Energy transition pioneer Germany slow to expand action to financial sector
Despite its longstanding experience with employing renewable energy sources, Germany is considered to be an international laggard in promoting and exploiting the concept of green finance for climate and energy policy. Sustainability aspects have gradually gained in importance in recent years, but Germany still trailed many other European countries on most sustainable investment metrics in a 2018 study by industry network European Sustainable and Responsible Investment Forum (Eurosif). As the biggest economy in Europe, Germany accounted for only nine percent of the region’s green funds market in 2017, whereas the UK and France boasted market shares that were twice as high, green finance researcher Novethic found.
A major obstacle in the creation of a concerted policy response is the lack of a comprehensive and standardised database for climate-related risks and green investments, according to Germany's finance ministry (BMF). While abundant data on company emissions and different categories of green finance instruments are available (see glossary), these are often fragmented, incoherent and mostly analysed in mere case studies.
As of 2019, the most commonly used reference for green finance in German-speaking countries is compiled by the finance industry's sustainability body Forum Nachhaltige Geldanlagen (FNG), which also launched the first label for sustainable fund management. The share of investments the forum classified as sustainable stood at 4.5 percent of the total market in 2018. The FNG report focusses on funds and asset management and does not cover lending. However, it clearly shows that the vast majority of investments were made without regard to the impact they have on emission levels or other critical climate and energy policy aspects. A similar sustainability metric for lending volumes has been under discussion for a while, but according to the Association of German Banks (BdB), too many definitions are still lacking to make the data operational.
The funding gap - climate policy needs allied finance sector
Implementating the Paris Agreement and achieving international emissions reduction targets will require enormous financial investments. According to UN calculations, these could reach the equivalent of up to 15 percent of individual state budgets or up to about seven trillion dollars per year globally. The shift to renewable energy sources, electric mobility, digitalisation and other measures associated with the energy transition therefore needs to be backed by a parallel decrease in fossil fuel investments and a rise in the funding of low-carbon alternatives and energy-efficient technology through a systematic inclusion of the financial sector in climate policy.
State governments rely on banks, insurance companies, investment funds and other financial market actors to act in alignment with climate policies. For Europe, the goal to reduce greenhouse gas emissions by 40 percent by 2030 is exacerbated by an annual funding gap of about 180 billion euros, the European Commission estimates. Germany alone would require additional investments of about 2.3 trillion euros to cut greenhouse gas emissions by 95 percent by 2050, equivalent to more than 70 billion euros per year, according to a study by industry federation BDI. Germany’s total federal budget for 2019 stood at about 356 billion euros.
The carbon bubble - finance sector needs clear climate policy
Global warming causes the financial sector faces two differents kinds of challenges at the same time. Financial investors not only face the immediate costs of more frequent extreme weather events but also a sudden devaluation of trillions in fossil assets due to unregulated divestment, as emissions reduction targets mean a large share of known reserves will have to stay in the ground. A mass withdrawal of funds invested in coal, oil and other fossil sources could let stock values plummet, turn balance sheets upside down and, by extension, deal a blow to pension schemes, insurers and government budgets around the world – a phenomenon known as the "carbon bubble".
A 2016 report by Germany’s finance ministry (BMF) assessed the impact of climate change and of possible political reactions to it from financial markets. The immediate effects of global warming on the financial system were considered negligible, at least in the medium run, but it found that an “orderly transition” to climate-neutral investments was necessary to avoid “severe losses” in the form of stranded assets, such as coal plants, in the case of abrupt carbon price rises that could destabilise the entire market. It also found that the value of the DAX, Germany’s most important stock market index, and the corporate bond market depend to a large extent on the business fortunes of high-emissions industries, especially producers of chemical and industrial goods and of cars. If companies were to internalise the costs caused by their greenhouse gas output through a higher carbon price, for example, this could wipe off more than 650 billion euros or five percent of company portfolios, even at still relatively low CO2 prices of 2016.
The ESG criteria - sustainability for investments
In order to minimise the disruptive effects of climate change and political responses to it on financial marekts, the Paris Agreement has stipulated a harmonisation of financial flows and emission reduction targets as one of its long-term objectives. This "shifting of the trillions" is meant to happen on two dimensions: First, by ensuring that investments do not run counter to emission reductions and, second, by raising capital for climate action measures. This implies systematically drying up financial flows that clash with reduction targets as well as a set of financial market reforms, such as a mandatory disclosure of climate-related risks, “Paris-compatible” investment criteria, adequate CO2-pricing schemes, stress-tests for credit systems, cutting fossil subsidies and decarbonisation roadmaps for industrial companies.
