Financing decarbonisation, decarbonising finance
Seeing the wood beyond the trees on financing climate action
The political storm of recent weeks over the Coillte/Gresham House forestry fund has got me thinking. First, there was the outrage about the British re-invading Ireland. Then, the ill-informed characterisation as a vulture fund. Finally, the suggestion that it will uniquely distort the Irish agricultural land market. As we have shown in our January newsletter, this is a very small element of what is contributing to overheat the Irish land market.
So, how will we finance land use change and sustainability investments in agriculture to deliver on our obligations in time?
We know decarbonising our industries and societies is urgent, and that it will cost a lot of money. This time last year, a McKinsey report estimated that the annual cost of getting to net zero by 2050 will be US$9.2 trillion. This is an additional US$3.5 trillion to be spent each year from 2021 to 2050 to limit warming to a maximum of 1.5 degrees. I had to refresh my own memory: one trillion is one million millions (1,000,000,000,000), or one thousand billions – an enormous amount of money. The required increase is equivalent to half of all global corporate profits in 2020, or one quarter of all global tax revenue.
Source: McKinsey, Jan 2022
Planting trees, rewetting bogs, reducing food production emissions, increasing renewable energy production, retrofitting buildings to improve their thermal efficiency, improving transport infrastructure to get people out of their polluting cars, all that requires major levels of funding. State funding to lead by example is crucial, but the size of the task is such that it will not be achievable without recourse to private funds.
Many investors want to support genuinely proactive projects that will actually contribute to fulfilling our climate and environmental obligations. Financial operators are under increasing scrutiny from shareholders, the public and the media. “Greenwashing” initiatives are no longer acceptable, real commitment to genuinely valuable climate action is now expected of them. Crucially, investment funds and other lenders also see this as an emerging part of their risk management strategy.
State funding will never suffice, so private funding, including from international investors, is critical, especially in a small open economy such as Ireland’s. After all, we do not reject foreign direct investment when it brings pharma and tech wealth creation and jobs into the country.
Private funds need a solid regulatory framework. They must fit in with the Irish Climate Action Plan, our biodiversity and water quality obligations. They must also be directed to projects with measurable and visible impacts matching investors’ own Corporate Social Responsibility (CSR) commitments. Last but not least, borrowers must be protected through Central Bank regulation.
In the agricultural sector, investors and financial regulators must gain a good understanding of what constitutes investments to underpin sustainability. Improving economic efficiency is often a win-win from an environmental or climate viewpoint – for example, increasing one’s dairy herd Economic Breeding Index (EBI) can improve milk output while reducing emissions. Yet, there could conceivably be pressures on private funders to adopt simplistic policies around what type of investment, or even what sector, to support with finance.
EU Taxonomy legislation: regulating financial institutions to fund the “right” projects
Financial institutions and investment funds come under more pressure to behave ethically, including when it comes to the environment and climate. Greenwashing no longer washes, and CSR goals are no longer box-ticking exercises. Investors are demanding better performances from funds to decarbonise and de-risk their portfolios.
In the EU at least, there are plans afoot to create legal obligations for sustainable finance. Two new pieces of legislation stemming from the 2019 Green Deal have been published: the EU Taxonomy regulation and the Sustainable Finance Disclosure Regulation (SFDR). They aim to “reorient capital flows towards sustainable investments, establishing sustainability as a component of risk management and promoting long-term investment and economic activity”.
The EU Taxonomy classifies green or sustainable economic activities as focusing on six environmental objectives:
- Climate change mitigation
- Climate change adaptation
- Sustainable use and protection of water and marine resources
- Transition to a circular economy
- Pollution prevention and control
- Protection and restoration of biodiversity and ecosystems.
To be considered “green” or “sustainable”, companies must engage in activities that contribute to at least one of those objectives, but also do not violate any of the others. They must also meet UN criteria around human rights and comply with technical screening criteria.
Part of the legislation has come into force from 1st January 2022, and the above list comes into play from this year.
This legislation is being developed with the support of a Platform for Sustainable Finance, to which contribute sustainability experts from the corporate and public sectors, from industry, academia, civil society and the financial sector.
A technical working group supporting the Platform is currently examining technical screening criteria for various sectors, including agriculture. It is drawing up definitions of what constitute sustainable actions and activities by farmers. This includes, for example, maximum N balances, which ultimately could be used to guide financing decisions and loan approvals.
Sustainable lending now part of banks’ risk management strategy
While the document is advisory and not (yet?) EU policy, this direction of travel is clearly influencing lending policies by banks and private investment decisions around the world. Banks and other types of lenders have realised the need to make environmental sustainability part of their risk management strategy.
Last month, Danske Bank published their Climate Action Plan, which references their position statement on lending within the agricultural sector. This document suggests certain “expectations” of environmental actions from loan applicants.
In New Zealand, a Sustainable Agriculture Finance Initiative (SAFI) has been developed by government in collaboration with the main banks, financial institutions and investment funds. This too aims to identify GHG reducing, mitigating and other environmental actions undertaken on farms which should be financially supported.
In a 2021 interview published by NZ Farm Life Media, the rural economist for ANZ (Australian and New Zealand Banking Group), Susan Kilsby, put it very succinctly: “Going forward, whether it’s banking or the price you get paid for your milk or meat, those who are doing a good job and farming in an environmentally sustainable way will be rewarded, and those who are not, it will get tougher and tougher from all angles – not just regulatory. There will be more differentials in pricing – eventually to the interest rate you get charged.” (sic)
Agri-finance: we’re not in Kansas anymore…
The pressure on farmers to do more to improve their environmental footprint will now also come from their banks’ greener lending policies.
This can be a real positive in supporting the decarbonisation of agriculture. It can provide farmers and the agri-food sector with better adapted, favourably priced or structured financial supports for costly, complex, often non-productive investments.
But this can only come from financial institutions having a detailed understanding of their agri-clients specific business needs. And that understanding must factor in different production systems’ technical and economic realities. Lenders who wish to green their agri-food portfolios must secure in-house expertise on farming and agri-food that is locally relevant and system specific. They must build links with local regulatory authorities and farm advisory agencies to ensure they are fully conversant with farmers’ climate obligations as well as the complex production and economic characteristics of each sector.
© Catherine Lascurettes, Cúl Dara Consultancy
