Financing climate resilience, the hidden challenge
With climate change set to have numerous physical impacts upon our world, it is important to ensure resilience at national, company and individual levels. Climate resilience was identified as the main issues at the 2019 United Nations Environmental Programme Finance Initiative (UNEP FI) Regional Roundtable for Africa and the Middle East.
Resilience is defined as ‘the capacity to recover quickly from difficulty’. Climate change presents us with countless difficulties, some already present and others, more difficult to predict, that will emerge and continue to worsen as average global temperatures rise in the future.
With $90 trillion of investment in climate projects needed by 2030[1], it is now more than ever that financial resilience and investment into resilient infrastructure must be developed.
Whilst in Cairo, we have attended this event, a small overlapping world of climate change and finance professionals. This post summarises the main discussion topics and issues surrounding the tools and solutions currently available to the public and private sector to build climate resilience at various levels.
Planning for resilient infrastructure
Financial investments into infrastructure in emerging markets are set to play a crucial role in building resilience, as infrastructure is designed to last decades. It is said that if infrastructure is to keep up with economic development, $3.3 trillion[2] of investments will be required per annum. This therefore means that partnership between governments and private businesses must occur to not only spread costs but also risks. If planned and implemented correctly, new infrastructure can be built to withstand future changes to the global climate. However, it is crucial that this should be done by focusing on what these changes to the climate will be imply and be like, as opposed to modelling and analysing historic data to predict the future when planning for new infrastructures and assessing the impact on existing ones.
The Organisation for Economic Co-operation and Development (OECD) analysis of flooding in Paris found that as much as 55% of the direct flood damages would impact the infrastructure sector[3]. Had future climate and flooding been modelled, the impact of the flooding could have been anticipated and reduced. There must therefore be both retrofitting and future planning for new infrastructure put in place to minimise the impacts of climate change upon society, building resilience for communities, companies and countries.
Another example could apply to new housing developments built upon flood plains. These should include buffer zones to mitigate and adapt to the changes in future water flow. Adding in vegetation, natural ponds and small hills can absorb the energy from tidal waves, reduce the amount of water reaching the infrastructure and thus reducing impact upon the area. It is an added bonus that it also adds aesthetic value! Further, modelling future climate increases the longevity of the infrastructure. For example, when building a dam historic river flow data is used when in fact future water flow should be analysed, as climate change will impact the quantities of water that will reach the dam.
Whilst these suggestions may require extra work due to the complexities of climate modelling, data collection/interpretation, infrastructure planning and space requirements, they should not be ignored. Current infrastructure systems were built over a period of decades and were not designed for either the current/future technological developments nor the changes to the climate. Due to the potential limitations this can have upon future societies, climate scenario analysis must be undergone and fully understood prior to design implementation.
Building resilient financial markets
Considering the scale of investments required, the financial sector needs to be on board. Banks and investors pursuing a different strategy will be exposed to significant and systemic risk of failure. According to William Martindale from Principles on Responsible Investment, there is now approximately 400 climate change-related pieces of legislation and initiatives for the financial sector worldwide, 50% of which have come live over the past 3 years. Here is a small number of established and emerging initiatives that have the potential to have a significant impact over time:
Principles on Responsible Investment (PRI): in order for investment companies to holistically report, track and consider the Environmental, Social and Governance (ESG) impacts of their investment. Backed by the United Nations (UN), the Principles ask signatories to incorporate, disclose and actively work to reduce any ESG issues faced by investments made. Through doing so, it is hoped that the market will build resilience as well as consumer knowledge of the risks faced by various sectors investments may be held in.
Principles for Responsible Banking: under development at the time of this post, 26 leading banks representing USD 16 trillion in assets are re-defining banks’ purpose and business model to align the sector with the UN Sustainable Development Goals (SDGs) and the Paris Climate Agreement. The Banking Principles are expected to direct banks’ efforts to align with society’s goals (SDGs, Paris Agreement, national and regional frameworks) through goal setting, reporting on their contribution to national and international social, environmental and economic targets, ensuring accountability and transparency on their impacts and challenging the banking industry to play a leading role in creating a more sustainable future.
The Sustainable Stock Exchange Initiative (SSEI): initiated in 2009 and supported by a range of UN agencies, the International Organization of Securities Commissions and others, the SSEI aims to further the availability of sustainable and climate-robust investment opportunities. It does so notably through forums that support stock exchanges’ sustainability-related activities and bring capital market players together to identify, discuss and take collective actions on common sustainability issues relevant to their region or globally.
