This  year has seen a dramatic shift in public awareness of the climate crisis that we are facing. The science is clear; if we do not make rapid changes to how we use energy and consume resources, it is likely that we will face runaway global warming with potentially devastating effects. What is not clear is how to address the problem. Technological solutions alone are not sufficient; we need a cultural, political and economic shift away from current short-term, isolated thinking to a long-term, systems-based approach.

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Up until now, the current way of thinking has worked for our benefit. The relentless march of capitalism has catapulted our world into the modern era, feeding off new technologies and economic growth. This has transformed our society for the better, bringing health, prosperity and quality of life to billions of people. But we now risk overshooting the limitations of our planet and consuming ourselves with our hubris.

 

Much like rabbits released onto an island devoid of predators, our growth and consumption has outstripped the natural rate of replenishment, until all the grass is gone and we are wiped out by an environment in which we can no longer exist. In order for the rabbits to survive, they need predators to control their numbers and maintain a sustainable population size. In order for us to survive, we need a system in place to maintain a sustainable consumption rate.

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Fundamental to this transformation is a financial model which incentivises investments into systems as a whole, not just a part of it. If someone was to build a sea wall for a village at a cost of £1 million, which over the next decade led to savings of £10 million through avoidance of property damage from flooding, overall the village will have made a net gain of £9 million. But how do we monetise avoiding losses? How do we reward an investment whose value is dispersed, indirect and difficult to quantify? Historically this kind of investment has been the role of public sector funding, but without mobilising the huge quantities of wealth in the private sector, we cannot hope to achieve the rate of change required to adapt to climate change.

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In order to do this, we need an understanding of the complicated relationships between investment choices and their wider impacts, in a quantifiable, standardised way so that we can fairly assess the value of each decision. Currently the markets are operating with incomplete information, meaning they cannot react accordingly to the risks presented by climate change. A framework is required in which disclosures of climate-related risks are standardised and mandatory across all financial institutions. This will empower investors to make the right choice, and hopefully trigger the biggest realignment of capital in history.

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The UK recognises this and is leading the charge towards establishing these mechanisms. In October 2019, the first ever public sector green finance summit was held in London. Hosted by the UK government with support from the University of Oxford and the UK Green Finance Institute, the conference looked at how to approach the transition to a green financial system. It drew leading figures from the financial world as well as representatives from 16 other countries. The scale of the task was apparent to all the speakers but they did not shy away from the problem, and instead came armed with solutions. Increasing transparency was highlighted as a key driver to this transition, by making markets more efficient, and economies more stable and resilient. The Task Force on Climate-related Financial Disclosures (TCFD) is one of these solutions, helping organisations enhance their disclosure of climate-related information. The Bank of England is heavily involved in this and is leading by example by committing to disclosing all their climate risks from next year, the first central bank to do so. Mandatory financial disclosing is still some years away, but BoE is pushing to put this in place as soon as reasonably possible.

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To truly improve how we invest green we cannot just transform finance. Each sector must establish their own tools for establishing a taxonomy of what is ‘green’, what is ‘brown’, and move towards measuring the system costs, not component costs. For example, in the electricity sector, generating costs are measured with the metric known as Levelised Cost Of Electricity (LCOE). It sums the total cost to build, operate and decommission a power-generating asset divided by the total energy output over its lifetime. This is used to compare costs of generation, which is useful to an investor who wants to know which assets are most likely to provide them with the highest return. However, this does not account for the total system cost of integrating that technology into an electricity grid. The LCOE of wind has dropped sharply over the last decade, but as the proportion of wind in our grid increases, the cost of balancing supply and demand increases exponentially. Energy storage can go a long way to addressing this issue, however this added cost is not being included in the LCOE.

 

In this context, other low-carbon generation technologies like nuclear appear too expensive, when in reality large-scale rollout of nuclear is actually cheaper at a system level than that of wind energy. This is evident when we compare the electricity costs of France, powered largely by nuclear, and that of Germany, who after embarking on an unprecedented mission to install wind and solar on a industrial scale, have a more expensive and higher carbon-emitting grid than their neighbour. A new metric which prices in the overall system cost is needed to ensure the best value for money.

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Some would argue that the efforts of the EU and UK to reduce emissions is futile in comparison to the emissions increase from China, India and other developing countries and that we should instead focus our attention on them. While it is true that the UK only contributes about 1% to global emissions, we have an incredibly powerful voice and influence. London is the number one financial capital in the world. The investments held in the City of London account for 15% of global emissions. Transitioning the City of London to a green financial system would be game changing and is a huge opportunity for the UK to be a world leader in this. By testing these new frameworks and proving its attractiveness to investors, it will lay down the foundations for a global transition towards green, sustainable finance.

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Currently the global green bond market is around $1 trillion a year, growing at a rate of around 20-25% a year. The IPCC estimates that we need to spend around $8 trillion a year to prevent runaway warming, so it is clear that radical intervention is needed, with speed and urgency far greater than the natural rate of change. Sweeping reform agendas, as opposed to marginal shift approaches, are essential to achieve the systemic transformational changes required. But this must be done correctly. We cannot hope to combat climate change without a strong and resilient economy. Another global financial crisis will quite possibly doom us all.