Getting green investment right

An expert panel on Sustainable Transition revealed insights into ‘equity,’ highlighting differences between financial risk-capital and social equity.

Sometimes, the best ideas come from completely unexpected places. A panel discussion on Sustainable Transition led to an insight on the differential usage of ‘equity’ on the spectrum of finance and society.

As a finance and investment professional, I spoke on the need for risk-capital in transition projects; such risk-capital being termed ‘equity’ in the investing lexicon. Another panellist, who had a more academic and social lens to the issues of transition, referred to how transition should take into considerations matters of ‘equity’; in her case, the idea was predicated more on aspects of just transition which takes all stakeholders along. Let’s call these financial and social capital, respectively.

Not just word play

This difference in the application of the word ‘equity’ is at the core of differences in approaches and expected outcomes for both sides.

An investor looking at investing equity thinks of it as the riskiest piece of capital: one that will absorb the losses, if any, from the project first. On the social side, equity seeks to bring flows of capital, projects, jobs, and a more stable life to those at the losing end of the climate-induced transition.

For a financial investor, the decision to bring in equity is a calculated move with expectations of high rewards if projects go through as planned; for the social sector, equity is a project for the well-being and upliftment of the society, an aspect that typically lies in the domain of public (government) investments.

Different roles and outcomes of public and private

Given the difference in approaches and expected outcomes, when equity is seen as a means of social harmony, such investment is typically left for the State to invest in.

In the parlance of climate-related investments, this largely (though, not exclusively) means investments in adaptation and resilience. Such investments seek to protect the citizenry from, or equip them to cope with, the impacts of climate change. These investments are typically not structured as commercial in nature; they almost always come from the public purse.

Think, for example, the creation of dykes for rising sea water or the training of the future generations in new skills for an impacted industry. The State may borrow from the banking or financial sector to invest in such projects; however, they are backed by the State’s ability to repay, not the projects’.

Creating public private partnerships

Commercial investors, who bring in equity capital, typically seek projects which have become investment-worthy due to a proper structuring of the transactions that allocates risk and rewards in a manner that makes it viable to generate risk-adjusted returns. Most such investments are largely in the field of mitigation of climate change—think of industries like renewable energy, electric vehicles, etc.

Such projects tend to benefit from a wider commercial adoption of the technology, explicit or implicit pricing of carbon, and regulations that support the industry (by either creating incentives for adoption or disincentives against competing products). The typical role the governments play in such projects and investments is to create a stable, facilitative regime.

When industries are younger (because either the technology is not mature or the economic viability is low), governments sometimes create pools of capital or facilitative regulations that support the growth of the industry. In such cases, the expectation is that the private sector can eventually find a pathway to profitability and returns in a stable manner. Think, for example, industries like pumped hydro storage, offshore wind, or green hydrogen.

In case the private sector does not find the industry economically viable, even after all the incentives of regulation or capital, the industry may either not take off or need to be created in public hands. This means that the government is putting in equity in these industries as an investor; such investments are typically justified from a social equity perspective for the population due to climate or other benefits.

Capital is global, society is local

The flow of financial capital is, by and large, global in nature. Investors seek opportunities around the world and bring equity in countries where they expect to generate the highest risk-adjusted return. Social capital largely requires investment in local communities, and their adaptation and resilience.

The global social linkage for capital comes through the climate finance flowing from global North to global South. There have been commitments of $100 billion a year of climate finance flowing through from developed countries to developing. Even as we belatedly reach this annual commitment, a vast majority of such financial flows are still commercial in nature (debt or equity).

An interesting outcome of the COP27 in Egypt was the idea of a loss and damage fund. There is expectation that COP28 could create structures on blended finance or exchange rate protection for global South to make larger flows of capital possible.

Bringing the two together

Return on equity is an important, but not the only metric that a private investor assess a project or investment on. It is important to demonstrate to both internal decision makers and external policy makers that the returns are sustainable. Sustainability can take a wide range of meanings: from commercial sustainability (ability of consumers to pay and for the firm to produce economically) to a harmonious relationship with the stakeholders (on the site and wider ecosystem). Private investments these days take into account aspects of ESG seriously in their return considerations. Tracking ESG metrics and performance can help create more sustainability in their returns.

Similarly, investments in social equity can create more viable investment opportunities. A more resilient and adaptive location and citizenry can help generate long-term value. If the value loss due to climate-related catastrophic elements can be minimised or avoided, this can lead to more sustainable financial outcomes for both industry and people associated with it. Investments in a properly trained workforce, which can adapt more rapidly to the changing industries and job patterns, can create income and social stability.

An investment in social equity can unlock larger equity investments.

Akhilesh Tilotia is with National Investment and Infrastructure Funds Limited, and he penned this piece for Financial Express.

Views are personal and do not represent the stand of this publication.