Using finance to green the planet

Why sustainable finance must follow, not lead, real climate action

- M S SAHOO & CKG NAIR

Governments, financial market regulators, and civil society organisations increasingly view financial markets as the key to achieving a greener planet. This rests on the premise that investors prioritise public interest over their private gains, aligning capital flows with sustainability goals. While finance certainly has a role, it cannot be the fulcrum of climate action for several reasons.

Financial markets operate on a risk-return calculus. They allocate resources among competing businesses based on risk-adjusted returns, which, in turn, reflect prices in product markets, and those prices reflect consumer choices. If a business, say a coal-based enterprise, is profitable based on prevailing demand and supply, it will attract investment unless there is a regulatory constraint or an economic disincentive. Expecting investors to routinely disregard prices, returns, and risks is wishful thinking. This is akin to expecting consumers not to buy Chinese goods while allowing their widespread sale.

That is neither how finance works nor how markets function.

Markets reflect choices; they don't define them. It is policy and regulation that establish the boundaries of permissible conduct and determine what gets produced and consumed, how, and how much. A more effective and honest strategy, therefore, is to discourage or disallow harmful businesses at the source rather than hope markets will voluntarily avoid them. Adoption of electric vehicles did not happen because investors wanted to invest in these enterprises, but because of incentives and disincentives that influenced the choice of consumers and producers.