A significant opportunity exists for New Zealand businesses to tap the growing pool of funds looking to invest in our 1.5 degree future, writes EY's Pip Best.
While our climate change conversation is stuck in a bind about limits to economic growth in certain regions, internationally mainstream institutional investors have started rapidly moving forward.
Large global investors are looking to invest in high-growth businesses that will deliver financial returns as well as align to a zero-carbon future, in an effort to limit temperature increases to 1.5 degrees. This is good news for businesses aligning their strategy to a low-emissions future.
This significant societal and economic change we are starting to witness stems from multiple sources.
First and foremost, the awareness of millennials and schoolchildren about the looming environmental crisis has reached fever pitch.
Not only is there increased awareness about the science behind climate change, this activism is impacting on consumer preferences, such as the increasing demand for plant-based food alternatives.
On top of societal pressures, businesses are starting to experience the financial impacts of climate change. For example, insurance companies' payouts related to extreme weather events are increasing, which will eventually result in upward pressure on insurance premiums.
Another source of concern is the increasing risk of climate litigation. Internationally, shareholder resolutions related to climate change are starting to pile up. These actions are intertwined with rectifying poor climate risk management and limiting behind-the-scenes lobbying by industry groups that seek to thwart meaningful action by business and government on climate change.
Aware of these pressures, rather than waiting for regulation, institutional investors are starting to take matters into their own hands. One recent example of this is the Net Zero Asset Owners Alliance, who have pledged to align US$2.4 trillion (NZ$3.78 trillion) in assets to a 1.5 degree future by decarbonising their investment portfolios by 2050. This additional capital will increase the focus on seeking out investments that are "1.5 degree-aligned". These significant sums of money will likely increase as other asset owners to look to diversify, and grow, their exposure to "green assets".
Meanwhile, emerging regulatory standards about what constitutes a "green asset" will impose further rigour on the sector. The European Union is leading the charge on this.
It has established a classification system for sustainable activities which make a substantial contribution to climate change mitigation or adaptation. Referred to as EU Taxonomy, this screening framework will cover sectors such as agriculture, transport, tourism and property — all extremely important sectors in the New Zealand context. With the implementation of these new rules for investing in other jurisdictions, New Zealand companies seeking finance from these regions will face increasing pressure to meet the standards. Importantly, these classification systems make the step from subjective to objective about what constitutes being green, in an aim to address greenwashing concerns.
On the back of these types of developments we are seeing emerging examples of innovative products that not only deliver a strong financial return, but also seek to mitigate or counter the physical impacts of climate change. There are products that are squarely aimed at commercial investors requiring investment grade financial returns. Examples are emerging in the agriculture space. For example, in Australia, investors are trading water rights with an aim to improve environmental water flows during normal weather (green benefits) and then provide a counter-cyclical financial return to farmers to offset the impact of drought during low rainfall years. These types of innovative mechanisms are the future, and bold New Zealand businesses and financial service providers who are investigating these "impact" projects will open their doors to green investors.
For New Zealand the opportunity is significant. To meet our global emissions targets, we are going to have to work harder other than some other countries. The action of the Ardern Coalition Government on emissions reductions will need to be supplemented, and led, by the actions of the private sector.
Many countries can make steep reductions in greenhouse gas emissions through decarbonising their energy grid. This is not a viable option for New Zealand, so innovation and across all sectors is vital.
It's time to do more on climate change. The tide has turned, and the smart money is flowing to those countries and companies that act meaningfully now. The focus on climate change presents an opportunity for innovative, green businesses to access capital and offers a route for investors to achieve investment grade returns and reduce their risk to climate change. That sounds like a groundswell to me.
New Zealand's sustainable finance products so far:
There are three main financial products being used to finance green assets or projects in NZ.
One is the green bond, a debt financing instrument.
These have been used by the Auckland Council for its electric train fleet project and by property company Argosy for its green building portfolio among others. Sustainable linked loans are another form of finance, a loan between a borrower and lender for a green project; the more successful you are with the project's sustainable aims, the lower the interest rate. Synlait used this instrument, agreeing a four year $50m Environmental, Social and Governance (ESG) linked loan with ANZ.
"Green bonds made up the majority of issuances to date, but sustainable linked loans are increasing because of the flexibility," says EY's Pip Best.
A green loan finances or refinances specific projects or assets. This is part of Contact Energy's Green Borrowing Programme in New Zealand, says Best.
While green bonds have made up the bulk of the sustainable finance market between 2012 and 2018, sustainable linked loans are on the rise.
• Pip Best is Climate Change and Sustainability Services Director at EY.
The views expressed in this article are the views of the author, not Ernst & Young. This article provides general information, does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information.
Pip Best co-authored the Sustainable Finance Forum's Financing the Future interim report which will be launched today by Climate Change Minister James Shaw. The forum is the first project launched by The Aotearoa Circle, recognising the critical role of finance to achieve, and accelerate, the transition to a sustainable economy, and the need for a financial system that is fit for that purpose.
Read the Sustainable Finance Report here.