Understanding the Fundamentals of Climate Finance

Climate change is one of the most consequential challenges faced by humanity. Tackling it calls for coordination between nations, corporations, and individuals. It also requires massive funding—a concept known as climate finance.

Below is an overview of what climate finance is, along with real-world examples, reasons investors should care about it, and actions investment professionals can take to address climate change.

What Is Climate Finance?

Climate finance broadly refers to any form of financing that combats climate change and its negative effects. It’s typically used to fund projects and initiatives that fall within two main categories:

• Adaption: Adjusting to climate change’s unavoidable short- and long-term impacts. This includes projects aimed at reducing vulnerability and exposure to climate change and its adverse effects, as well as those that exploit its potential benefits.
• Mitigation: Mitigating and minimizing climate change’s negative effects. Projects that focus on mitigation strive to reduce greenhouse gas emissions (carbon reduction) and remove them from the atmosphere (carbon sequestration).

Climate financing happens through direct investments and infusions of cash but can take other forms, such as lines of credit or affordable debt.

Sources of Climate Finance

Many projects and initiatives aimed at mitigating or adapting to climate change are grand in scale. For example, those focused on transitioning from carbon-based fuels to renewable ones require updating electrical grid systems to handle and store new forms of energy. This demands a significant amount of funding to implement and achieve.

Most climate financing originates from public and government sources. The environmental initiatives in the recently passed Inflation Reduction Act (IRA) are good examples.

Private funds have increasingly played a role in supporting climate initiatives. Investment companies, wealth managers, commercial banks, insurance companies, sovereign wealth funds, private pension funds, and individual investors can all significantly impact climate projects by directly funding them or pressuring private corporations to change business practices.

How Climate Change Affects Businesses

Businesses in all sectors of the domestic and global economy may be negatively affected by climate change in the coming years. According to a report by Deloitte, climate change and the extreme weather it causes directly impact 70 percent of global economic sectors.

How climate change affects businesses varies and typically depends on the industry and region. Here are several ways climate change impacts businesses:

• Rising sea levels: Rising sea levels threaten people and infrastructure worldwide, including more than 136 megacities crucial to international trade. Warehouses, factories, airports, and seaports are essential to business operations but could be underwater in the coming years. The economic costs of rising sea levels are expected to exceed $1 trillion by 2050.
• Supply chain disruptions: Extreme weather (e.g., hurricanes, droughts, wildfires, and flooding) disrupts supply chains by causing travel delays and damaging infrastructure, such as roads, ports, and bridges.
• Rising cost of agricultural goods: Changing weather patterns make it more difficult for farmers to plant, grow, and harvest crops. These challenges can reduce productivity and cause demand to exceed supply, exerting pricing pressure on everything from food staples to industrial crops like cotton and soy.
• Rising insurance costs: More frequent extreme weather is expected to cause increased damage to property, vehicles, and supply chains. This may result in rising payouts by insurers that then pass expenses to customers—including businesses—in the form of higher insurance costs. According to a recent report by Capgemini and Efma, insurance companies have already experienced these effects; it’s estimated that insured losses from extreme weather have increased by approximately 250 percent in the last 30 years.
• Labor shortages: If global temperatures rise by 1.5 degrees celsius, an estimated 1.2 billion people will be exposed to dangerous heat waves globally, which may lead to increased workplace injuries or death. Industries where workers are exposed to the environment, like agriculture, may experience severe labor shortages due to rising temperatures.

From a productivity standpoint, these and other effects are expected to impact domestic and global gross domestic product (GDP).

According to a 2020 report by the Commodity Futures Trading Commission (CFTC), the United States’ GDP will decrease by 1.2 percent for every one degree Celsius rise in temperature. Globally, a 1.5 degree Celsius rise in temperature could reduce the world’s real GDP per capita by approximately seven percent by the year 2100. According to estimates by the United Nations Environment Programme (UNEP), the cost of coping with climate change in developing countries could reach $280 to $500 billion per year by 2050.

Why Should Investors Care About Climate Change?

Climate change is projected to negatively impact the domestic and global economy over the next 50 to 100 years. While some industries may be more insulated from its effects, all businesses will be exposed to some degree of risk due to a warming planet.

Individual and institutional investors must consider these risks and factor them into any investment decisions to minimize losses and maximize gains.

Caring about climate change isn’t just a moral question; it’s good business.

What Can Be Done to Fight Climate Change

Investors who want to leverage investments to combat climate change have a few options.

First, they can direct investment dollars to companies that have taken action to address climate change. For example, they can exclusively invest in businesses that pledge to reduce carbon emissions, power facilities via renewable energies, or reduce water consumption. This enables them to reward companies that align with their values while pressuring other firms to follow suit.

Investors can also allocate funds to companies that research, build, and offer products or services that help fight climate change. This can be accomplished in several ways, such as backing new climate- and energy-related technologies or renewable energy utilities companies.

Finally, institutional investors can back large-scale climate projects by providing the capital required to get them off the ground or cross the finish line.

No matter the methods used, sustainability in business is essential to our planet’s survival. With the right tools, you can play an active role in resisting climate change’s negative effects. Climate finance may not be the sole answer to this pressing issue, but it’s a starting point for creating a more sustainable world.

Are you interested in leveraging your investment dollars to make the greatest impact in the fight against climate change? Download our free e-book on becoming a global, purpose-driven professional, and explore Sustainable Investing, one of our online business in society courses.