The Sustainable Banking Network (SBN): facilitated by the International Finance Corporation, SBN is a community of financial sector regulatory agencies and banking associations from emerging markets committed to advancing sustainable finance in line with international good practice. Launched in 2012, the SBN facilitates the collective learning of members and supports them in policy development and related initiatives to create drivers for sustainable finance in their home countries. It promotes 3 pillars: environmental and social risk management, green financial products and services and eco-efficiency.
However, most of these initiatives are voluntary mechanisms that have not always proven to provide enough incentives to be fully adopted or trigger change at scale. While creating awareness is essential to get the market to initiate a shift, policy-makers have a pivotal role to play to ensure the entire market is getting up to speed. A better case needs to be made for “sustainable investment”. The chairman of the Egyptian Financial Regulatory Authority, Dr Mohammed Omran, has for instance mentioned that the ESG index in Egypt has over the past 6 years been the best performing index of the stock exchange. If that really was the case, we should soon see a surge of investors towards sustainable investments.
Deep integration of environmental and investment specialists is required to align investments, climate change, mitigation, adaptation and climate resilience. This will allow further the development of low-carbon and climate resilient instruments at an international level.
Sustainable investments and the need of complementary expertise
Many companies offer ‘Green’ or ‘Sustainable’ trackers which you can select from. However, the lack of homogeneous definition for sustainable investments means that there is no market consensus on what is a low-carbon or a climate-resilient investment. In addition, the green or sustainable attributes are often used for low-carbon investment rather than for climate resilient ones. There is also the risk of existing investments being ‘green-washed’ – making the investment appear more sustainable than they are, diverting funding from robust activities. Collaboration and integration of financial, environmental and social experts is needed to ensure that the market become more resilient and consistent.
In order for low-carbon and climate resilience investments to grow in a high-quality manner, systemic market changes must take place. With the investments required to achieve the UN SDGs, as well as to keep up with economic development, corporate investment must run alongside public investment. This would not only spread costs but also the risks involved – neither can fund the requirements alone. Whilst this will take work, collaboration and numerous experts, there must be public-private partnerships for future projects to be resilient to climate change.
While currently serving low-carbon investment rather than climate resilient ones, Green Bonds are one of the private sector solutions that can contribute in achieving sustainable growth and climate change resilience. They are loans which fund environmentally friendly and sustainable projects only. 2018 saw the largest amount invested into Green Bonds ever seen, with a record $389bn[4] loaned. Nevertheless, green bonds have been slow to take off in developing nations due to a lack of clearly defined asset classes, market standards and secure transactions.
The Adaptation Benefit Mechanism is one of the instruments under development by the African Development Bank to foster result-based payments investment into adaptation and could play an important role in meeting the Paris Agreement adaptation objectives. For instance, a project developer may get paid $50 per farmer it makes climate-resilient. Payment would be made by the investors (e.g. a commodity trader) once it has been demonstrated it has succeeded.
Resilience for the poor - the role of FinTech
In developing countries, financial Technology (“FinTech”) has the potential to act as a corridor towards sustainable and resilient development for personal, corporate and government bodies.
FinTech can provide easy access to both finances and financial information. For example, online banking through a mobile device can free up time previously spent queuing at the bank, increasing available time for economic generating activities, social care or education. This can therefore build and promote climate resilience for individuals.
It works also for companies and governments, as innovative technologies such as blockchain can process and manage complex multi-national transactions in a secure and audited platform. This can aid financing solutions for infrastructure projects, green bonds and other financial instruments required to bridge the funding gap for climate resilience.
This development requires innovation from both the technology and finance industries as well as collaboration between the two to form new products that can solve future issues generated by climate change.
In order to sustainably develop, mitigate and adapt to climate change, financial resources and physical infrastructure are required beyond that which governments alone can provide. We must therefore see partnership between public and private sectors to balance costs and risks as well as to grow economies sustainably.
Identifying issues with business resilience through risk analysis can be one way of taking an active step towards reducing pressures of climate change on your business. There are various voluntary reporting metrics which ask for companies to disclose these risks either publicly or privately such as the Climate Disclosure Project (CDP) and the Dow Jones Sustainability Index (DJSI). One framework soon to become compulsory is the Task Force on Climate-Related Financial Disclosure (TCFD) which provides a reporting methodology. This can be used to aid understanding and calculation of the risks posed by climate change and your business’s resilience.
[1] https://www.climatebonds.net/cbi/pub/data/bonds
[2] UNEP FI 2019
[3] http://www.oecd.org/environment/cc/policy-perspectives-climate-resilient-infrastructure.pdf
[4] https://www.climatebonds.net/files/reports/cbi_sotm_2018_final_01k-web.pdf