This report was presented as a background document for an Organisation for Economic Co-operation and Development (OECD) and European Commission (EU) C high-level expert workshop. It sets a basis for reflection and discussion. The workshop is part of a five-part workshop series in the context of an OECD/EC project on managing environmental and energy transitions for regions and cities.

Challenges of financing environmental and energy transitions

Current financial practice’s narrow focus on financial return calculations is less suitable for funding sustainability transitions. Transitions mainly happen at the city and region level, but academic finance does not pay attention to the subnational level, where proximity and context-specific solutions matter. This gap also applies to financial institutions, which lack the structures to deal with local initiatives.

Investment criteria based on integrated value

To fill this gap, adopting investment criteria based on integrated value can bridge the gap between financing and subnational level governments. Integrated value assessments are needed to report on a new type of alternative asset class- societal impact projects.

Role of the financial sector

ESG investing should include both environmental and social dimensions in decision-making, and the financial sector needs to become more long-term oriented. Three broad strands of sustainable finance literature are identified- the relation between environmental, social, and governance (ESG) factors and financial returns; impact investing; and value creation. Positive-based investment methods are gaining ground, and this report suggests that adopting fundamental investing with engagement can improve the transition preparedness of companies.

Policy recommendations

The report provides various policy recommendations aimed at bridging the gap between financing and subnational governments. These recommendations include:

• Adopting investment criteria based on integrated value in subnational green bonds.
• Providing green loans that contain provisions that lower interest payments if certain economic thresholds and environmental targets are met.
• Setting procurement targets that maximise integrated value by considering both the total (financial) cost of ownership as well as the non-financial costs and benefits of ownership and usage.
• Introducing societal impact projects as a new type of alternative asset class. Asset owners and managers can then invest in this asset class, just as they have set up commodities and hedge funds as alternative asset classes in the past.

Bridging the gap between financing and subnational governments’ lack of knowledge to take that role requires both the financial and public sectors to transcend business-as-usual and take on new roles and structures. Adopting investment criteria based on integrated value, educating students and practitioners on transitions and systems thinking, and creating new structures that are adapted to local conditions with active roles for city, and regional governments are needed to build a sustainable future.