Resources Radio: Catalyzing Markets toward Sustainability

Resources Radio, a podcast produced by Resources for the Future (RFF) that launched late last year, is this magazine’s weekly podcast, hosted by Daniel Raimi and Kristin Hayes. Each episode features a special guest who talks about a new or interesting idea in environmental and energy policy. Transcribed here is one such episode, in which Kristin Hayes spoke with Kyung-Ah Park about the potential to catalyze markets toward further investments in environmentally beneficial products and services.

Kyung-Ah Park is the head of environmental markets and innovation in the newly formed Sustainable Finance Group at Goldman Sachs; she also serves on the board of RFF. Previously, Park headed the Environmental Markets Group at Goldman Sachs.

The transcript of their conversation has been edited for length and clarity.

Resources Radio: Can you begin with a brief description of environmental markets and sustainable finance, particularly as they relate to your work at Goldman Sachs?

Kyung-Ah Park: The conventional definition of environmental markets relates to harnessing the power of markets to promote better conservation and stewardship of ecosystems and the environment. For example, you can put a value on the services that forests provide, whether it’s carbon sequestration or biodiversity, that creates incentives to conserve the forests, rather than cutting them down.

For Goldman Sachs, environmental markets have been about leveraging our core competencies as a global financial institution to help address critical environmental issues, including climate change, in a way that enables us to better serve our clients and generate long-term value for our investors. For example, we have a goal to mobilize $150 billion in financing and investment to scale clean energy around the world. Energy is the largest contributor of greenhouse gas emissions, and it is capital intensive. Bringing clean technologies down the cost curve and scaling them up has been a very important part of addressing climate change.

In terms of sustainable finance, an exciting evolution is that the business thesis around sustainability has become incredibly compelling—certainly on the climate transition, but also, importantly, on inclusive growth. And we’ve been doing a lot on that front as well, whether it’s in underserved markets with our Urban Investment Group; investing in women-led investment managers and businesses through the Launch With GS program; and in our asset management business, where we now have $35 billion of assets under supervision that are specifically dedicated to environmental, social, and governance (ESG) and impact strategies.

So the idea behind the recent formation of the Sustainable Finance Group is really to bring together these key pillars and the breadth of our capabilities as a firm and turbocharge our ability to serve our clients, capture growth, and drive innovation.

Can you expound on this concept of inclusive growth?

Inclusive growth involves everything from underserved markets; to inclusion on gender and diversity issues; to helping provide access to healthcare, financial services, and education.

Why is it critical to harness the power of markets in addressing climate change and other environmental and sustainability challenges?

With climate change, an oft-quoted number is $1 trillion per year just on the clean energy transition that is needed to meet our key climate objectives. And then, when you think about the UN’s Sustainable Development Goals, which entail 17 key goals to drive sustainable development globally, the number that is often quoted is several times bigger: somewhere on the order of $5 to $7 trillion per year. So when you step back and think about what needs to happen, it’s quite daunting. The good news is that there is significant capital out there, and more of it is getting harnessed for sustainability.

If you think about the public capital markets in particular, which are incredibly deep and liquid, some of the numbers out there show that there’s upwards of $150 trillion of capital outstanding, and there are a lot more financial tools that are unlocking greater capital flow from the market for green sustainable investments.

You also have institutional investors. These are some of the sovereign wealth funds and public pension funds, among others, that hold somewhere around $100 trillion of assets and are increasingly considering environmental and social factors, in addition to governance issues.

And, importantly, strategic capital—investment from companies that are investing in clean energy and other sustainability solutions—both as a way to de-risk and to capture growth and innovation.

So we definitely need to harness the power of markets and the private sector.

What are some innovative finance mechanisms that are helping to ease the flow of private capital for some of these solutions?

There’s a lot of innovation that is happening in the markets, but in the interest of time, let me highlight an example in the fixed-income market. There’s been a lot of focus and momentum around what are called green bonds. These are akin to conventional bonds and are simple, plain-vanilla instruments, where the risk-return profile from the issuer is exactly the same, whether the bonds are green or conventional. The only real difference is that you have a dedicated use of the proceeds toward environmentally beneficial purposes, along with reporting and transparency around the actual allocation of those proceeds and their impact.

Last year, the market for green bonds amounted to almost $200 billion. This year, we’re on a trajectory to well exceed that amount. And instruments have gone from not only green bonds, but also to social bonds, which relate to inclusive growth and social benefits, along with sustainability bonds, which combine both the green and the social benefits. We are also seeing performance linkages to ESG and sustainability goals, along with opportunities to leverage securitization and project-level bonds.

You mentioned that there’s a more robust system of monitoring and verification for the use of the proceeds. Who actually does the monitoring and verification? Who’s checking to make sure that the use of proceeds is in fact meeting the goals laid out in these green, social, and sustainability bonds?

