In November 2015, global leaders gathered in Paris to discuss the future of our planet. The most ambitious climate agreement in history, the Paris Agreement outlines a long-term, durable framework that promises to reduce global greenhouse gas emissions in an effort to reverse some of the most serious impacts of climate change.
Signed by more than 190 nations and supported by global stakeholders of all stripes, the Paris Agreement is a triumph for all who believe that climate change is a serious risk over the long term. Most strikingly, some of the most active voices in Paris were those from the private sector ― corporate executives and investors who believe that climate change is a risk that must be addressed immediately.
As participants began returning to their home countries, corporate headquarters and executive suites, many of the follow-up discussions revolved around capital and investments. How are we going to mobilize capital in order to support key tenets of the Paris Agreement? How is climate finance going to help address climate change? What are the mechanisms we will use to support innovation toward renewable energy? Where will these funds come from?
In particular, Ceres and Bloomberg New Energy Finance (BNEF) analyzed the global investment levels in new renewable energy solutions that will be required if the world is to reduce its greenhouse gas emissions enough to limit temperature change to 2 degrees Celsius or below. The study estimates that “[t]otal clean electric power generation infrastructure capex over the next 25 years under a ‘2ᵒC scenario’ presents a $12.1 trillion investment opportunity in total.”
Funding for clean energy projects often comes from banks in the form of project finance, which tends to be very specific and focused. Large global organizations such as the World Bank have played an important role in this area, and this source of funding will continue to be vital moving forward.
However, as renewable energy solutions gain greater momentum and general acceptance in the wake of the Paris Agreement, we are poised to see a notable shift in the types of financial structures being put to use. In particular, the Ceres/BNEF study notes a clear transition toward greater diversity of financing structures for new renewable energy solutions, while maintaining the historical debt to equity ratio at 70 percent debt versus 30 percent equity.
This means that the growing focus on funding new renewable energy solutions will present a particularly compelling opportunity for fixed income investors. Overall debt investments are expected to increase by 32.6 percent over the 2021-2025 period and by 23.8 percent over the 2026-2030 period, with a drop-off in growth rates thereafter.
As the space matures, debt issuers will be seeking funds from a more diverse array of sources. A particularly strong increase in on-balance sheet financing via corporate debt is projected by the Ceres/BNEF research. This investment approach is expected to increase by 73.2 percent over the 2021-2025 period and by 35.1 percent over the 2026-2030 period. By 2035, on-balance sheet corporate debt is expected to represent 17.1 percent of all assets allocated toward new renewable energy solutions, and 24.2 percent of all debt allocated toward these solutions.
New funding needs also portend a growing interest in asset-backed securities, green bonds and other similar vehicles to back renewable energy solutions. These investment approaches are collectively expected to increase by 170.2 percent over the 2021-2025 period and by 79.9 percent over the 2026-2030 period. By 2035, asset-backed securities, green bonds and other similar vehicles are expected to represent 12.7 percent of all assets allocated toward new renewable energy solutions, and 18.0 percent of all debt allocated toward these solutions.
As the global community continues to strive toward implementing the ambitious goals of the Paris Agreement, fixed income investors have an important role to play. At the end of the day, fixed income investing is about risk mitigation, and the risks of climate change are simply too great to ignore.
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