Global finance requires a sea change to save the planet. This climate expert explains how

Humanity will require capital to successfully transition through climate change. A lot of it. Despite the lofty goals of global superpowers, the international financial community, and major philanthropists, there isn’t enough at the moment. According to the United Nations, the gap between urgent climate action and the funds needed to sustain it are roughly $2.5 trillion every year. Where does that money come from? 

Dominic Hofstetter, the director of capital and investments at EIT Climate-KIC — Europe’s largest climate innovation initiative — suggests in an expansive whitepaper that traditional banks and financial institutions aren’t set up to fill that gap. In a blog post published last spring, he argues that even Environmental, Social, and Corporate Governance (ESG) and sustainable finance aren’t prepared, either. These systems are all focused on investing in single assets such as real estate or equities, he writes, and are therefore ill-prepared to tackle the unprecedented challenge of salvaging humanity’s survival amid climate collapse. 

The solution, Hofstetter believes, is transformation capital. This mode of thinking prioritizes long-term, systemic shifts over short-term gain, and rethinks the role money itself plays in driving these changes. “It seeks to engage all the levers driving a socio-technical system — technology, policy, finance, skills, business models, citizens, and production systems — and recognizes that the most promising way of affecting systems change is through the creation of a portfolio of deliberate and connected innovation experiments,” he writes. Yet he warns that transformation capital is, at this point,  simply a hypothesis. It hasn’t yet been tested in a real-world setting. 

Future of Good’s feature and news writer Brennan Doherty spoke with Dominic Hofstetter about the role transformation capital could play in tackling the climate crisis. 

The following conversation has been edited for length and clarity.

Future of Good: Let’s start with the basics. What is transformation capital?

Dominic Hofstetter: I call it an investment logic, for lack of a better term. What’s important is that it’s not just an investment strategy. It is a coherent collection of mindsets, worldviews, value sets, and then also tools and methods to make that actionable. But it’s much more than a new take on impact investing or a new take on sustainable finance. It’s much more holistic and it is structurally, conceptually, and philosophically different in each stage of the investment process. 

Future of Good: When I was reading it, I couldn’t tell if it was a philosophy and investment strategy or a political manifesto. What is it?

Dominic Hofstetter: Well, it’s all of the above, right? Because that’s what you ultimately need to affect structural change. You can’t transform the way the world operates if you come at it from existing axioms and paradigms and practices. We see that in ESG investing, we see that in cleantech venture capital — those are instances of traditional orthodoxy being applied to wicked problems. We don’t see the type of change at the scale and pace that we need from these incremental approaches, which is why you need something coherent. 

ESG investing, we see that in cleantech venture capital — those are instances of traditional orthodoxy being applied to wicked problems.

Future of Good: The white paper talks a lot about how the global financial sector is not suited to making this deep structural change. Why is that? 

Dominic Hofstetter: I think, from a philosophical perspective, the financial sector is mostly interested in preserving the status quo, because the decision makers within that system benefit from the status quo — particularly because the effects of climate change will not play out over a time when they will be personally affected by it. 

Now, the other reason is certainly because the paradigms of the practice with which finance takes place today is just inherently unsystematic. It’s not designed for complexity. What you see in finance is almost the antithesis of an investment approach designed for complexity and systemic intervention. For instance, you have the single-asset paradigm: investing in one project, one company at a time. But all of the impact goals stipulated in the Paris Agreement exist at the level we call society. All finance does is it tries to change the individual parts, individual companies, individual projects. It doesn’t pay attention to what’s happening in the system at large. 

Future of Good: What about non-profits or philanthropic models? They’re not as bound by the demands of stakeholders or the need to make a lot of money very quickly. Are they not already in a position to make these kinds of systemic changes happen? 

Dominic Hofstetter: They’re certainly in a better position because the way they articulate their purpose often is at the level of the system. They’re not at the level of individual interventions. However, most of the foundations and even the multilateral financial institutions like the World Bank are also stuck in that single asset paradigm. In the World Bank’s case, it’s maybe the single intervention paradigm. There are some foundations that do good work: amongst others, the McConnell Foundation in Montreal. They have a solutions finance program, for instance. It’s a much more sophisticated way of investing than what traditional foundations have. 

Future of Good: Why is that? What makes it sophisticated? 

Dominic Hofstetter: Well, they blend their grant activities and their investment activities together, which is not what many foundations do. Most foundations have their asset management activities separate from their program activities. However, the most interesting approach I’ve seen in this space is what’s called ecosystem investing, where you look at a system and you make investments into complementary spaces within that system. When they have the capacity, they try to bring these initiatives together and make sure they benefit from each other. 

