1.3. Challenges and prospects
On the one hand, from academic perspective, we have some challenges associated with green finance, including:
– Lack of standardization: The field of green finance lacks a common standard, complicating efforts to consistently define and classify what constitutes environmentally sustainable finance. The lack of a globally recognized framework makes it difficult for investors and consumers to distinguish between truly sustainable businesses and those engaging in greenwashing. Research shows that lack of standardization can lead to market inefficiencies, where funds may not be allocated to the most effective or worthy green initiatives (Busch, Bauer, & Orlitzky, 2016). Without clear standards, companies’ green claims can be vague and unverifiable, leading to investor skepticism and hindering the development of truly green finance initiatives.
– Data availability and risk assessment: Since the first issuance of green bonds in 2008, green finance has grown significantly. However, data on the efficacy and outcomes of green finance initiatives remain sparse and fragmented. This scarcity of reliable data complicates efforts to assess which companies are effectively utilizing green finance for sustainable development. According to Busch et al. (2016), the ESG data is limited, making it difficult to assess the true impact of investments and to develop benchmarks for success. Then, assessing risk in green finance is complicated by the lack of standardization and the scarcity of data. This results in difficulties in pricing green finance products accurately, which can deter investors who are unable to adequately the potential risk and return (Garz & Volk, 2011). Besides, Gianfrate and Peri (2019) shows how the inherent uncertainties of green finance, such as technological risks and market acceptance, add layers of complexity to financial risk assessment. These uncertainties can lead to premiums that might deter short-term investors.
– Uncertain Financial Performance: Investors are often hesitant to commit to green finance due to uncertainties about its financial performance, especially in the short term. While long-term data suggest that green investments can be profitable, short-term returns can be volatile and unpredictable. For example, Karpf and Mandel (2018) shows that the performance of green investments and note that while they often yield lower returns in the short term due to higher initial costs and market adaptation challenges, they tend to outperform traditional investments over the long term due to lower operational costs and increasing regulatory support.
– Regulatory concerns and transition risks: Green finance is heavily influenced by government policies and regulations, which can change significantly over time. Additionally, the transition to a low-carbon economy requires significant changes in business practices across many industries, potentially leading to significant transition risks. Investors may be concerned that future environmental regulations could negatively impact the returns on current investments or that policy reversals could lead to stranded assets. The changing in environmental policies and regulations can lead to substantial financial risks for investors in green finance, emphasizing the need for stable and predictable regulatory frameworks to foster confidence and investment in sustainable projects (Battiston, Mandel, Monasterolo, Schütze, & Visentin, 2017). Besides, transition risks represent a significant challenge for investors in green finance, as industries adapting to low-carbon standards might face short-term financial hardships, technological mismatches, or shifts in consumer behavior that can render existing assets obsolete or less valuable.
On the other hand, from academic perspective, we have some prospects associated with green finance, including:
– Promote economic transition towards sustainability, including: (1) Economic growth and job creation: Green finance is crucial in facilitating the shift from traditional, carbon-intensive industries to sustainable practices, which is essential for achieving global climate targets and promoting ecological resilience. This transition is expected not only to mitigate environmental risks but also to spur economic growth through the creation of new industries and job opportunities. According to a report by the International Renewable Energy Agency (IRENA), the renewable energy sector alone could employ more than 42 million in the renewable energy sector, 21 million in energy efficiency and almost 15 million in power grid and energy flexibility (IRENA, 2020). This potential for job creation spans across various sectors including energy, manufacturing, and services, all of which benefit from investments in green technologies; (2) Innovation and competitive advantage: Investing in green finance encourages innovation by funding new technologies and business models that contribute to environmental sustainability. Companies that adopt green practices often gain a competitive advantage by improving efficiency, reducing costs, and meeting the growing consumer demand for sustainable products. This competitive edge is crucial for businesses in a global market where environmental concerns are increasingly influencing consumer choices and regulatory frameworks; and (3) Financial market diversification and stability: Green finance contributes to financial market stability by diversifying investment portfolios. Investments in green assets are often less correlated with traditional financial products, providing a hedge against economic downturns. Moreover, these investments tend to attract long-term commitments, which enhance financial stability and reduce volatility. The growth of green finance markets also facilitates the development of new financial instruments and asset classes, broadening opportunities for investors.
– Enhancing public health and quality of life: Green finance plays a pivotal role in improving public health and overall quality of life by reducing environmental pollution and enhancing the resilience of communities to climate change. Investments in green infrastructure, such as clean water services, sustainable urban transport, and green buildings, lead to significant health benefits by reducing pollution-related diseases and enhancing urban livability.
– Facilitating regulatory compliance and access to capital, including: (1) Alignment with global standards and regulations: As international environmental regulations become more stringent, green finance enables businesses to align their operations with global standards, thereby avoiding penalties and benefiting from incentives for sustainable practices. This alignment is critical for companies operating in multiple jurisdictions and serves as a foundation for sustainable international trade; and (2) Enhanced access to capital: Green finance improves companies’ access to capital by attracting investors who are increasingly mandated to consider environmental, social, and governance (ESG) criteria in their investment decisions. Funds that focus on sustainability criteria are growing, as evidenced by the rapid increase in ESG assets under management. This trend provides a fertile ground for companies with strong sustainability profiles to secure funding.
– Strengthening Energy Security and Climate Resilience, including: (1) Energy security through renewable investments: Investments in renewable energy projects, which are a core component of green finance, enhance national energy security by reducing dependence on imported fossil fuels. This diversification of energy sources helps countries to stabilize energy prices and reduce susceptibility to external shocks or geopolitical conflicts; and (2) Building climate resilience: Green finance is essential for funding infrastructure that can withstand the impacts of climate change, thus enhancing the resilience of economies to extreme weather events and environmental changes. By financing the development of resilient infrastructure, green finance reduces the economic and human costs of climate-related disasters.
