If Warren Buffet were 30, he’d invest in climate

Although Finance has a bad notoriety, I work in the Decentralized Finance (DeFi) space. To understand why, you can read Why do I DeFi. In short, everyone would benefit from a fairer, more transparent, and more resilient financial system than the existing one.

This bad notoriety does not come out of thin air. The sector is old, extractive, corrupted, and embracing the status quo. It’s also often blamed for contributing to Climate Change through investments in destructive solutions and services while better alternatives exist.

I’m not here to say that we should abolish the financial system. I’m here to explore the intricacies between Climate and Finance and find solutions to reshape and leverage this inevitable tool to fight Climate Change. In short, finding ways to align Finance and Climate.

First, the basics. There’s scientific evidence that the climate is changing at a rapid pace. Faster than any other climate cycle that the Planet faced (10 times faster, to be accurate).

Why is it a problem?

The last Intergovernmental Panel on Climate Change (IPCC) report is quite bleak:

• More droughts, water shortages, and food shortages are expected.

• More extreme events, such as fires, tycoons, and floods, are expected.

• Huge biodiversity loss is expected.

Because theory is nothing without practice, below are some real-world examples of such events:

• Hurricane Ian, cost ~115.2B (yes, billions), ~161 casualties.

• 2019–20 Australian bushfire season, cost ≥ $900m, 445 indirect casualties, 1B animals killed, more than 1/3 of the surface of France scorched.

• Indian droughts, thousands of casualties, millions of people displaced.

The list goes on.

Those events directly affect human beings and biodiversity; some places have been totally erased, like Australia's gigantic BBQ. A simple cause-effect chain could be described as the following:

destructive events → shortage of shelter, food, water (casualties + economic cost) → migrations → instabilities → wars (casualties + economic cost)

Overshooting the temperature limit of the Paris Agreement (1.5C) will obviously worsen things, causing deaths and substantial economic costs if not anticipated.

Given where we are, there’s more than a 50% chance to cross this threshold by 2040. Because of economic externalities, i.e., costs or benefits arising from a transaction that affect third parties who are not directly involved, the worst-case scenario can cost us way more than anticipated.

We’re flipping coins: Heads: we lose $1; Tails: we lose $8.

Wanna play? I bet it’s a no, right?

Thing is, you don’t have a choice.

Climate change is a phenomenon known as early as in the mid-1900s. Since then, we’ve done many studies about its causes and consequences. Yet, Finance is heavily invested in fossil fuels (because it’s easy and very profitable), which are responsible for most Greenhouse Gas (GHG) emissions and, thus, Climate Change.

The current and planned fossil fuel infrastructures may release 850 GtCO2 by 2050 (roughly the mass of 84 158 416 Eiffel Tours). Staying below 1.5C requires the rejection of less than 510 GtCO2 worldwide during this period. No need to have a Ph.D. in math to conclude that we’re not heading right.

Continuing on that curve should deter financial actors from investing in those projects since it would expose them to substantial economic downturns in the coming decades (cf the cause-effect chain above).

This is not the case since 12 banks alone have poured more than $2 885B into fossil fuel projects between 2016 and 2022 alone.

Meanwhile, those actors expose themselves as leading actors in the transition.

In practice, “53% of green claims on products and services make vague, misleading or unfounded information” in Europe.

Many funds and projects are surfing on the Environmental, Social, and Governance (ESG) trend, meeting client demands by proposing more sustainable and green investment opportunities (on paper, at least…).

In widely taught economic models such as neoclassical economics, nature is taken for granted, free with infinite resources (which might be a reasonable assumption in the early 1900s). There’s no cost for destroying common goods such as air, water, or forest: this is the tragedy of the commons. Some resources are depleted far quicker than what they can generate (like freshwater or fish). It leads to shortages at some point and/or can be rendered useless after a certain threshold.

Economic models are tools to predict the future and make relatively good decisions given the information at hand. How can a model assuming endless planetary resources be predictive of anything?

Better prediction capabilities would generate more profits for the financial sector (another argument for economic actors to consider nature).

In a more practical view, nature must be considered to avoid dramatic consequences such as wars (cf again to the cause-effect chain).

According to the IPCC, we need at least $2.3 trillion of investment per year worldwide to fund the climate transition. And yes, bartering alone won’t solve the problem.

Some sectors (like transport, industry, etc.) are intense in physical capital. They need a lot of money over the years/decades to make structural changes to their core business.

Usually, those sectors are operated by significant actors who can receive large loans from banks or issue bonds to finance their transition.

