This article was first published by the World Economic Forum on September 22, 2021.
The landmark IPCC climate report revealed an alarming reality: the globe is likely to reach 1.5C in the next 20 years. We need to cut greenhouse gas emissions urgently and at scale to prevent irreversible damage to our planet.
The good news is that both public and private stakeholders from industries, finance and governments have announced ambitious pledges to reduce carbon emissions. Net-zero commitments today cover ~68% of global GDP.
However, translating commitments to action is no simple undertaking. Over $4 trillion will be required annually for the net-zero transition. While some of this financing will be needed for energy efficiency improvements and demand reduction efforts, achieving net zero will require the deployment of decarbonization technologies – which reduce carbon emissions from the process chain – across all industrial sectors.
Direct electrification is expected to be the cheapest and most energy-efficient decarbonization technology, but electrification alone will not be sufficient to avert a climate disaster. Nearly half of the emissions reductions required to achieve net zero by 2050 will be attributed to technologies which are not currently commercially available (e.g. hydrogen-based fuels). This is especially true for the “hard-to-abate sectors” – including shipping, aviation and steel – which comprise over one-quarter of global CO2 emissions. Take shipping and aviation as examples: electric engines with improved battery storage will help decarbonize short-distance transport, but sustainable fuel alternatives will be required for zero-emissions long-distance travel.
The promise of a net-zero future lies within the adoption and large-scale commercialisation of these technologies.
Financing challenge: commercial viability and risks posed by early-stage decarbonization technologies
While financial institutions have made capital commitments in excess of $70 trillion, the deployment of capital to transition finance investments has been inhibited by two types of challenges: macro-level supply/demand-side issues and deal-level investment risks.
Early-stage decarbonizing technologies are often in the pilot project and/or early deployment stage. While they are past the research and development stage and have been validated at some level, scaling these technologies to a point where they are commercially viable remains a capital-intensive and high-risk undertaking. With the help of private capital, the widespread deployment of these technologies can be vastly accelerated.
However, the broader transition finance investment environment faces supply and demand-side issues, which are hindering the deployment of capital. These include:
- Mismatch in the opportunity profile between capital supply and demand. There is misalignment between the risk appetite/risk-return frameworks of individual institutions and the risk and return profile of transition finance investment opportunities, as well as mismatch between typical debt financing tenors and project financing needs.
- Limited pipeline of bankable opportunities. A shortage of opportunities has resulted from stressed balance sheets in the aftermath of COVID-19, resulting in muted demand for finance for innovation, a lack of “first-mover-advantage” for firms that undertake decarbonization and capacity/resource constraints within financial institutions.
- Political and regulatory uncertainty. Legislative uncertainty is compounded by an absence of global standards and certifications, and a lack of granular policies and economy-wide transition plans.
- Limited data and clarity on pathways. There are persistent data gaps across portfolio alignment metrics, transition plans and investment performance of climate-solutions.
Given the early-stage nature of several decarbonizing technologies, financing is associated with perceived higher risk profiles than typical carbon-intensive investments, further hindering the deployment of capital at scale. While these risks are particularly significant early on where there is a reliance on enabling environments, they tend to decline throughout the later stages of operations.
Exhibit 1: Key groups of risks and where they fall along the project lifecycle
Source: Oliver Wyman/World Economic Forum
Mitigating these challenges and risks will require the cultivation of an enabling environment for transition finance, and targeted measures to improve the commerciality of these investments.
The proposed solution: financing blueprints and policy enablers to improve commercial viability, deploy de-risking measures and unlock private capital
To mobilize the trillions of dollars needed to progress decarbonization technologies towards commercial-scale deployment, a multi-stakeholder transition finance ecosystem must be cultivated to enable coordination and collaboration across industry, the public sector and private finance.
Success will be driven by two critical inputs:
1. Innovative financing blueprints.
At the investment level, breakthrough financing and de-risking solutions must be developed to mitigate the risks and challenges associated with transition finance opportunities. These solutions must define roles for stakeholders across the investment value chain, public sector and industry to enable risk-sharing. Innovative deal structures, where capital stacks are optimised to yield the lowest required green premium, will enable green products and processes to compete with existing alternatives at scale. These blueprints must be tailored to sector-technology pairs, with careful consideration of the financing needs and unique risks associated with the sector and technology at hand.
2. Policy intervention.
In order to accelerate the deployment of capital at the pace and scale required, the public sector must cultivate an enabling environment for investors. Policymakers must improve the commercial viability of decarbonization investment opportunities. Further, governments should catalyse the development of the transition finance ecosystem by carving out a leadership role for multilateral development banks to leverage their capacity, financing abilities and technical expertise. Other key priorities for the public sector should be to develop global governance, standards and guidance, and carefully design policy interventions to avoid unintended consequences
The Financing the Transition to Net-Zero Future (FTT) initiative was launched by the World Economic Forum in collaboration with Oliver Wyman to identify financing and de-risking solutions to enable the commercial-scale deployment of early-stage technologies. FTT has engaged a community of over 50 leading financial institutions and several industry stakeholders to develop sector-specific financing blueprints. In a forthcoming report to be published this October, the initiative will share specific financing blueprints for decarbonizing technologies across aviation, shipping and steel, and outline targeted policy interventions and de-risking measures that can create an enabling environment for transition finance investments.