COP26 and the Climate Finance Bubble

Public demand for action on climate change is rising. According to a YouGov poll published in the UK last year, more than two thirds (67%) of people want the UK’s government to be a world leader on climate policy.

But away from the showy glitz and glamour of COP26’s celebrity and business star participants, it is apparent that governments cannot do it alone. Private capital (and backroom deals) will be essential if voters want the planet to be able to cash the political cheques its world leaders are now writing.

Private capital plays a key role in “climate finance,” the term broadly used to describe funding for activities that help slow climate change. This means private investments have the opportunity to reduce key climate technologies’ production costs relative to their output, while also accelerating said technologies’ ability to scale.

Indeed, COP26 marks six years since the signing of the Paris Agreement, where nearly all the world’s nations agreed to commit to cutting greenhouse gas emissions.

But with every G20 country behind in honoring commitments — and almost every other country following targets that are highly or critically insufficient to reversing current climate trends — private investment capital is becoming increasingly essential to accomplishing climate-related goals.

What’s Needed to Meet Global Emission Reduction Targets?

It is estimated that existing technologies combined with sufficient climate finance can reduce up to 65% of the emissions needed to reach the UN’s net-zero target by 2050. The emissions reductions that need to occur before 2030 can largely be achieved by existing technologies like solar, while the post-2030 emission reductions depend on innovative technologies, along the lines of improving energy efficiency, hydrogen fuels, and carbon technologies. A report from the World Economic Forum notes that to successfully expand and deploy these climate solutions in the 2030s, emerging climate technologies need to be validated at commercial scale in the 2020s.

However, the remaining 35% of emission reductions will require technological breakthroughs, according to a report from Boston Consulting Group. The report expects that this technology gap can be closed through climate tech innovations, which will require an estimated $100 trillion to $150 trillion over the next 30 years–equivalent to roughly $3 trillion to $5 trillion annually.

And even though climate tech venture capital has seen a tremendous influx in 2021, reaching $30.8 billion for the year to date and 30% more than the total in 2020, much more private capital needs to be invested through flexible and patient channels (for an overview of the burgeoning climate tech startup ecosystem, see PitchBook’s recent Climate Tech Taxonomy here).

PitchBook data shows that venture capital comprises roughly 3%-5% of total climate finance. But, since it plays a key role in discovering, backing, and scaling companies that create innovative solutions to otherwise intractable problems, venture capital is critical to address the technology gap.

Venture-backed companies have a long history of driving breakthrough technologies, from semiconductors to vaccines. This time around, though, venture capital must accelerate the deployment of technologies that mitigate climate change by decarbonising swathes of the global economy.

While COP21 proved groundbreaking, as it led to the adoption of the Paris Agreement, COP26 will likely reveal how much climate technology and climate finance are needed to attain those goals. In response to growing political and consumer pressure, along with corporate pledges to go carbon neutral, climate-based environmental, social, and governance, or ESG, investment reached a record $51.1 billion of net new money in 2020–more than double the year prior.

And despite their essentiality to achieving the Paris Agreement, climate tech venture capital and ESG funds remain nascent and somewhat nebulous. More structure in the climate investment landscape will help:

  1. Ensure climate-focused private capital does what it should, and;
  2. Enable climate-focused investors to invest along the double bottom line more easily.

Streamlined ways to invest patient capital into climate technology and to define accountable ESG frameworks, along with transparent reporting mechanisms, will be key in determining the environmental impact of these well-intended investment strategies. Below, we map out a few key players in this effort.

1. Catalytic Capital

Currently, most emerging climate technologies cannot compete with greenhouse-gas-emitting alternatives and are prone to market failure because of what the World Economic Forum called “an inability of businesses to secure financing for the initial commercial-scale deployment.” As investments into climate tech are often high-risk and capital-intense, capital structures that blend different sources of public and private capital are necessary.

That’s why catalytic capital, the combined climate finance from both public and private actors, is necessary. Catalytic capital reached $640 billion in 2020, according to a report from the Climate Policy Initiative, with indications that climate financing may exceed $1 trillion in 2021.

Still, experts suggest that these amounts need to be in the trillions of dollars to meet emission targets. Around 6 times more capital is needed annually to not exceed the 1.5-degree Celsius temperature increase.

Private equity and venture capital receive much attention, yet only account for a small slice of global climate finance. While private investors poured $40 billion into climate funds and $30 billion into startups in 2021 for the year to date, this amount of private capital is not nearly enough.

Catalytic capital will need to be patient, risk-tolerant, and readily available to support climate tech startups throughout high-cost research & development phases. Catalytic funding modalities can bridge geographic, institutional, and logistic gaps by, for example, accelerating commercialization and declining cost curves for key climate solutions. In addition, guaranteed offtake frameworks can de-risk projects by guaranteeing customers for the product or service, and targeted project financing can help scale novel technologies.

2. Accountable ESG Reporting

Environmental impact ratings (the E in ESG) are increasingly popular because they allow investors to align portfolios with low-carbon solutions. They have the potential to provide essential information on corporate climate risks and opportunities. Accordingly, numerous financial products and practices have emerged to align capital with climate emission targets, such as indexes and portfolio products, along with third-party ratings.

Even though ESG and tech go well together in principle, research shows that technology innovations can have negative environmental impacts, and funds marketed as sustainable are frequently guilty of greenwashing.

recent study from Util found that, of 77 funds with names containing the terms “green,” “clean,” “climate,” or “sustainable,” only four have a positive impact on environmental targets.

In the study, peer-reviewed academic publications were reviewed to extract positive and negative relationships between a company’s products and the 169 U.N. Sustainable Development Goal targets. The aggregated impact of both–the total U.S. fund universe and the sustainable fund universe–scored negatively against the Climate Action Sustainable Development Goals (SDG 13), with negative 10.6% and negative 5.88%, respectively.

About $68 billion has gone into ESG exchange-traded funds (ETFs) in 2021 for the year to date, with $118 billion over the past 12 months, according to Bloomberg. With this rising trend, it is crucial that capital has the intended impact, and contributes to meeting climate targets. Insufficient reporting mechanisms, weak frameworks, and confusing terminology at…

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