Green Investment Vehicles: A Pathway to Fight Climate Change?

As the world continues to grapple with the realities of climate change, green investment vehicles have emerged as a critical pathway toward a sustainable and equitable future. These investment vehicles offer unparalleled opportunities for businesses and governments to accelerate the transition to a low-carbon economy while driving sustainable growth and job creation.

What are Green Investments?

Green investments include securities, electronically traded funds, mutual funds, and bonds, in which the person issuing the instruments is involved in operations that aim to improve the environment. This can range from companies that are developing alternative energy technology to companies that have the best environmental practices.

Unfortunately, because individual beliefs on what constitutes a 'green investment' vary, their exact qualifications are a bit of a gray area. Purchasing stock in a business that leads the industry in environmentally-conscious business practices in a traditionally "ungreen" industry may be considered a green investment to some but not to others.

For example, consider an oil company that has the best record for environmental practices. While it is environmentally sound that the company is taking the best precautions in preventing any direct damage to the environment through its day-to-day operations of drilling for oil, some may object to purchasing its stock as a green investment because burning fossil fuels is the leading contributor to global warming.

Environmental, Social, and Governance (ESG) standard is a common approach by using conscious investors to screen potential investments and assist with this gray area. Environmental criteria consider how a company safeguards the environment, including corporate policies addressing climate change, for example. Social criteria examine how companies manage relationships with employees, suppliers, customers, and the communities where they operate. Governance deals with a company's leadership, executive pay, audits, internal controls, and shareholder rights, among others.

The recent U.S. climate bill makes also helps make ESGs a reality. The Inflation Reduction Act's investments target climate change, confirming that Environmental, Social, and Governance (ESG) is the ultimate trend of the decade.

With the U.S. climate bill, we see an unprecedented $370 billion invested in cutting U.S. greenhouse gas emissions while providing a launch pad for green investment and kickstarting a transition toward more renewable energy. The capital is necessary for the U.S. to achieve its 2030 target of reducing greenhouse gas emissions 50-52% below 2005 levels.

Even after adopting the climate bill, the U.S. still has work to do. Still, it's taking a massive step in the right direction by slashing greenhouse gas emissions by 31-44%, according to the nonpartisan climate think tank Rhodium Group.

Additionally, the bill contains tax incentives to encourage consumers, manufacturers, and other businesses toward clean energy options and more efficient energy usage – mainly by reducing the cost of buying rooftop solar panels, electric vehicles, heating equipment, and more.

The bill plans to use incentives to spur investors to accelerate the expansion of clean energy, such as wind and solar power, speeding the transition away from oil, coal, and gas that strongly contribute to climate change.

This bill means that the transition away from fossil fuels is about to accelerate. The U.S. bill is expected to lead to a massive increase in clean technology and drive the cost of renewables down even further. In other words, the climate bill intends to shift the U.S. from a fossil fuel-reliant economy to a clean, efficient, and electronic one.

The European Union is also taking steps in the same direction as the European Green Deal. This is a similar package of policy initiatives aiming to set the EU on a green transition path, with the ultimate goal of reaching climate neutrality by 2050. It supports the transformation of the EU into a fair and prosperous society with a modern and competitive economy.

The Unprecedented Flow of Capital Into Green Investments

At present, capital is flowing into green investment vehicles at an unprecedented rate, with green bonds and sustainable financial markets rapidly gaining traction. In 2020 alone, the global issuance of green bonds reached a record high of $269.5 billion, according to data from BloogbergNEF.

Similarly, the sustainable finance market is projected to grow to $53 trillion by 2025 as investors increasingly look to align their portfolios with ESG factors.

Over $500 billion flowed into ESG-integrated funds in 2021, contributing to a 55% growth in assets under management in ESG-integrated products, according to a JP Morgan Asset management report. Quite simply, investors – from individual savers to large institutions – are directing an ever-increasing proportion of their portfolios toward sustainable strategies as they look to use their capital to create a more sustainable world.

Absorbing Capital to Fight Climate Change

Capital flows toward sustainable projects through many ways, including special purpose acquisition companies, also knowns as SPACs.

SPACs are publically traded corporations formed with the sole purpose of effecting a merger with a privately held business to enable it to go public. Compared with traditional IPOs, SPACs often offer their targets higher valuations, greater speed to capital, lower fees, and fewer regulatory demands.

In 2020, many more serious investors began launching SPACs in significant numbers. Established hedge funds, private equity and venture firms, and senior operating executives were all drawn to SPACs by a convergence of factors:

• An excess of available cash.
• A proliferation of start-ups seeking liquidity or growth capital
• Regulatory changes that standardized SPAC products

This influx of capital presents a golden opportunity for businesses and governments to invest in sustainable projects and technologies that can help address the most pressing issues related to climate change. For example, renewable energy projects, such as wind and solar farms, can promote the generation of clean and affordable energy, reducing reliance on fossil fuels and curbing harmful emissions. Sustainable agriculture and forestry projects can promote the restoration and conservation of critical ecosystems while supporting local communities and boosting food security. Similarly, green transportation projects can reduce emissions and promote the adoption of cleaner, more efficient modes of transportation.