The financial sector can help those actors to fund their redirection. Prognostics show that those investments would be even more profitable than playing the status quo.

Let’s take the energy sector for example. Current renewable energy solutions are not ideal:

• They are intermittent, i.e., they can’t produce energy whenever we want.

• We can’t store power efficiently.

• They demand a lot of primary resources (aluminum, iron, chromium, copper, etc).

If we don’t want to return to middle age, we must make progress and find innovative solutions. We need more experiments that usually call for long R&D phases and are capital-intensive. We need money to fund them. This is where financial actors, especially Venture Capitalists (VCs), can help. They can take risks like they took risks to support internet startup companies in the 2000s.

Some VCs are slowly following the Clean Tech and Climate Tech trends since it is perceived as one of the “next big things” they should not miss in the following decades.

Clean Tech encompasses any project that tries to make some existing systems more efficient in terms of resource consumption and/or minimizing the impact on the environment (water treatment, waste reduction, recycling, transportation, etc.), while Climate Tech focuses specifically on addressing climate change (building, transportation, etc.).

By allocating money to projects in these sectors, Finance acts as a rudder. If Climate Tech becomes mainstream for VCs, it will be easier for such projects to raise funds, in turn pushing more founders to join, driving more VS to be interested, etc. It creates an economic flywheel.

Carbon credits also try to reshape incentives by making unprofitable projects profitable. For example, if cutting a forest and making wood out of it is more profitable than preserving it, carbon credit could make it more beneficial to do nothing. If done well, it could reshape incentives around common goods and make nature count in economic models for once.

In some regions, it’s also mandatory for companies to buy carbon credits to compensate for their GHG emissions. However, this is not widespread as the market is only $25B worldwide in 2022 (Europe being the most significant market with 52.1% of the shares). The difficulty lies in standardizing a carbon credit, while sources can differ, and the quality varies greatly (there are many frauds).

The efficiency of such a solution is still to be proven. As there’s no worldwide market, the effect is limited since not all companies must compensate for their emissions. To palliate that, some companies opt for the Voluntary Carbon Market (VCM) and buy carbon credits even if it’s not needed in their region. Again, this is limited since the VCM was only about $2B in 2021.

Of course, carbon credits should only be viewed as a complementary solution and MUST extend structural changes at the company level. Else, it falls into the greenwashing garbage.

There are several ways that Finance can be better used.

In some cases, talking about biodiversity and natural resource protection does not even move (greedy?) people (and that’s fine). In this case, the best argument is to show the financial incentives; financial actors would make more money if they aimed for a temperature rise of 1.5C instead of 2C.

They would be more inclined to fund projects searching for climate change solutions if it’s good for their portfolios than if it helps keep some random penguins in the Arctic thousands of kilometers away. Truth is hard. Warren would testify.

Governments should be long-term aligned with the population they manage in theory.

Governments have the power to initiate large-scale plans that can bring structural changes. This is how the Internet has been created in the US and how train transportation and nuclear power plant networks have emerged in France.

Countries should kickstart and make bold moves for climate change and stop being passive. The benefits are numerous:

• Economic activity boost because new opportunities would be created in a world where economies have slowed down for the last decades.

• Employment boost (it demands to train workers for new jobs, though).

• Fulfillment for the population (satisfaction could come from having a positive impact on society and caring more about the Planet instead of shopping in a mall on Sundays).

People are changing their habits, favoring companies aligned with climate change. It creates more incentives for them to continue in this direction.

People care more and more about where their money goes, questioning their banks on what they do with the capital they have or changing to new banks (like Green Got in France) more aligned with their values. I may be biased (a lot?), but blockchains can help since any transaction is traceable. If it were the backbone of the financial system, corruption and greenwashing would be easily spotted.

The more instability and zones under stress, the less likely people can pay insurance, in turn reducing insurers’ economic opportunities. Insurances have strong incentives to coordinate and lobby to fight climate change as well.

Let's also let people directly invest in projects they think are worth it. These projects could be at a local or even global scale. Those platforms already exist, like Lita.co, or Team for the Planet, and provide better yields than standard saving accounts. The scale is not there yet to meet expectations, but this is a good step toward impact investing. I’m confident that those platforms will take off in the following years.

The financial system needs a reboot. It’s not sexy, and it’s hard to be proud of being in this sector. But Finance is also a great tool to finance projects. If we fund the right ones, we’ll make this Planet a better world. So we must fix Finance.

Special thanks to Bastien Velitchkine, Clément Dehondt, and Sixtine Mailleux for their review.