First and foremost, the issuer owns and takes the responsibility for this.

But the market has evolved, so that you are seeing more independent opinions. And now, the vast majority of green, social, and sustainability bonds have these opinions associated with them—both at the front end, when you actually do the green bonds and launch into the market—and then on the back end, once the actual allocations happen. Typically, every year, the issuers report through a separate impact report, or they include a green or a social sustainability section on the bond allocation. And many of these will get assured by auditors or other verifiers.

This system is robust, relative to where we were in the very early stages of the market. But we also have to keep in mind that $200 billion sounds like a large number, but compared to the full breadth of the fixed-income market, it’s a small drop in the bucket. So, we’re still at the earlier stages of that market development, and we need to do more.

What would you say to folks who are asking, particularly when it comes to climate change: Don’t we actually need to do a lot more at a much quicker pace than markets have been able to achieve so far?

I think that’s a fair observation. And certainly, when we published our Environmental Policy Framework in 2005, one of the key things that we did up front was to recognize the urgency and the scale of the climate change challenge, the need for us to collectively do more, and, as a global financial institution, to step up.

But when you think about how capital flows, markets fundamentally are highly efficient; therefore, capital flows toward optimized return for the risk that underlies it. And when you think about the climate equation, that optimal risk-return has to be made more favorable for low-carbon investments, and more broadly to environmentally beneficial solutions such as conservation. And at the crux of this, you need pricing signals that reflect the true costs or the risks inherent in that system, thereby ascribing economic value in a way that harnesses the market to what you’re actually trying to mobilize capital for.

And also importantly, you need to take that into account in a way that values it today, not way into the future, given that there is a lot of discounting when you think about the financial values of future cash flow.

How do you see the role of policy in complementing market mechanisms and perhaps giving some of these signals that markets might not necessarily adopt for themselves?

Policy absolutely has to play a more meaningful role, working in concert to help address these issues and providing the optimal market signal. There’s been an increasing focus, even here in the United States, around the question of putting a price on the externality of carbon.

But to pull this conversation back to the broad environmental markets: there’s also a lot of focus and effort around putting value on other aspects of environment—for example, broader ecosystem services. RFF has done some terrific work both on the carbon pricing question and, more broadly, around some of the values ascribed to ecosystem services.

Having said that, one of the things that I think is important to recognize is that putting a price on carbon is not a panacea. There are many places that do have carbon pricing, but the pricing signals tend to be low and therefore are muted. But even if you could increase the signal significantly, there are areas with market or behavioral barriers. Energy efficiency is a good example of this: for a number of reasons, carbon pricing alone is not going to stimulate much energy efficiency; therefore, many governments have put standards and mandates into place.

When we think about the climate challenge and its urgency and magnitude, renewable energy has to be a key component, along with energy efficiency and transport solutions. But we need a lot more, right? For example, the private sector is less well-equipped to increase investments in early-stage R&D and in areas such as commercializing carbon capture use and storage, and this is where the government can play a critical role.

Innovation feels like a particularly optimistic part of the conversation around climate change. What are some other ways to harness markets and accelerate the momentum to get some of these technologies into the marketplace and address these environmental challenges?

We’re seeing an increasing number of corporations setting up venture capital arms, or partnering with venture capital firms and investing in disruptive technology, to help bring startup technologies more quickly into the market and help scale the companies. In particular, for cleantech, renewables, and clean transportation, we are seeing a large number of examples that are quite successful.

We’re also seeing more partnerships between traditional competitors—“coopetition”—where competitors in the industry are coming together to join forces and invest in innovative technologies to drive scale and market access. In the oil and gas industry, the Oil and Gas Climate Initiative is an example that is very much focused on carbon capture and sequestration.

Innovation also comes from business models, where companies are strategically repositioning their businesses— de-risking from areas that are increasingly becoming constrained, and capturing opportunities in growth and innovation. Coming back to the oil and gas sector, companies are moving into renewable energy; electric charging stations; energy storage; and, in some cases, retail utility to capture electrification—traditionally the domain of utilities, which have also been at the forefront of business-model changes.

One last thing to mention is the significant role that nongovernmental organizations can play in catalyzing more innovation, and pooling and bringing together greater action. RE100 is a great example of this, where they’ve brought many, many companies together with 100-percent-renewable energy commitment. I think there are now close to 200 companies, and that’s galvanizing a significant amount of renewable energy globally. And companies that are at the forefront of this are not just leveraging their own operations, but now are also working across the entire supply chain. This is an incredibly important part of the innovation equation, and one that is driving a significant amount of growth in the renewable energy scale-up.

The world of finance continues to evolve rapidly, and the layperson is constantly learning how to keep up with the various changes. It’s great to hear from one of the experts about how things are evolving on the environmental market side, so Kyung-Ah, thank you for talking with us about this topic.