Easing the way for asset owners to scale climate finance

Asset owners want to invest in climate solutions. The financial ecosystem needs to make it easier to do so.

That’s the crux of a new report from S2G Ventures that looks at the barriers and solutions to scaling climate finance. 

The Chicago-based investor surveyed more than 50 asset owners, including family offices, sovereign wealth funds, public and private pensions, endowments and foundations, and insurers representing $450 trillion in institutional capital and real assets. 

Those investors believe that climate-related investment is a growth area “with significant opportunity for alpha generation in the coming years,” writes S2G, which oversees $2.5 billion in assets and invests in venture and growth-stage startups across food and agriculture, oceans and energy. Several family offices cited a focus on long-term returns and interest in owning “resilient and growth-focused assets.”

Nearly half of surveyed asset owners have set targets to increase their investments in the climate megatrend, while another 24% are considering targets. Some three-quarters expect to boost their climate investments over the next three years.

What’s holding them back: market, political and institutional barriers to deploying green capital. 

As stewards of retirement savings, pension funds, for example, are understandably focused on risk. The report argues for greater transparency by asset managers on the track record and performance of green investments, and for more information sharing by investors actively investing in climate. Also needing more daylight: pay structures. Half of the surveyed asset managers have compensation or incentives tied to key performance indicators.

Even marginal increases in those institutional investors’ green investments can make a meaningful dent in what Barclays estimates is a $100 trillion to $300 trillion need to reach a net zero economy by 2050.

‘Partnership’ with investors

While Climate Week in New York City will focus on the urgency of tackling global warming, the pressing need to create a “fit-for-purpose” capital markets system to help fund the climate transition is gaining prominence.

The solution: “We believe the most impactful and perhaps swiftest approach to designing a fit-for-purpose capital market system is partnership with asset owners,” says the report, titled “The Climate Finance Relay Race.” Such an alliance would spawn what S2G called an “enabling ecosystem” that includes large asset management firms like BlackRock, convening organizations, catalytic capital providers, policymakers and academics.

Innovative financing

Anchoring S2G’s well-functioning climate finance ecosystem: bespoke, creative and experimental financing models, especially for the “missing middle,” or the lack of capital for growth-stage companies. New models will ensure financing of catalytic, first-of-a-kind and other high-risk projects, the report says. 

S2G doesn’t detail what creative financing models might look like. Designing them “will require doing the hard work of financing research.” Still, it says that “familiar financial instruments” — debt and equity investments, for example – have a role to play.

The firm says that while the Inflation Reduction Act, the Biden administration’s landmark climate legislation that includes the $27 billion Greenhouse Gas Reduction Fund, is a catalyst for the foundational climate-finance ecosystem, more such legislation is needed globally to remove frictions for investors.

‘Packaging’

The report cites an estimated $30 trillion opportunity to invest in climate transition through 2030, with only about 20% of that opportunity now being met. 

But simply increasing the amount of deployed capital doesn’t go far enough. Green financing, S2G says, “must also be ‘packaged’ so that it can target high-priority opportunities.”

The report also calls for philanthropies and foundations to jumpstart an enabling ecosystem by considering “market-making strategies with potentially high, but less measurable impact.” And it advises asset managers to lead with the good news.

“Asset owners largely want to hear about returns before impact,” S2G says, adding that “leading with the opportunity and upside versus the reputational risk or importance of values” can push things forward.

6 prescriptions

The report suggests six moves climate stakeholders should make to enable a well-functioning climate-finance ecosystem:

—Asset managers should provide more data about an investment’s track record and performance.

—Regulators and policymakers should sharpen and define carbon pricing metrics, climate-related disclosure laws, green investment mandates or quotas, and double materiality reporting.

—Investors should pressure their boards to make clear climate commitments and targets.

—Asset managers should make their key performance indicators more transparent.

—Organizations should hire, if they don’t already have one, a chief sustainability officer or strategy head.

—Investors should have staff with climate-based investing expertise.