The message from climate scientists is clear: only through rapid, extensive green transitions in energy, land use, infrastructure and industrial operations can the world curtail the worst effects of climate change.
Countries, industries and businesses all have a major part to play – and face risks for their own business if emissions are not cut. For decades the European economy has been underpinned by capital-intensive, high-emitting sectors that have benefited from a low-rates environment; this era now seems to be over. An economic transformation must be comprehensive, far-reaching and fair.
While European policymakers have historically been ambitious on climate policy, often setting the tone for the rest of the world, they must not rest on their laurels. As well as the climate crisis, key structural problems – high debt levels, an ageing population and a high dependency on imported raw materials – will collide, requiring a full-scale policy response to keep Europe globally competitive.
The financing gap
In the eyes of Michael Lewis, head of ESG research at €821bn AuM ($910bn) Germany-headquartered asset manager DWS, governments and the private sector should focus on three key carbon-intensive sectors for the green transition: buildings, transportation and power generation.
The World Economic Forum estimates a $2.4trn annual global investment gap for climate change adaptation, as well as $1.7trn for the required technological evolution and $1.5trn to manage demographic shifts.
Despite the urgency for action, there is the suggestion that Europe is still struggling to finance transformative projects on the required scale. The EU Commission estimates that green transition will require €470bn of investment per year for buildings, transportation, power and industrial sectors by 2030. Part of this will be EU financed, but there will still be an estimated annual funding shortfall of €250bn to meet these targets. This will be difficult to finance and will likely fall heavily on the shoulders of the private sector.
Net zero will require a major overhaul to transform the overall quality of the building stock and improve energy performance and efficiency. Investors in real estate, SME lending funds and engagement with banks all have a role to play as well as specific sustainable infrastructure investments.
“There’s a very exciting opportunity in Europe, particularly when it comes to transport: if we include aviation, it is the one sector where emissions have gone up over time, compared with a majority of other sectors where emissions have declined in recent years,” says Lewis. “If we take electric vehicles (EVs) for example, there is huge consumer demand across Europe due to interest in cutting carbon emissions, air pollution and high energy prices, and a fairly strong market already. Stronger roll out of EV charging is an important priority and opportunity.”
Huge investments will be needed to install charging points, develop and manage the grid, and build out the renewable energy infrastructure and capacity required to support a green transition from internal combustion engines to EVs. Fresh capital is required for all these new technologies, says Lewis, and while some public money is available, the lion’s share will need to come from the private sector.
And for power generation, there are dozens of greenfield energy generation projects – such as North Sea and Atlantic Ocean floating offshore wind – requiring project finance. They will then need to be properly integrated into grids, which will also require considerable capital.
The policy gap
Lewis says that the EU’s policy response thus far has been more stick than carrot. To truly mobilise the private sector and put sustainable investment on price parity with more traditional investment, better incentives will also be required.
The concern is that regulation of public market investors through the Sustainable Finance Disclosure rules is not helping to transition the European economy into a sustainable, green future. Today’s sustainable investors are structurally at a disadvantage versus financial investors through regulation, fees and the higher cost of tailored research, Lewis explains, while expected returns are similar for sustainable and traditional products.
This leads to capital misallocation and, for companies, divestment over transition or transformation, with the risk that carbon-intensive assets end up in private hands with a lower level of scrutiny and few disclosure requirements.
The International Sustainability Standards Board’s work will be important here in levelling the playing field of sustainability data, but, so far, they are not focused on full environmental and social impacts, which is not sufficient for investors committed to net-zero emissions.
In the US, the Inflation Reduction Act tabled in 2022 does this well, with huge incentives for corporates that invest in renewable energy or energy efficiency projects. It also creates an attractive opportunity for asset managers to form partnerships with corporates and their supply chains, working alongside other investors that are looking for secured financial returns, says Lewis.
No transition time to waste
Regulation must be an enabler of the green transformation, but capital can already play an important role in the transformation of Europe. There are various options the investment industry can do today and asset managers can also utilise their political capital to encourage policymakers in the right direction.
“As a European asset manager, we see our role as providing products and funds that can assist the transformation,” Lewis explains.
Buildings present a considerable opportunity too. Around 35% of all European commercial real estate is owned by institutional investors. The need to retrofit nearly all of Europe’s buildings is an opportunity and a challenge for many different asset classes.
Today, buildings are the single largest energy consumer in Europe, using 40% of the continent’s energy and creating 36% of its greenhouse gas emissions. Beyond commercial real estate, investors can help accelerate residential building renovation via their role as debt and equity investors in banks and other mortgage lenders, as well as covered bonds, mortgage-backed securities, and private loans to developers.
One method is via an EU-backed collateralised loan, which could be distributed by mortgage providers to give homeowners access to financing for renovation. It’s a win-win: energy efficiency also reduces mortgage portfolio default risk and increases the value of homes.
Some models include public-private partnerships for energy efficiency, or new forms of collaboration between asset managers and multinational corporations to reduce their emissions, particularly in supply chains, where around 80% of the average company’s climate impact exists. This model has been tested in the US, an example being one of the world’s largest technology companies leading the way in decarbonising its supply chain both at home and in China. This approach could be replicated for success in Europe.
Europe’s economic model today is still based on the infrastructure of previous centuries. That has to change; complacency is not an option. Demographic changes will put pressure on healthcare and pension systems, and as China and India represent an ever-growing proportion of the global population and economy, Europe’s influence will inevitably wane.
Governments, businesses, and the investment industry must be proactive in ensuring Europe adapts in order to thrive.
Disclaimer: This editorial contribution has been prepared in partnership with a third party. Despite the careful selection of sources, no liability is assumed for the correctness of the contents. All statements and performance data do not constitute financial analysis. They are for information purposes only and in no way encourage the purchase or sale of financial instruments or securities. Historical performance and any awards for it are not guarantees of current or future performance.