All of these measures are comprised in the concept of sustainable finance, which aims to ensure that the full impact of investments is understood and resulting risks are weighed against potential profits accordingly. Sustainable finance typically is based on so-called ESG criteria, which gauge the environmental, social and corporate governance dimension of capital flows. From a climate action perspective, the focus naturally rests on investments’ environmental aspects and is commonly referred to under the term “green finance”.
Green Finance Glossary
Asset management - The handling of financial investments by a professional agent
Best-in-class – Investment strategy that opts for funding leaders in given rankings in industries, technologies or categories
Carbon disclosure - Publication of climate-related activities by companies; spearheaded by NGO Carbon Disclosure Project and its disclosure leadership index
Corporate governance - The compliance of a company with laws, guidelines, voluntary agreements and other norms in its business conduct
Divestment – Withdrawal of capital from funds, equity or other capital assets from certain businesses or fields of operation, such as the coal industry
ESG –The Environmental, Social and company Governance dimension of business activities
ESG-Integration – The explicit inclusion of ESG-criteria in traditional risk analysis
Engagement – Long-term dialogue with invested companies to adapt investment decisions to ESG considerations
Exclusion criteria – Systematic elimination of certain investments or other categories, like companies or states, if they fail to abide by certain standard practices
Green Bonds – Bonds issued with the condition to finance environmentally friendly projects
GRI Standards - Globally used standard for sustainability reporting in finance launched by the Global Reporting Initiative Framework (GRI) since 1997
Impact investment – Investments made with the aim to make financial gains while also deliberately influencing ecologic and social developments
Integrated reporting - The inclusion of environmental and social impact information in company reporting to indicate financial and non-financial business aspects in parallel
Socially Responsible Investing (SRI) - Screening of funds to exclude companies which generate a given share of their revenue with activities conflicting with given environmental, social or ethical values
Sustainability-themed funds – Financing of business areas or other assets that are associated with sustainability and have a connection to ESG-criteria
Government under pressure to couple finance with climate policy
In the aftermath of the 2008 financial crisis, governments around the world reviewed their financial sectors’ architecture and stability. With the financial dimension of climate policy becoming more discernible, many have in recent years also begun to more systematically integrate the finance sector in climate policy. France, for example, has been compelling investors by law to disclose the carbon footprint of their projects since 2015, Norway has been integrating ESG-criteria in its influential government pension fund since 2010 and China pushed green finance in the G20 during its 2016 presidency. In addition, the European Commission in 2018 began work on its Sustainable Finance Action Plan, a comprehensive strategy to introduce a common European taxonomy for sustainability, a classification system intended to provide policymakers, companies and investors with sound information on the impact of financial flows.
In Germany, state-owned development bank KfW has been a crucial contributor to the development of green finance and the Energiewende, especially through energy efficiency loans to small and medium-sized companies. It pioneered the country’s green bond market in 2014 and remains one of the most important international issuers of this credit instrument. However, the KfW’s activities are not comprised in an overarching green finance strategy. Moreover, the federal government’s investments are not subjected to sustainability criteria, the government-appointed Council for Sustainable Development (RNE) pointed out.
As countries around the world are making their emission reduction policies more concrete, the market for green finance is expected to grow rapidly over the coming years. Germany’s government committed itself to gaining ground in this critical policy field and booming business and vowed to make the country “a leading location” for environmentally and socially sustainable investments. In June 2019, the Council on Sustainable Finance was launched with the aim of bringing state actors, the financial industry and civil society together to make Germany more attractive as a source of sustainable investment products.
Country’s “three-pillar” banking sector focussed on locally limited approaches
Germany’s financial sector is among the largest in the world and very exposed to international markets. As most businesses rely on bank credits for their funding rather than on equity, it is an important pillar for the country’s general economic stability. With a total value of 111 billion euros, financial services contributed about four percent to the country’s gross domestic product (GDP) in 2017 and employed about 1.2 million people, according to government agency Germany Trade & Invest.
