2021 was a banner year for sustainable finance, with the creation of Glasgow Financial Alliance for Net Zero (GFANZ) managing over $140 trillion in assets; sustainability bond issuance up to $1 trillion and record inflows of more than $120 billion to Environmental, Social and Governance (ESG) targeted funds. There seems to be no shortage of funds today for ESG.
Do this mean that the global transition to a low carbon economy is now on track? Yes and no.
For sure, mobilizing finance to reward ESG compliant companies through financial markets is absolutely necessary. However, simply classifying financial assets as ESG does not deliver better outcomes if those funds cannot land where they are most needed. Critically, they must overcome two built-in imbalances in global finance.
The first imbalance is between emerging markets and developed markets. Over half of the global investment towards net zero needs to happen in the developing world – Asia alone requires $3 trillion annually from now until 2030 in order to achieve the UN Sustainable Development Goals (SDGs). And yet, critically, most of the ESG tagged assets are in Europe, and only 10% are in Asia. So Asia still lacks ESG funding.
The second imbalance is between large and small companies or projects. The shortage of funds for micro, small, and medium-sized enterprises (MSMEs) is a sad story of market failure. MSMEs create over 80 percent of all jobs in developed or emerging markets, and contribute significantly to growth, social stability and innovation. And yet they are persistently finance-starved, even when the world is awash with liquidity.
The pandemic widened the global trade finance gap to $1.7 trillion, borne primarily by MSMEs. McKinsey estimated that 65 million MSMEs have credit constraints globally. Funding these enterprises can support potentially 2 to 3 billion people out of poverty.
The plain fact is that global finance as currently structured does not find it profitable to lend or invest in small amounts to small enterprises. A high-earning banker would prefer to lend to two or three borrowers requiring $30 to $50 million each with good collateral, rather than worry about a loan book of $100 million from a thousand small borrowers with scant credit records. As a result, most banks chase large borrowers, instead of choosing to serve the small.
These imbalances have serious consequences for our global climate fight. Since SMEs account for over 40 percent of the emissions reduction in value chains and are too small to access banks and stock markets, how can they contribute seriously to achieve NetZero?
These inequities occur everywhere even when intentions are good. Hong Kong’s Green and Sustainable Finance Grant Scheme offers a telling example. The scheme aims to reduce the costs of issuing green finance by subsidizing the costs of issuance, including lawyer, accountant, sustainability auditor, and other professional fees. In its first few months, the scheme supported mainly large well-established companies, which arguably didn’t really need the support. Even lowering the minimum loan threshold from US$25 million to US$12.5 million in the recent Budget is unlikely to attract more SMEs to apply, since by definition, most SMEs have revenues of less than US$20 million.
The market reality is that for both big banks and SMEs, it is simply not worth the trouble of paperwork and credentialling needed to process small loans. Many factory owners find it faster and easier to get a 2nd mortgage or consult a money lender rather than go through the hoops of meeting well meaning “know your customer and anti-money laundering conditions.
The good news is that digitalization can help by drastically lowering the cost of loan processing while creating trusted data needed to improve risk management. Today individuals can open bank accounts and access modest loans in a matter of minutes, as ANT Finance and WeBank have shown. Can we scale the same model for SME finance, with an ESG twist?
Any ESG oriented project or company should be able to “list” their credentials and funding requirements through a digital platform, using ESG data formats verified by blockchain against existing audit providers or cloud platforms drawing data from simple hardware such as sensors, smart cameras and robots. The standardization of ESG data plus AI-driven analysis could match deserving companies and projects to interested investors, who could then deliver funding and knowhow with speed, scale and scope.
The world is currently awash with startups and innovators offering net zero or SDG targeted solutions. Their greatest problem is that the market for talent, funding and branding is fragmented, geographically bound, and difficult to penetrate. Whilst universities, banks, and multinational companies have launched incubators or startup competitions with the best of intentions, such schemes are top heavy and lack scalability.
We are not asking for new digital platforms to be created overnight. The marketplaces that daily matches supply and demand through standard bulletin boards, data credentialling, and trusted clearing and payments platforms are none other than today’s stock markets. 54,000 companies are currently listed worldwide, but the entry barriers still remain too high for MSMEs.
Luckily, stock markets do aim to support ESG, with Hong Kong, Singapore and Jakarta all exploring the launch of wide-scale voluntary carbon markets. These platforms would match holders of nature based or technology climate assets with potential buyers of carbon credits through a credentialed, secure, trusted process that could be global on both ends (investors and carbon assets). But why stop at carbon credits?
By opening up these platforms to ESG positive projects or companies, then carbon credits plus ESG fund matching become part of the same game.
Market failure occurs because market players pay too high transaction costs from non-transparency and liquidity. If stock markets behave only as monopolies, no one wins. When they lower social costs for everyone, new opportunities arise. If Hong Kong is serious about innovation and ESG, time to take some risks and break out of Business as Usual.
Pamela Mar and
Pamela Mar is Executive Vice President, Knowledge and Applications, Fung Group
Andrew Sheng is Distinguished Fellow, Asia Global Institute, University of Hong Kong. Views are personal to authors.