The City could rehabilitate itself and help combat climate change by focusing on clean finance, but the market will need new instruments and new skills

The environmental movement and big finance have always been unlikely bedfellows. But there is little doubt that due to its sheer scale, the heavy lifting in the battle to mitigate climate change will fall to the capital markets.

According to the IEA, tens of trillions of dollars of investment must be made in the low carbon economy if global carbon emissions are to be reduced. It is a daunting task, but recent signs have been encouraging. According to Bloomberg New Energy Finance (BNEF), in 2010 global renewable energy investment totalled $240bn, a compound annual growth rate of 29 per cent in comparison to 2009.

BNEF Chief Executive Michael Liebrich believes such impressive growth proves that the solution to climate change will be financial rather than political or regulatory. The $1trn mark, he said, “should serve as a message to the UN and all those in Durban to stop obsessing about a binding deal to cap carbon emissions, and to think much harder about how to speed up investment in the solutions.” For the UK, the City’s global prominence, location within the European Trading Scheme (ETS) and the UK’s adherence to the Kyoto Protocol have already made London the de facto green finance capital of the world. With tens of billions of pounds-worth of new investment set to flow into the market in the coming years, a growing band of policy makers and financiers believe further developing London as the global capital of clean finance, what one minister described as planting “the Union Jack firmly in the middle of this agenda”, offers a unique opportunity to revive and rehabilitate the UK’s financial services industry.

While many major banks abandoned their embryonic interest in the carbon market following the disappointment of the 2009 Copenhagen climate summit, a groundswell of specialist green investment institutions have emerged to take up the slack. Ben Caldecott, Head of Policy, Advisory at Climate Change Capital, an investment manager and advisory group managing around $1.4bn in commitments, says long-term indicators point to a huge expansion of the clean finance market.

Caldecott argues that the creation of billions of new middle-class consumers in the next 20 years will place unprecedented strains on commodities, and notes that many investors are anxious to offset risk. “What happens if you’ve got a very significant portfolio of assets that are exposed to high carbon?” he asks. Caldecott believes the risk-management aspect of green finance will become much more high profile in the next year or two, adding that investment in low carbon technology is now equal to that in fossil-fuel systems.

However, Caldecott warns “there’s still a lot that needs to be done,” in turning around the mindset of a financial world that has long seen green investment as low-reward or even fraught with risk. “We have a lot of hand-holding,” he continues. “City financial institutions collectively don’t know enough about these issues; but that’s changing, and changing quickly.

“Part of the reason for that is that banks and other financial institutions can act like herd animals. They tend to follow and need robust transactional records before serious capital will be deployed.

“Once a tipping point is reached, where a sufficient number of them get it, the changes wrought will be very significant indeed.” In the past, major low carbon investments have traditionally been carried out by utility companies or banks through traditional project finance. But with energy firms stretched and European banks preoccupied with consolidating their capital ratios, there is a new focus on attracting major pension funds and institutional investors to the market. Craig Mackenzie, head of sustainability at Scottish Widows Investment Partnership (SWIP), says “there is some appetite” among pension funds to make clean finance investments.

SWIP is a member of the Institutional Investors Group on Climate Change (IIGCC), a forum for some of the largest pension funds and asset managers in Europe; collectively representing around $10trn. IIGCC hopes to use its clout to spur governments and companies into providing favourable conditions for clean investment; last week it issued a seven-point strategy document laying out its investors’ expectations of how companies should respond to climate change, with a particular focus on encouraging energy efficiency. But before such huge resources can be fully harnessed, Mackenzie says pension funds and asset managers would like to see several barriers to clean finance investment dismantled. One major problem has been the inconsistency of government policy; Mackenzie cites the recent slashing of solar power subsidies in the UK as the kind of unpredictable change that spooks investors. Another, he explains, is that “we just don’t have products to invest in”.

There is little doubt that this unprecedented sphere of finance will require entirely new investment mechanisms. According to Sean Kidney, co-founder of the Climate Bonds Initiative (CBI), a network of academics and investment experts that aims to promote the rapid growth of ‘Climate Bonds’, greenspecific bonds have traditionally been labelled as a niche concern, and currently represent a “trivial” proportion of the $100trn global bond market. Kidney believes the Climate Bonds concept – bonds tied to specific climate change mitigation or adaptation investments – will be an important method of mobilising major investment and delivering secure, long-term returns at competitive levels of risk. November saw the launch of the Climate Bond Standard, a screening tool designed to assure investors and governments of a particular bond’s relevance to developing a low carbon economy. Mackenzie is supportive of the CBI initiative, but stresses that any new financial mechanisms must not daunt or confuse investors. “They need to look quite similar to the existing investment products that those fund mangers invest in anyway,” he says.

“So they either need to be equity products of some kind or they need to be bond products of some kind. And if they are really exotic, then that inherently limits the number of investors that are going to back them.” The emergence of the clean finance market will not only require an entirely new architecture, but new skills and an energised and committed workforce. With the banking industry’s image at an all-time low, Kidney believes the social value of clean finance could help entice potential recruits and rebuild the sector’s reputation. “You’ll see banks that promote their carbon finance work specifically to get graduates back,” he says.

Some of those graduates are likely to emerge from the University of Edinburgh Business School, which last year launched the world’s first MSc in Carbon Finance. Francisco Ascui, the programme’s director, says getting the course off the ground was a “two and a half year slog” and “wasn’t an easy sell”. Once established, though, the course proved popular, and in the end around 150 applicants had to be whittled down to 20 students hailing from 13 different nations.

Among the first intake is Richard Doherty, who left behind a finance career forged in London and Singapore to return to Scotland and complete the course. “I always wanted to get into a more ethical branch of finance,” he explains. Doherty had repeatedly heard from those within the scientific and financial worlds that there was no clear dialogue or link between the two sectors. “There was no one to cross the boundary and talk from both sides of the fence,” he adds. After casting around for a qualification that might bridge the gap, he eventually came across the Edinburgh degree: “The only course I saw that hit the nail on the head.” Doherty explains that “the thing that really attracted me to this course, and still does, is the real world element to it”. “We don’t want people to go out of here with unrealistic expectations about what the financial world is like,” says Ascui. “It really is a gap of culture and mentality as much as knowledge and skills.” Another plus for Doherty is the sheer breadth of the course, which touches upon subjects as various as science, finance, economics, law, globalisation and diplomacy. This emergent group of finance professionals will be far more three-dimensional than their predecessors; Doherty describes how lectures can skip from the glacial science to convertible bonds and back again. “It’s different to being a generic finance professional, because you have to be so attuned to what’s going on in the policy world,” says Ascui, “the biggest impact on your investment may be a regulatory decision.” While Ascui admits that his students are “taking a risk” on a course that is the first of its kind during a period of uncertain employment prospects, he is “pretty confident that will very quickly pick up and they’ll be in the position of being pioneers in the field”. If the “herd animals” of the City can be switched on to the opportunities of clean finance, they may find themselves ahead of the pack.