The amount of capital investment required to transition to a sustainable economy is estimated to be as high as $5tn per year. This means that, with their long-term horizons, vast capital and market influence, public pension and sovereign funds are increasingly at the forefront of transition finance. The potential of these global public funds to drive the capital needed to hit net zero cannot be overstated.
Against this backdrop, OMFIF’s Sustainable Policy Institute has established the Transition Finance Working Group. The group, featuring Franklin Templeton, EY and MSCI, convened 12 bilateral meetings with public pension and sovereign funds representing over $5tn in assets under management. That process yielded more than 20 hours of detailed, engaging, challenging, collaborative and at times difficult discussions on the state of transition finance.
These conversations have informed the working group’s first report. ‘Global public funds and transition finance’ explores pension and sovereign funds’ approaches to transition finance so that they can learn from each other and identify areas of common concern, including internal challenges, regulation and policy and the broader financial markets. It encourages all stakeholders to work together and create credible investment opportunities to meet the net-zero goals of transitioning companies, industries and entire economies.
Key conclusions
Asset owners must share experience to improve best practices, critique, improve and drive global initiatives, lead the way on ownership practices and use their collective as well as individual influence. At the same time, policy-makers need to ensure that policies are aligned with market outcomes and provide incentives for investors, such as risk-sharing and carbon prices.
Most funds believe that they need to be allowed to increase portfolio emissions in the short to medium term to create long-term positive outcomes on decarbonisation, which can be difficult to manage with stakeholders.
But scarcity of available assets, lack of credible transition plans and scepticism about certain markets and products are holding back the development of funds’ portfolios. While investors recognise the potential role of blended finance in assisting the emerging markets’ transition, few believe today that there are realistic investment opportunities. Governments need to invest in infrastructure development and bring in private capital.
The working group and the funds we spoke to shared positive stories of transition projects delivering returns and big opportunities for impact in the energy sector. But the discussions made one thing clear: capital is still not moving at the pace and scale needed. Divergence in standards, uncertain policy environments and lack of projects are key barriers, as is the need to upskill teams, overcome risk perception and generate better data.
It was also clear that client demand for sustainable investment and divestment from dirtier industries is growing. Clearly defining what a transition finance investment is will be a major challenge, and there is a need to ensure that the transition is both credible and just – two words that came up throughout our conversations.
Making a positive impact
Many asset owners feel they can currently create more of an impact and deliver better returns in private rather than public markets. Although that limits the scale of their investments today, they are confident that lessons learnt via direct or private equity stakes can be applied across their growing portfolios in the future.
Perhaps most importantly of all, many working group members already report that they can make at least similar returns on brown-to-green transition investments as in the rest of their portfolios. And they believe that, as these markets develop and mature, transition-related investments will begin to outperform.
While there is still much work to be done, it is remarkable how much progress many of these funds are making and that broad areas of consensus are to be found. Some expect up to 30% of their portfolios to be run through a ‘transition lens’ by 2030, even if they are continuing to work out where those investments will sit and how their internal teams will be staffed and structured to manage these.
OMFIF very much hopes that this report plays its own small role in the development of transition finance. We plan to reconvene the working group members and participants next year, and in years to come, to track progress and delve even deeper into the transition challenge. If you want to join us on that journey, please let us know.
Clive Horwood is Managing and Editor and Deputy Chief Executive Officer, and Emma McGarthy is Head of the Sustainable Policy Institute, OMFIF.
Download ‘Global public funds and transition finance’. Watch a discussion of the report’s findings here.
