The rising threat of the climate emergency propels the urgency for a quicker and deeper commitment to a green transition. This includes the importance of worldwide financial markets aligning investments with the journey to net zero. It is vital we mainstream climate finance solutions for SMEs and mobilise and scale up sustainable finance so SMEs can take action.
Financial markets are key to achieving the transition to low-carbon economies. They are just the beginning of integrating climate transition opportunities and risks into investment decision-making. However, several barriers are preventing the scaling up of investment.
This article will discuss how we can mainstream climate finance solutions into SMEs to drive the green transition.
Present challenges in increasing financial flows to market-driven climate-smart solutions in the private sector
Developing economies and emerging markets will require a large portion of climate financing to bring down greenhouse gas emissions and adapt to the current impact of climate change. The investment could reach $1 trillion per year by 2030. That is if we remain on track to achieving net-zero emissions by 2050.
Developing economies could require up to $300 million annually by 2030 to adapt agriculture, water supply, infrastructure, and other parts of their economies to counterbalance the physical impacts of the climate emergency, according to the UN. If the efforts to reduce emissions fall short of the goals set out in the Paris Agreement, the requirement for adaptation financing will rise significantly.
Estimates vary from $520 billion to $1.75 trillion per year according to the International Monetary Fund (IMF). Environmental, social, and governance (ESG) investing approaches have become increasingly popular. They are currently being used as a tool to align long-term value with finance, including climate-related opportunities and risks. It is clear sustainable finance has become a crucial area of focus for investors across the globe.
However, more needs to be done to make sure that these financial flows also align with transition and carbon intensity-related opportunities. There are also a lot of other challenges and barriers to financing sustainable growth. For one thing, unfortunately, sustainable finance is typically not high enough on the strategic agenda.
Other challenges correspond to costs, regulation, knowledge, and timeframe. Regulations vary from country to country and this results in inconsistent views affecting sustainability standards. The costs associated with making large changes also must be considered.
It’s important to question what kind of support is readily available for enterprises to begin making these necessary changes. Like most areas of sustainability, there is also a significant knowledge gap surrounding the topic of sustainable finance. It is both a diverse and substantial topic.
It seems the way to get industry players to adopt sustainable finance is through sustainable finance’s benefits as well as rewards and incentives. In saying that, to completely address the climate emergency, more funding is required to help people adapt. This means significant creativity and commitment from the private sector.
Private investors are beginning to identify these funding opportunities, but more has to be done to establish the climate-smart, inclusive ecosystems of the future. Traditional funding sources have long been the means to conquer global development issues like conflict, food insecurity, and poverty.
In addition to the above challenges, some other sustainable finance barriers SMEs may encounter include:
- Lack of data on the sustainable financing needs of SMEs amongst financial institutions and banks,
- Incomplete incorporation of sustainability performance into the assessment of risks facing SME investment decisions,
- Inadequate diversity of financial institutions providing long-term capital for the climate finance needs of SMEs, and
- Lack of climate financing products both focused on specific opportunities and across the enterprise life cycle.
Mobilising and scaling-up sustainable finance from an SME perspective
It is important to be aware of the essential role small and medium enterprises currently play in our economies and their potential. However, it is also vital to consider how vulnerable they are to the impacts of climate change. With this in mind, building their resilience is paramount.
Supporting governments in strengthening the wider enabling environment which could support SMEs in building resilience is also needed. This would be through incentives for investing in resilience, wider capacity building, and the provision of climate risk data.
As well as addressing risk, climate resilience will also help SMEs access new business opportunities. For instance, green infrastructure, resilient building materials, and agribusinesses for new crops.
It’s clear sustainable finance has a crucial role to play in empowering SMEs to manage climate risks and explore other opportunities to build resilience. Sustainable finance will play a crucial role in unlocking opportunities for also boosting resilience in the private sector.
This is particularly the case for SMEs as they begin to adopt science-based targets to show their commitment to reducing greenhouse gas emissions, tackling climate change, and future-proofing their business.
However, sustainable finance is much needed to help SMEs get past the current barriers they face concerning their uptake of climate solutions. Doing so also enables us to ensure we are financing the private sector to achieve climate resilience and low-carbon goals.
The magnitude of the developing economy and emerging market climate finance needs will require major scaling up of private finance sources. Underinvestment in climate change adaptation and mitigation in developing economies and emerging markets could result in worldwide financial stability risks as a result of greater exposure to climate-related financial risks.
It’s uncertain whether the very big and growing environmental, social, and governance (ESG) investment flows will help in scaling up private sustainable finance. SMEs contribute massively to employment, growth, social cohesion, and innovation for sustainable development. To accelerate the green transition, more attention has to be given to the financial needs of SMEs.
To date, the sustainable finance and SME financing agendas have operated in parallel. This showcases a missed opportunity for mechanisms that can improve SME financing. Finance must be enabled for SMEs so that they can improve their sustainability performance. However, it should also be allocated to enable them to focus on expanding sales of sustainability-related services and goods. Ultimately, SMEs need tailored solutions that respond to the diversity of their life cycle needs and to the various actions they plan to take to achieve environmental goals.
Improving the buy-in and institutional capacities of financial institutions
Mobilising institutional assets to drive sustainable development is at the heart of the financing for development debate. According to the OECD, a shift of just 3.7 percent of the USD 100 trillion of assets held worldwide by institutional investors toward sustainable activities in developing countries would be enough to fill the 3.7 trillion USD gap.
In saying that, to achieve this, we must have a strengthened collaboration between both official and private actors. This includes development finance providers in order to make sure the right standards and tools are being put in place to mobilise private capital for developing countries aiming to achieve the SDGs.
Developing countries require long-term investors to assist with financing activities that support sustainable growth. The same can be said for small and medium enterprises. They are struggling to play their role in the green transition and need to adapt rapidly to meet the current targets.
How do we improve access to sustainable finance? Current measures that respond to the climate emergency are no longer sufficient. Climate finance flows are below half of what is needed to adapt and mitigate climate change. The private sector is the biggest greenhouse gas producer and energy user. This means it will play an essential role in mitigation.
Small changes to behaviours can result in a significant impact. However, SMEs are in a unique position to be able to deliver certain services and technologies that can increase the resilience of the poorest areas too. With that, it is clear why we need to not only prioritise greening operations but also ensure financial flows reach SMEs.
The capacity for SMEs to recognise their potential position in climate action is restricted by not having access to sustainable finance. This is because of three factors mainly – weak enabling environments, limited awareness and knowledge of investment opportunities, and a lack of financial products.
These barriers must be removed to allow sustainable finance to flow to SMEs. Strengthening climate policies and financial infrastructure as well as strategies will encourage sustainable investments. Additionally, mainstreaming climate finance solutions into SMEs will help to inform investors about sustainable financing opportunities.
All of this will help to establish financial risk management solutions too. For SMEs, climate finance will incentivise and facilitate the use and production of top-quality climate technologies so they can get involved in climate action. Knowing they can access these investments will also encourage SMEs to improve their knowledge of all things climate change and why it is important to tackle it.
According to the SME Finance Forum, two-thirds of small businesses are worried about how to navigate climate action. They need additional guidance and resources to reduce emissions. Sustainable finance will play a very crucial role in enabling SMEs to manage their climate risks and explore opportunities to build resilience.
However, ensuring they have access to climate finance will also allow them to create innovative solutions and technologies that can help developing countries mitigate and adapt to climate change too. Accessing these financial flows will see SMEs strengthening their business and becoming more resilient as a result.