Unlocking climate transition finance: key risks and opportunities

Investors have an essential role to play in providing the funding needed to move the world towards net zero emissions. Yet they must also balance expectations of both regulators and stakeholders. What will it take to accelerate funding for companies in transition?

As part of London Climate Action Week, HSBC convened a panel of sustainable investment executives to discuss the way forward for transition financing.

Here are five key takeaways from the discussion:

Policy and regulation have a material impact on the allocation of capital for the green transition around the world, and the US is leading the way.

The European Union’s Net Zero Industry Act (NZIA) is seen as a response to the US’s Inflation Reduction Act (IRA) and its USD369 billion in clean energy subsidies. Among other things, the EU law aims to scale investment in net zero tech manufacturing. However, it does not provide any direct financing because that happens at state level, according to James Rydge, EMEA Head of ESG Research for EMEA at HSBC.

“In the green industrial race, Europe and the UK are at great risk of falling behind,” said Rydge. EU member states will need to offer clearly defined funding, with clarity around amounts and duration, to stem the IRA-driven flow of capital to the US, he argued.

Indeed, the IRA is already having an impact by helping scale up green investment at the energy majors which will help them reduce their scope 1 and 2 emissions, pointed out Jennifer Anderson, Co-Head of Sustainable Investment and ESG at Lazard Asset Management.

With companies now reporting on how their businesses align with the EU Taxonomy of sustainable activities, investors can analyse such disclosures to assess how corporates are aligned with a net zero transition. HSBC’s Research team developed a metric to screen companies based on taxonomy disclosure data that, through high levels of aligned green capex investment today, have the greatest potential to deliver higher shares of green turnover tomorrow and transition more rapidly to net zero, said Rydge.

Similarly, Lazard Asset Management has built a range of tools and analytics internally to better understand data around climate, including a climate alignment assessment model to show to what extent companies are aligned with net zero. That helps the firm prioritise and focus its engagement efforts around where they will have the most value, said Anderson.

The speakers agreed on the importance of engagement. Global investment firm Carlyle focuses strongly on companies’ transition plans and progress and does due diligence on the cost of these activities, according to Katharina Neureiter, the firm’s Head of ESG & Impact for EMEA & APAC.

Carlyle has on occasion decided against buying into companies where it felt the transition pathway did not make commercial sense, Neureiter added.

Meanwhile, bondholders are increasingly looking to wield their influence for positive environmental impact. Railpen, the UK’s £37 billion Railway Pension Scheme, is seeking to help develop and standardise the approach to debt investment, disclosures and engagements and recently published guidance on this topic, said Chandra Gopinathan, Senior Investment Manager at Railpen.

The panelists also agreed that the approach to emerging market corporates and financing the transition should be more tailored and nuanced. Anderson said a one size fits all approach to decarbonisation and net zero doesn’t work when regional economic development and local government policies in EM are so diverse. After all, an emerging markets portfolio is likely to have a high carbon footprint, but it could invest in companies that are leading and financing decarbonisation efforts for that region, Gopinathan added.

What’s more, with climate change impacts intensifying around the world and an estimated 3.5 billion people extremely vulnerable – mostly living in Africa and South and Southeast Asia – many may be forced to move over time. HSBC Research¹ into the potential size and impact of climate-driven migration suggests the UN’s own estimates are “implausibly conservative”, according to Rydge. Such shifts are likely to have a huge impact, not just on vulnerable countries, where there may be vast movements of people internally, but on other nations receiving rising inflows of climate migrants.

Companies are starting to think through the risks and opportunities of higher levels of migration – not only on their manufacturing centres but on their consumer bases too. International companies are already noticing the impact of extreme heat on their supply chains, as workers choose to relocate.

Laws in some US states restricting the use of ESG factors in making investment and business decisions are the clearest example of an anti-ESG backlash². Pushback against ESG and sustainability has been a particularly hot topic in the past 18 months, said the panel moderator, Farnam Bidgoli, Global Head of ESG Solutions in HSBC's Global Banking team.

But such moves are mostly politicisation of the topic and may not be in the interests of the state pension schemes and the beneficiaries they affect, said Lazard’s Anderson. Ultimately, she added, it’s important to consider ESG as part of financial analysis, and some of Lazard’s biggest clients are still keen to understand how ESG is financially material to investment outcomes.

Railpen’s Gopinathan agreed with Anderson that ESG had become a “political football” in the US, but suggested there was a positive aspect to come out of this: it is an indicator of how far ESG has come. Whereas companies and investors initially merely needed to set net zero targets, for instance, now when they talk about decarbonisation strategies, it means committing capital, he said. “That may mean a deep and sometimes controversial discussion, which ultimately is a sign of progress.”

Today we finance a number of industries that significantly contribute to greenhouse gas emissions. We have a strategy to help our customers to reduce their emissions and to reduce our own. Find out more: https://www.hsbc.com/who-we-are/our-climate-strategy