliers who meet specific sustainability criteria. They lend green microloans, which are small, low-interest loans by which small businesses make certain sustainability upgrades. Neobanks can offer sustainability-linked loans with interest rates specifically tied to the borrower’s achievement of sustainability targets.

 

SUSTAINABLE FINANCING: A GLANCE TOWARDS HOME

The EU has been at the forefront of implementing sustainable finance regulations that can provide industries with clarity and structure, committing significant investment behind SDGs:

1. EU Taxonomy is a classification system establishing a list of environmentally sustainable economic activities, providing companies, investors, and policymakers with definitions for which economic activities can be considered environmentally sustainable. It gives clarity and helps parties avoid “green washing” practices.
2. Sustainable Finance Disclosure Regulation (SFDR) requires financial market participants to disclose how they integrate ESG factors into their risk processes.
3. European Green Deal: This is the set of policy initiatives aimed at making the EU climate neutral by 2050, with a proposed €1 trillion investment over the next decade.
4. The EU Corporate Sustainability Due Diligence Directive aims to hold companies accountable for their environmental impact to foster a culture of sustainability within the private sector. However, its success relies heavily on each member nation’s compliance and provision of the necessary resources for the transition. Many EU countries still grapple with the tension between economic recovery post-pandemic and the push for sustainability. The European Green Deal is ambitious but needs robust public financing for transitioning sectors. There is a risk of leaving behind businesses still recovering from economic strain.

A glance towards home shows that Lithuania has been actively promoting sustainable finance with its Green Bond Initiative. The Bank of Lithuania has been encouraging the issuance of green bonds. Thanks to Lithuania’s fintech-friendly regulations, the country has attracted numerous fintechs, many focusing on sustainable finance solutions. Lithuania’s National Energy Independence Strategy aims to increase the share of renewable energy sources in total energy consumption.

Like other European banks, EMBank implements sustainable financing programs: The latest is ILTE (formerly Invega) Guarantee which enables EMBank to offer microloans to SME’s such as fisheries, primary producers of agricultural products, and road freight transit firms so that they can make sustainable transitions to update their fleet, switch production modes in order to comply with EU regulations, or simply to continue operating their environmentally sustainable practices. Also, as a digital-native neobank, our core and support functions are highly digitalised. Our employees hail from Lithuania and around the world, so that we work remotely, which decreases our carbon emissions. Moving into the cloud in 2024 with Oracle was a big, positive step increasing our operational sustainability.

Sustainability has also become an integral part of our decision-making regarding loan approvals. As an avid follower of EU regulations and strategy on ESG, our assessments reflect on the EGS risks and readiness of specific industries, while we also evaluate companies’ status individually.

 

SUSTAINABLE FINANCING: LATEST GLOBAL DEVELOPMENTS

86 countries are currently implementing the Integrated National Financing Frameworks (INFF) initiative. It is the work in progress of governments mobilising financing in alignment with national priorities. INFFs have already leveraged $16 billion for sustainable development investments.

Green Taxonomy Adoption: Countries that have founded green taxonomy frameworks have successfully redirected investments toward sustainability. Again, the EU is the pioneer here and is showing great results. A record high of USD 1.3 trillion was invested across energy transition technologies in 2022 in the EU. Approximately 75% of global investment in renewables from 2013 to 2020 came from the private sector, especially solar PV. The Latin American region has seen pioneering taxonomy development, with Colombia emerging as the regional leader in establishing a green bond taxonomy. The framework covers eight key sectors including energy, construction, transportation, and agriculture.

The sustainable bond market in ASEAN+3 region demonstrated remarkable growth of 29.3% in 2023, outperforming both global and euro-area markets. The region’s outstanding sustainable bonds reached $798.7 billion, nearly 20% of global sustainable bonds.

Norway’s sovereign wealth fund is successfully implementing a green investment strategy. With $1.2 trillion in assets and approximately 1.5% of all global shares, their green investment strategy has significant global influence. Its “engage to change” approach with clear climate-related voting and investment policies.

The USA has rejoined the Paris Agreement and enacted ambitious domestic climate policies, especially The Inflation Reduction Act (IRA), with the most substantial climate investment in US history, mobilising investments in clean energy solutions and creating new jobs. The first US national green bank was established through the Greenhouse Gas Reduction Fund (GGRF) with $5 billion in capital. The Coalition for Green Capital’s network aims to transform the $5 billion NCIF award into $40-69 billion in combined public-private investment after seven years. The total cumulative public-private investment facilitated by the Coalition for Green Capital’s network of over 40 green banks now stands at $25.4 billion. Current US policies are projected to achieve only 28-34% emissions reduction by 2030. If the USA leaves the Paris Accord again, it could lead to an additional 4 billion tonnes of US emissions by 2030 and undermine global cooperation on the issue.

The UK’s Green Finance Strategy (GFS) developed in 2021 aims to turn the UK into the sustainable finance capital of the world. It calls for public financing initiatives to guide investments in green projects. There is a recognition in the UK’s GFS that the finance sector needs enough information to manage the risks of climate change and nature loss. It warns that a disorderly transition could cost UK banks around £110 billion by 2050, with insurers potentially worse affected. Britain now targets net-zero greenhouse gas emissions by 2030. Its new administration is expected to form two new entities, Great British Energy and the National Wealth Fund, to spur private-sector investment in clean energy.

Developing countries face a unique set of challenges. Private financing is scarcer, and the need for public financing is more acute. Without significant international aid or investment from multilateral development banks, many developing countries may find themselves locked into high-carbon development pathways. This is why the World Bank and the IMF may play a key role in bridging the financial gap between developed and developing countries. Setting market efficiency principles into “green aid” can help level the playing field for developing nations. For example, Kenya has successfully implemented green bond frameworks that enable private investments in renewable energy projects, demonstrating how government-led initiatives can catalyse private financing.

 

CONCLUSION

In conclusion, the outlook on the finance of sustainability transition is cautiously optimistic, with more awareness and concrete action across sectors. Challenges remain, particularly in financing fast enough on a big enough scale to achieve a sustainable world economy. Financial institutions, including fintechs and neobanks, will play a vital role in financing the sustainability transition inclusively. Their innovative approaches, when coupled with supportive regulatory environments, will hopefully help bridge the sustainability financing gap. As we strive to reach targets for our country, region, and planet, we can expect to see an acceleration in sustainable finance.

Sarp Demiray, CEO of EMBank