Not all SPACs will find high-performing targets, however, and some will fail completely. Nevertheless, SPACs are here to stay and may well be a net positive for the capital markets. Why? Because they offer investors and targets a new set of financing opportunities that compete with later-stage venture capital, private equity, direct listings, and the traditional IPO process. They provide an infusion of capital to a broader universe of start-ups and other companies, fueling innovation and growth.

A Growing Interest in Clean SPACs

Green energy-focused companies are in high demand as policymakers drive the transition to net zero to tackle climate change. This rapidly developing market requires huge amounts of investment to meet the challenge, and investors are equally eager to make their portfolios greener. With the SPAC market being well-suited to raise funds in sectors that offer potential for significant growth, SPACs are increasingly shopping for green companies. Beyond renewable energy, clean SPACs have targeted ESG-focused businesses, as well as electric vehicles and battery storage companies.

In a recent examination of the characteristics of SPACs focused on green causes, the authors found that the amount of capital raised depends on geographical focus, CEO characteristics, choice of exchange, and specialization of respective legal counsels. The speed is IPO is related to respective geographical and legal-counsel characteristics. At the same time, green SPACs exhibit cumulative market-adjusted returns in the range of 6% to 12% around merger announcements.

At the end of 2022, approximately 350 SPACs (with $96 billion in raised proceeds) faced a 2023 deadline to acquire a target – and most of them must make a deal during the first quarter. With so many SPACs under pressure to hook up, potential targets have an opportunity to strike favorable deals that overcome the pitfalls of such mergers.

The proceeds from the SPAC IPOs in the first quarter of 2021 exceeded those in the entirety of 2020. For all of 2021, SPAC IPO proceeds accounted for 39% of the global IPO market. SPACs used the proceeds to merge with high-profile startups, including DraftKings, Grab, Lucid, Polestar, and WeWork. These transactions provided SPAC sponsors and investors with enormous returns.

But later, the SPAC boom led to greater regulatory scrutiny. As the frenzy peaked in 2021, the U.S. Securities and Exchange Commission (SEC) proposed stricter rules covering forward-looking statements and account disclosure.

Are ESG Standards Just a Marketing Tool?

While many businesses and investors are eager to participate in the green investment movement, some still questions whether ESG is little more than a marketing tool. Critics argue that many companies are using ESG initiatives to appear sustainable to consumers and investors while doing very little to reduce their environmental impact.

It's true that some businesses may use ESG as a marketing tool to boost their reputation, but the reality is that sustainability and profitability go hand in hand. Companies that prioritize sustainability are more likely to attract investors and customers, reduce their costs, and build reputations as more responsible corporate citizens. Additionally, companies that fail to address ESG factors may face significant risks and penalties, including regulatory fines, consumer backlash, and reputational damage.

However, it seems the credibility of ESGs is under threat of derailment. Recently, Vanguard, an American registered investment advisor, because the latest apostate to pull its $7.2 trillion of assets from the climate coalition management, effectively quitting the net zero climate effort.

The 'environmental' component of ESG has been the driving force behind attracting new investment, but often, 'social' and 'governance' override environmental concerns, depending on political expediency.

For example, several weapons manufacturing companies became ESG-compliant assets last year as soon as funding for fighter jets and missiles became critical to the war effort in Ukraine. Hustling after ESG-compliant verification is why oil manufacturer Exxon Mobil ranked as a top 10 ESG company, while electric vehicle manufacturer Tesla lost its ranking in the S&P 500 ESG index.

In response, dozens of states have either proposed or adopted anti-ESG regulations, including bans on pension fund managers from incorporating ESG factors into investments.

So, What Next?

Green investment vehicles present a unique opportunity for governments and businesses to address the pressing issue of climate change. The unprecedented flow of capital into these funds can support the development of clean and sustainable infrastructure.

For the sustainable fund sector to become an effective driver of change, policymakers should:

• Make the rules of the game clear. Urgently strengthen global climate information architecture, including data, disclosures, sustainable finance classifications, and climate taxonomies – both for firms and investment funds.
• Implement proper regulatory oversight to prevent greenwashing. By eliminating greenwashing, tools, such as financial incentives for investments in climate-oriented funds, can be utilized to channel savings toward transition-enhancing funds and complement other critical climate-change mitigation measures, such as a carbon tax.

Supportive government policy and coherent regulation can be vital to encourage companies to meet their ESG obligations and convince investors of the long-term viability of sustainable investing since sustainable investors are less sensitive to short-term returns.