Digitalisation & the Future of Financing
Published 23rd April 2021
By Sarah Casey, Portfolio Director, Climate Council
Sustainable finance can be described as taking due account of environmental, social and governance (ESG) considerations when making investment decisions. This process is intended to lead to increased longer-term investments into sustainable economic activities and projects and lasting benefits to both clients and society at large. Under the sustainable finance umbrella falls sustainable funds, green bonds, impact investing, microfinance, active ownership, credits for sustainable projects and development of the whole financial system in a more sustainable way.
The environmental aspect of this refers to a wide range of things including climate change mitigation and adaptation, as well as the environment more broadly, such as the preservation of biodiversity, pollution prevention and circular economy but this article will focus on the climate change mitigation aspect; more specifically low-carbon and renewable energy.
Clean Energy Investment
In 2019 IRENA estimated that to put the world on track with the objectives of the Paris Agreement, cumulative investment in renewable energy needs to reach USD 27 trillion in the 2016-2050 period. Similarly, in 2018 the IPCC found that a 5x increase of investment is required in low-carbon energy and energy efficiency investment annually and in 2017, the OECD reported that around USD 6.3 trillion of infrastructure investment is needed each year to 2030 to meet development goals, increasing to USD 6.9 trillion a year to make this investment compatible with the goals of the Paris Agreement.
To put this into perspective, in the power sector alone, the global energy transformation would require investment of nearly USD 22.5 trillion in new renewable installed capacity through 2050. This would imply at least a doubling of annual investments compared to the current levels, from almost USD 310 billion to over USD 660 billion.
Whilst the Covid-19 pandemic and consequent downturn stunted investment into renewable and low-carbon energy, the IEA noted that even before 2020 investment trends were poorly aligned with the world’s projected needs and a flat trend of spending since 2015 is far from enough to bring a lasting reduction in emissions. There is marked gap between reality and targets and clearly a sea change in the financing of low-carbon energy sector needed as soon as possible.
The role of Digital Finance
One of the key challenges faced by the global financial system today is to mobilise private capital to support sustainable growth and a stable financial system and digitalisation may be one key tool to solving this.
Digital finance refers to the integration of big data, artificial intelligence (AI), mobile platforms, blockchain, and the Internet of things (IoT) in the provision of financial services and both the finance and energy sectors are still assessing how to utilise these technologies to provide value, in 2017 PWC reported that AI alone could lift global GDP by an estimated US$15-20 trillion by 2030.
In a 2019 survey and report, DNV GL found that as subsidies are being removed from renewables projects and they are therefore becoming increasingly exposed to the full volatility of the market, financiers and developers are increasingly turning to digital technologies to better inform their assessment of the value and risk associated with projects.
Digital finance at its core enables larger amounts of complex data to be available, processed and analysed more cheaply, quickly and accurately and this access to high-quality and comparable data will be vital to increase opportunities for more sustainable investments.
Such access to high-quality and comparable data reduces the costs of obtaining timely material information relevant to sustainability impacts and investments’ financial risks and increases transparency. Since data is the backbone of investment decision-making, this continued access will be necessary to increase opportunities for more sustainable investments and bring us closer to climate targets as laid out in the Paris Agreement.
Importantly, investors need to better understand and quantify risk as well as returns and many investors are looking for ways to measure the ESG impact of their portfolios and set benchmarks. As a consequence, the ESG data market is booming. Data providers have developed a wide range of ESG products and have multiplied their data sources. With an expected annual growth rate of 20% for ESG data and 35% for ESG indices, the overall market could approach $1 billion by 2021.
In addition to helping investors quantify risk and returns and benchmark for ESG purposes, good data will also help overcome other issues investors face which hinder clean energy investments including understanding how companies may fare as the environment changes, how regulation evolves and how customer behaviours shift. Further, it will enable them to gain a better understanding around things including indirect carbon emissions in the value chain of a company, standards and to avoid facing humungous amounts of low quality data.
In addition to making large amounts of valuable data available more quickly at lower costs thus increasing transparency and access to information related to sustainable investments, digital finance also promotes greater inclusion and innovation. These outcomes will increase opportunities for citizen participation in the financial value chain and unlocking new sustainable business models.
When combined, sustainable digital finance can take advantage of emerging technologies to analyse data and power investment decisions to accelerate investment into low-carbon and renewable energy projects and thus support the transition to a low-carbon economy and reach vital climate targets.
Before the Covid-19 pandemic Carbon Tracker calculated that the renewable energy investment opportunity alone could reach $1 trillion per annum. Whilst the downturn has affected investment in renewable energy investment and resulted in a degree of uncertainty on the market, governments worldwide are holding true to the green agenda and driving forward green economic stimulus packages.
In order to maintain this momentum and importantly speed it up in order to meet targets, more organisations in the finance industry need to adopt digital technologies as digital sustainable finance has the ability play an essential role in efficiently channelling this capital to fuel innovation, growth and job creation, at the same time supporting the transition to a sustainable, low-carbon economy.
Some of the barriers to this adoption include a lack of understanding and clarity around revenue streams coming from digital technologies and uncertainty about revenue which could be generated in the future. Similarly, there is a lack of senior level buy-in and a lack of digital mind-set contusing to the lack of widespread adoption.
Given the clarity that sustainable digital finance can provide to investors, it is vital that the finance industry finds ways to overcome these barriers and widely adopt digitalisation technologies so that investors can make their financing decisions with confidence and support the acceleration of the clean energy transition.