Transition Finance Market Review: How do we pay for net-zero?

Ricardo's Dr James Davey explains the importance of the Transition Finance Market Review, published in the UK in October 2024, and how it sets out the actions that Governments and financial institutions can take to scale-up investment in net-zero.

How expensive is the energy (and industry, agriculture, waste etc.) transition to net-zero? Various institutions have made their own calculations and, while there are significant variations between the different sets of figures, one thing is very clear: building a global economy which emits (net) zero greenhouse gases (GHGs) is going to be expensive. Very expensive.

It should go without saying that this is no reason to halt decarbonisation. Building any kind of future economy is going to be expensive. Cars, boilers, nuclear power stations, steel plants, farming systems etc. have a finite lifetime and need to be replaced. Every day we are building new bits of tomorrow's economy, and someone somewhere is paying for it. In short, whatever we do is going to be expensive.

Furthermore, the damage costs of climate change will, in any case, far exceed the costs of action.

But since GHG pollution is an externality (that is, the person doing the emitting doesn’t pay for the damage the emitting does) simply recognising the necessity of net-zero does not, in itself, lead to net-zero. And while innovators – in many cases supported by Ricardo – have developed net-zero solutions for every sector of the economy, the mere availability of net-zero technology (even low cost net-zero technology) does not mean that it will ever be fully deployed.

In a market economy the role of the Government in building the future is quite limited. Of course, fundamental infrastructure like roads and rail remain dependent on public planning and funding, and the work that public officials play in setting product standards is probably under-appreciated. But, in general, governments don’t dictate how much stuff gets built and - beyond your car failing its annual checks- when you have to replace assets.

But since net-zero is running up against a deadline (to avoid breaching the Paris Agreement target we have <10 years to very significantly reduce global emissions), and because net-zero requires a fundamental shift in technologies (a wind turbine is not like a coal-fired power station), the ‘theory of change’ behind decarbonisation largely focuses on the role policy plays in a global shift from ‘brown’ to ‘green’. There are thousands of different policy recipes, but they largely boil down to banning ‘brown’ stuff, subsidising ‘green’ stuff, and tilting the playing field from brown to green by Carbon Pricing or similar instruments.

What if there was another model? What if we could unleash the billions and trillions banks and other financial institutions invest each year to massively increase investment in ‘green’? And if we did, how could the UK financial services industry position itself to be the world leader in products and services for net-zero, which would generate UK jobs and UK growth?

These are the two questions the Transition Finance Market Review has been wrestling with.

I won’t attempt to precis the full Review, which is long and technical, but also essential reading for anyone interested in how we finance the transition to a net-zero future. What I can say is that the Review does not identify a magic solution. There is no secret sauce that will see banks and others rapidly pull finance out of ‘brown’ and into ‘green’.

But it does underline how Governments have a fundamental role in both setting out how they expect different sectors of the economy to reach net-zero, and in devising the policies that ensure that those who invest in, say, sustainable aviation fuel or industrial heat-pumps, can make returns on those investments.

Does this mean that financial institutions have no role to play until Governments provide them with a set of instructions and a rulebook? Not at all. As the review finds, clean technologies and services already provide excellent return on investment. At a business strategy level, financial institutions already have all the tools they need to develop a Transition Plan.

And there are many ‘real economy’ companies looking to capture ‘first mover’ advantage, to meet stakeholder expectations, and who are proactively investing in clean technologies ahead of policy requirements. By investing in - and supporting customers to invest in - net-zero projects and entities already aligned with net-zero, banks and others can get ahead of the curve in the transition.

Transition Plans are worth expanding upon as they are very much the zeitgeist of the decarbonisation agenda. With European companies already required to develop Transition Plans - and UK organisations likely to follow - they represent a framework through which companies can not only set out how they will align company activity with net zero, but also state how they will tackle climate risk. The damages wrought by extreme weather will – if ignored – be very serious and, for some businesses, existential. Companies should address them head on. Climate scenario analysis and adaptation planning is essential to ensure future risks are understood and addressed before they become issues. 

From decarbonisation options to scenario analysis, adaptation planning, energy audits, lifecycle emissions, greenhouse gas inventories and full Transition Plans – for financial institutions and ‘real economy’ actors – Ricardo can support you to navigate a complex but increasingly pressing agenda. So talk to us…

Dr James Davey is our head of private-sector climate risk and worked on the Transition Finance Market Review. #TransitionFinanceMarketReview