De-risking the Transition


The transition to a zero-emissions economy is well underway. Over two-thirds of the global economy is now covered by a net-zero target. Financial institutions with more than $70 trillion of assets have committed to steer their balance sheets to net-zero financed emissions by 2050. And renewable energy accounted for more than 80 percent of the world’s new electricity capacity last year.

Despite these encouraging developments, the world must move faster if we are to hold temperature rise to 1.5°C. Rates of renewable investment need to triple over the next decade whilst we rapidly scale critical breakthrough technologies in so-called ‘hard to abate’ sectors. Some of the world’s largest corporations need to transform themselves into different businesses, with different products, different balance sheets, and different skills and capabilities.

This collection of perspectives examines what needs to happen through the lens of risk. It identifies some of the most obstructive risks inherent in the transition to net-zero—and asks how these can be overcome. It begins with a series of articles examining the particular risks faced by companies deploying new low-carbon technology and transforming their business models. The series then turns to the role of financial institutions in supporting the required transformations through lending, underwriting, and investment strategies.

Overcoming risk
The march of renewables continues in the power sector, but the transition has barely started in many other high-emissions sectors where getting to net-zero depends on the development and commercialization of critical technologies such as hydrogen or carbon capture. Unfortunately, technologies such as these are initially uncompetitive relative to existing technology and exposed to considerable uncertainty regarding how policy will develop or how enabling infrastructure will emerge. This is starkly apparent in the case of European trucking, where a cloud of uncertainty hangs over the sector. Which technology—hydrogen, electrified roadways, or high-speed battery charging—will be prioritized? And for each, what are the prospects for development of the relevant infrastructure?

Insurance for new technologies is critical if they are to secure financing and be deployed at scale, but new technologies often present new risks that are poorly understood and hard to insure. The construction sector provides a good example, where low-carbon construction materials like cross-laminated timber and novel cements are better for the climate, but not necessarily better for insurers’ loss ratios.

Even seemingly mature technologies—such as renewables—face new risks that threaten access to finance and undermine project economics. Innovations in parametric insurance are helping renewables developers manage extreme weather and power market risks, but the increasing scale of renewable projects and the exposure to natural catastrophe risks in many optimal locations (the best place for wind farms is, unsurprisingly, where the wind blows) is contributing to a lack of insurance capacity and the possible emergence of a ‘green protection gap’.

Perhaps the most difficult risks to overcome relate not to technology and infrastructure, but to organizations and people. For example, oil and gas companies will need to simultaneously transform their “cultures, structures, procedures and workforce” if they are to successfully transform into customer-focused energy services companies. Nor is the problem unique to energy companies—financial institutions also need to embed climate-related considerations across roles and functions if they are to successfully steer their portfolios to net-zero emissions over the next thirty years. It is these ‘soft’ factors that arguably present some of the most material execution risks for companies’ net-zero ambitions.

The role of financial services
The role of financial institutions in helping companies overcome these risks will be crucial. Investors, banks, and insurers need to develop new products and services to help companies finance risky low-carbon capital expenditures and transfer new risks. And as they adopt net-zero targets for their own portfolios, they will need to support high-carbon companies through the transition with new stewardship and engagement strategies.

The proliferation of net-zero targets in the financial sector is a source of opportunity. It has led to a surplus of financial capital seeking net-zero investment and lending opportunities . Businesses with credible net-zero plans should be able to access capital on favourable terms; the surplus will also likely drive financial innovation as banks and insurers develop products to incentivize decarbonization among their clients.

The importance of collaboration
A recurring theme across the perspectives in this series is the importance of collective efforts to overcome risk. In the energy sector, stronger collaboration between government, insurers, and industry is needed to develop ways to parse, diversify, and transfer risk and militate against a green protection gap. In the construction sector, close partnership between insurers and construction companies will be needed to anticipate, manage, and transfer new risks affordably. In trucking, new public-private partnerships are required to foster new business ecosystems, share costs across the public and private sectors, and develop common standards.

Perhaps the most important partnerships will be formed between financial institutions and their portfolio companies, as banks, insurers, and investors work with businesses in high-carbon sectors to overcome the risks they face. In so doing, financial institutions can manage their own transition risks and help steer their portfolios to net-zero emissions.