Germany's banking sector features several peculiarities that makes it different from those of other industrialised countries. An important feature is the banking system’s three-pillar structure, which consists of the influential public Sparkassen/Landesbanken and the cooperative Volksbanken as the first two pillars and the purely commercial banks as the third. The public and cooperative banks have a dense and locally rooted branch network and thus stay well-informed about the business prospects of the companies they fund. Together, they account for nearly two-thirds of company credits issued in Germany.
The inclusion of the sustainable finance (ESG) criteria in Germany was spearheaded by a range of small and specialised financial institutions connected to the ecologic movement and, notably, the church, which helped finance the Energiewende’s early stages and until today remain relevant best-practice examples for sustainable finance. The number of green financial products on offer ballooned with the introduction of Germany’s Renewable Energy Act (EEG) in 2000, funded for the most part by public and cooperative banks, an analysis by the University of Stuttgart found. By 2018, a total of 271 billion euros had been invested in wind power, solar power and other clean energy sources, according to industry group Renewable Energies Agency (AEE).
The vast majority of these investments was made by small investors through specialised mediators rather than by larger banks, investment funds or other institutional actors. While individual citizens, cooperatives and small and medium-sized companies own more than half of Germany’s installed renewable energy capacity, banks and funds accounted for just over 13 percent in 2017, the AEE found. However, despite their key role in financing energy transition projects, the Stuttgart University analysis as well as an industry survey by the consumer protection organisation Verbraucherzentrale.NRW found that public and cooperative banks so far remain largely unaware of the green finance market potential and stick with tailor-made local projects. A more concerted effort by publicly owned financial institutions could allow Germany to leapfrog development and quickly spread green finance principles across the entire sector, according to NGO Finanzwende.
Financial companies eager to clarify impending changes
The growing market volume for green products and uncertainty over regulatory intervention has fanned calls in Germany’s financial sector to clarify future guidelines and risk assessment metrics. The industry has started to embrace sustainability on a broader basis in recent years, with sustainability association FNG noting that key industry actors and large investment funds helped boost investment volumes by almost 50 percent in 2019. The interest has been bolstered by recurring analyses that found no long-term negative impact on investment profitability if ESG criteria are applied.
The launch of Germany’s Green and Sustainable Finance Cluster (GSFC) and the associated Hub for Sustainable Finance (H4SF) in 2018 showed that market actors are eager to develop an adequate infrastructure and regulatory framework for sustainability in finance. The GSFC started as a joint initiative by government sustainability council RNE and stock market operator Deutsche Börse Group and soon gained support from leading commercial banks and insurance companies, including Deutsche Bank, Commerzbank and Allianz, which are the largest holders of assets under management in the country.
Sustainability initiatives by financial actors have often been accused of being mere greenwashing vehicles that are far from being as ecologically effective as they are advertised, however. NGOs like Urgewald have repeatedly rebuked commercial and public finance actors for upholding adverse investments while otherwise flaunting a clean slate. So far, there exists no legal mechanism for Germany's financial supervision authority BaFin to hold issuers of misleading advertisements to account, let alone to penalise them for ignoring sustainability standards.
Information gap hampers German citizens’ green investment involvement
The participation of ordinary citizens and small investors is seen as vital for the sustained success of green finance, both due to the direct financial flows to climate projects and the pressure this exerts on credit providers to come up with corresponding financial vehicles. Most German citizens, however, are rather sceptical towards financial markets in the first place and investing in equity and other capital markets is far less common in Germany than it is in the US or the UK.
While the share of shareholders across the population stood at 25 percent in the US and 23 percent in the UK in 2016, the figure was merely 6 percent in Germany, the Association of German Banks (BDB) reported, and physical currency savings or bank deposits account for a much larger share of households’ financial assets, according to OECD data. About 40 percent of the official 6 trillion euros in monetary wealth held by Germans in 2018 rested in low-interest cheque or savings accounts, the BDB added. A possible explanation is the mandatory public retirement insurance system in place in the country, a pay-as-you-go system in which the vast majority of the workforce is enrolled, making a reliance on market-based pension schemes less attractive.
A survey by the University of Kassel, however, suggested that the market for private investors for sustainable financial products in Germany covers about ten percent of the population, around seven million people. About 40 percent of private investors are interested in such products but less than five percent so far have considered ESG criteria when actually carrying out an investment. Respondents stated that the main reason for not investing in corresponding products was a lack of information and scarce consultancy by their banks.