Part of the research work that went into our whitepaper was to survey sustainable finance initiatives to see what’s out there and how they operate. We were very surprised to see that most of these initiatives are either mute about their theory of change or have a very vague understanding of their theory of change. They say things like: ‘We commit to align our portfolios to the Paris Agreement’, but there’s extremely little understanding of what that would look like in practice, and how such an alignment then produces the outcomes that the Paris Agreement stipulates. 

Future of Good: You mention the idea of ‘systematic investment points’ in your whitepaper as opportunities. For example, a government deciding to ban internal combustion engines would create a place for an investor to step in and make a difference. What I found really interesting about your whitepaper is that policymakers set up these opportunities, not investors. Policymakers set up financial markets and change regulations. Why, then, is your approach largely tailored towards investors themselves? 

Dominic Hofstetter: One of the hallmarks of transformation capital is that investment activity should not take place in isolation, but in a broader systems approach. And within that broader systemic approach, policymakers have a big role to play in shaping the conditions for that investment to happen. What we see in the wake of COVID-19 is a much stronger and more opinionated involvement of the public sector in setting investment agendas. Governments have the goal of crowding in private capital, but they set the agenda. They set the mission because they’re democratically legitimized to do that and they have the power of regulation and public procurement. 

What we see in the wake of COVID-19 is a much stronger and more opinionated involvement of the public sector in setting investment agendas.

Future of Good: More than a few environmentalists argue that capitalism is in fact the contributing factor to climate change, not the solution. What would you say to people who think that way? 

Dominic Hofstetter: My first question is: how have you defined capitalism? What they probably mean is an unrestricted market-based economy. You can go 10,000 years back and you see markets evolving, even before humans became sedentary — markets always operate within boundary conditions. The question is, how do we set those boundary conditions as a society? I think there’s a lot to be said about updating or evolving the mode of capitalism that we have now. 

That being said, what concerns me greatly is that most sustainability policies are predicated on the notion of green growth. That we can decouple economic growth from environmental harm. It’s what is at the heart of any Green New Deal. It’s what’s at the heart of the UN’s STGs. What worries me is that now there’s an increasing amount of empirical evidence that suggests that green growth might be a myth or might not be possible.

 If green growth is indeed a myth, then I think we’re in trouble because all of our sustainability policies are predicated on that paradigm. We may just change the problem. We may be able to decarbonize Europe, but then all of the pollution goes to Africa or Latin America. If that’s the case, then we’re at a complete loss. We don’t know how to live in a world of de-growth. Nobody’s tried it. Certainly not in the Western world. If you think of the ramifications of that — the political, economic, social ramifications of a de-growth strategy — it is beyond comprehension. 

Future of Good: Is there a specific role for the non-profits and other organizations that use money from sustainable finance to fight climate change? 

Dominic Hofstetter: Sure. They’re the starting point for it all. The starting point for transformational capital is not finding ways to allocate public money, but rather finding a transformational challenge and then making sense of that challenge. Where is our city or country or sector today? Where does it need to go in the future? What are the systemic interventions that need to take place in these levels of change — policy regulation and social engagement, but also the social sphere. What is the investable universe here? How do we make sense of that? How can we construct strategic portfolios to invest in them? Only at that point do you actually go and do the bare-bones financial work and raise the capital. 

The city governments, city councils, corporations, or whoever receives this capital are very much in the front and centre. Finance is around it. We go back to a system in which money serves a purpose, and that purpose is not just to multiply itself, but to facilitate human existence. It’s money as a lever of change. It can flow in different ways, from citizens directly into these projects. 

Future of Good: How are you and the other architects of transformation capital making this work?

Dominic Hofstetter: We’re obviously at the beginning of the journey. The whitepaper is the starting point, the result of a 12-month collaboration co-design process that involved dozens of people. It’s a synthesis of some of these ideas and it now needs to enter its next phase, which is mostly centred around prototyping and field-building to prove its applicability and value in real world settings for the next two to three years. The question then is how do you even scale something like this at a global level? Because the challenge is to move trillions of dollars. The investment gap is about $2.4 trillion over the next 15 years. That’s beyond the sphere of influence of a single organization or even a consortium of organizations.

In the absence of the ability to produce someone like Greta Thunberg, how do you get the idea of systemic change to go viral? It’s the same question any marketer asks themselves. How do you do that? There are so many good ideas that die on the way, not because they’re bad ideas, but simply because people can’t pay attention. 

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