The Green Power of Climate Finance

Finance will play a crucial role in mitigating the impacts of climate change on the global population. Financial institutions and companies around the world are being urged to put the climate at the heart of their financial decisions, and mobilising international climate finance is one of the four stated goals of COP26, the United Nations’ climate change conference held in Glasgow under the presidency of the United Kingdom.  

But what exactly is climate finance? What role can it play in the fight against climate change? And how can researchers help?  

Professor Radu Tunaru and Dr Panagiotis Tzouvanas, researchers in the Department of Accounting and Finance, explain. 

Q. What is climate finance? 

PT: Climate finance describes the two-way interaction between climate change and finance. Climate change has a direct impact on finance as changes in weather patterns (e.g., heavy-storms, more frequent heatwaves, and increasing global temperature) can deplete labour productivity, reduce food production and cause uncertainty for firms, leading to increased risk in the financial markets. At the same time, finance can play a role in mitigating climate change, through funding zero carbon projects or implementing regulations that limit carbon emissions, for example. 

RT: Climate finance is not just about the future, however. It is about the present, and how we transition to the future using financial channels as a way of improving societal activities to change the way we do things and reduce carbon emissions.   

Q. What role can climate finance play in mitigating climate change? 

PT: The role of finance to mitigate climate change is multifaceted. For instance, green bonds are an efficient financial instrument that encourages sustainability and funds low-emission environmental projects. Another solution is the establishment of carbon trading. In some regions, such as in the EU, carbon emissions have been financialised as commodities and are exchanged in a cap and trade system. Through this system, firms are made properly aware of their maximum permitted carbon emission levels and urged to minimise polluting.  

RT: Imposing constraints and ratings on cash-flows may help to reorganise economic activities in such a way that activities reducing carbon emission are encouraged while others are discouraged. Climate finance may also help to accelerate innovation that could offer solutions to CO2 problems. Innovation requires access to funding and risk dispersion. Climate finance is naturally suited to do that.   

Q. What particular aspects of climate finance does your research explore? 

PT: My research spans several fields within the climate finance literature, such as the systemic risk of climate change, carbon and financial performance, as well as the nexus between energy and the environment. In my most recent paper, published in the International Review of Financial Analysis, my co-author and I found that environmentally conscious firms offer seven percent better returns along with 30 percent less risk compared to their polluting counterparts. This breakthrough research is the very first to examine and prove that it is financially profitable to be green.  

RT: My research is considering the role played by various top economies in the larger financial system, as well as looking at climate finance derivatives and how these can be used to hedge climate change risk. Dr Tzouvanas and I have also been involved in organising climate finance research events at the University of Sussex Business School that bring together policy makers, industry leaders and academics from top schools around the world. Academics have an important role to play working alongside specialists from financial institutions, firms and policy makers, to assess, implement and design solutions that will mitigate the effects of climate change. 

Q. What is the future for climate finance? 

PT: Climate finance is a growing phenomenon and it will emerge into a mainstream field of finance. As the globe gets warmer, it is almost certain that governments will impose stricter environmental regulations. What we don’t know is whether firms will be able to adhere to these new regulations and still be competitive. On another note, given that climate change is the defining crisis of our times, financial institutions have already issued weather derivatives, carbon credits, green bonds, green credit cards and even green cryptocurrencies to mitigate this crisis. It would be interesting to see if these green financial products are here to stay and, most importantly, if financial institutions intend to further expand the range of green financial products and services that they are offering. 

RT: Climate finance represents the new way of doing business in financial markets, and I would say that the impact it will have on our lives will be similar to the effect of when banking was first introduced into societies a few centuries ago. There has been a global commitment to unprecedented levels of investment in climate finance, which will provide a strong incentive to all active and passive players to consider and be involved with the new instruments. There is also new regulation that is steering innovation and business in that direction. We all want the future to be rosy, but for that to happen, first, it must be green.