There is huge need for financing climate-related projects in emerging markets, but the social costs and the lack of return are acting as deterrents to global lenders.

Developing countries will play a crucial role if the world is going to meet climate goals like the Paris Agreement on climate change, which aims to limit global temperature rises to less than 2 degrees C. Investors and policymakers in developing countries are caught between a rock and a hard place, however, as the social and financial cost of a rapid green transition could be huge, something that has been compounded by the coronavirus pandemic, market participants say.

The World Bank's International Finance Corp. estimated funding needs of $29.4 trillion by 2030 in infrastructure, energy-efficient buildings, renewable energy and water management in emerging markets.

"It is not difficult to create a buzz around renewable energy as long as it creates a return on investment," Mikkel Larsen, chief sustainability officer at southeast Asia's largest lender, DBS Group Holdings Ltd., told S&P Global Market Intelligence during a panel discussion Oct. 13.

The U.N. launched its 17 Sustainable Development Goals, known as the SDGs, in 2015 with an aim to create a safer, more prosperous planet by eradicating poverty, eliminating hunger and providing clean water and sanitation worldwide by 2030.

"While they are really good for the economy and society, they don't necessarily attract a return for the lender or the investor that is attractive," Larsen said.

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Balancing green and social needs

If emerging markets fail to transition to greener business models, it will have serious consequences for global climate goals, bankers said.

"This is where it's going to happen. It's either going to develop in the right way to reduce greenhouse gases or for companies to be more resilient. Or it's not going to happen at all," said Stefen Shin, principal investment officer for capital markets and structured products at the Asian Infrastructure Investment Bank, a multilateral development bank with a focus on Asia.

While the move to renewable energy is "quite astounding" in emerging markets, they still lag Western Europe and the U.S., and finding ways to transition will be key for a low-carbon future, Shin said in an interview.

According to the Climate Bonds Initiative, a nonprofit organization that promotes development of green finance, developed countries issued 82% of green bonds — debt instruments that finance solar power or wind farms — in the first half of 2020, while emerging markets' share fell to 13% from 21%.

Another challenge is that emerging markets often still rely heavily on power sources like coal. Transitioning rapidly out of fossil fuels in these markets, which also often have high levels of poverty, could have a negative impact on communities.

"If you begin to eliminate parts of the carbon industry very, very rapidly, you will find there are some very unattractive impacts from that as well and not just in the richer countries but in the poorer countries," Rick Lacaille, executive vice president and global chief investment officer at State Street Global Advisors Inc., told the Institute of International Finance Forum on Oct. 14.

Lenders are grappling with this dilemma. HSBC Holdings PLC introduced a policy in 2018 to phase out financing to new coal-fired power plants except in Bangladesh, Indonesia and Vietnam because their economies needed coal. In 2020, it decided to pull out of new coal investments globally.

"It's not lost on many people that there are still thermal coal plants being put up round the world and that's why a number of companies like Glencore PLC are still mining thermal coal even though they have had pressure from shareholders and they may be winding it back," Lacaille said.

'Massive opportunity'

Coordination between the world's markets can help balance the need to meet global climate goals with the social needs in emerging markets. China and India will need private finance to transition to carbon-neutral economies, Ben Caldecott, director of the Oxford Sustainable Finance Program and associate professor at the Smith School of Enterprise and the Environment at Oxford University, told the Institute of International Finance Forum on Oct. 14. The huge capital needed presents a "massive opportunity" for banks, Caldecott said.

Expertise from global financial centers such as London can ensure the financing of projects takes into account risks as well as the environmental and social impacts, according to Caldecott.

"China and Chinese financial institutions do want Western capital and Western financial expertise to co-finance projects so there is an opportunity there to make sure that these risks and impacts are managed as a result of access to international capital," he said.

The global nature of finance means that what happens in one region has consequences for the rest of the world.

"This is an interconnected system so it can make or break our collective progress. We can do as much as possible here [in Europe] and hopefully in the U.S. as well," Elsa Palanza, global head of sustainability and citizenship at U.K. lender Barclays PLC, told the Institute of International Finance Forum on Oct. 14. She added that events such as the COP26 climate conference in Glasgow in 2021 "are so critical to make sure there is a global confluence."

Speaking at a panel on sustainable investment in developing countries at the Organization for Economic Cooperation and Development's Green Finance Forum on Oct. 9, Indonesian Finance Minister Sri Mulyani Indrawati said her country had issued green bonds and undertaken fiscal measures to fight climate change. It provides transfers of tax revenues to local governments to help pay for the cost of protecting the country's tropical forests, for example; it also offers tax incentives to the private sector, but the country needs international support to meet its climate goals, she said.

Standard Chartered PLC CEO Bill Winters told the Institute of International Finance Forum on Oct. 14 that emerging markets lack an annual $2.5 trillion to meet their emission requirements, and while risk has to be measured, so does the sustainable nature of a project.

"The projects are there. Getting the right risk profile in place hopefully with the help of supranationals and wealthier sovereigns will be very important, but there is private sector capital available," he said.