UK Chancellor Rishi Sunak, in his COP26 Finance Day speech, highlighted the challenges, opportunities and actions to increase and accelerate public investment, mobilise private finance, and rewire the entire global financial system for Net Zero and achieve carbon neutrality targets.
The G20 in its Rome Declaration has committed to scale up climate adaptation finance and facilitate access to funds. This is supported through the IMF’s USD $650 billion allocation of special drawing rights (SDRs).
Private sector support is growing considerably, the Glasgow Financial Alliance for Net Zero (GFANZ) including 450 global financial institutions with assets worth over USD $130 trillion has committed to financing the transition to Net Zero emissions and meeting targets by 20501.
A transformation of global financial systems is essential to channelling substantial funding to the green economy. There is a need to promote sustainable finance products and de-risk investment in sustainability projects, broader adoption of climate risk analysis tools, and consistent climate-related reporting standards.
Is enough being done to mobilise the capital needed to finance the decarbonisation of our economies?
Reactions to recent climate finance commitments range from ‘cautious optimism’ to ‘same old empty promises’.
According to the more optimistic market participants and observers, recent climate financing commitments recognise the capital injection needed to create a green economy and meet both Net Zero targets and maintain global temperature increases below 1.5oC. Based on FTSE Russell data (FY20), the green economy represented 3,000 global listed companies, with a US$4 trillion market cap (i.e. 5.4% of total listed equity market). Since 2009, the green economy has grown at 8% annually (twice the rate of the broader economy)2.
For those expressing scepticism, COP26 was a lost opportunity. The continued significant investment in carbon intensive and extractive industries represents failure to address the causal issues of climate change, and promotes greenwashing. Furthermore, the laissez-faire attitude to missing previous targets, such as the 2009 COP15 commitment of providing $100billion of climate finance a year by 20203, is a reminder of the lack of accountability to pledges.
There is broader recognition of increasing global political will, growing public consciousness, and stronger engagement from financial institutions on the sustainability and climate agenda.
The emergence of green finance products such as sustainability or green bonds presents an opportunity to quickly raise significant capital from public and private finance sources using proven, and highly effective financial instruments, which increases investor confidence. Bonds backed by high credit-ratings enable risk reduction, lower costs and provide stable long-term returns. In 2020 we saw a record-breaking US$269.5 billion in green bonds raised, the fifth consecutive year of growth in issuance4.
We are seeing more industry collaboration and stakeholder buy-in to sustainability and climate initiatives such as GFANZ, and Public-Private global initiatives such as FAST-Infra (‘Finance-to-Accelerate-Sustainable-Transition-Infrastructure’)5. FAST-Infra initiative aims to unlock significant private finance for sustainable infrastructure projects to help reduce the high carbon emissions trajectory and ensure climate resilience. FAST-Infra aims to address $6.9 trillion annual-funding gap by 2030 (reference OECD).
Though strides have been made to increase climate financing, develop Net Zero transition plans, and strengthen regulatory oversight, the critical question for financial institutions remains how to turn commitments into tangible actions to achieve timely results and deliver meaningful impact?
1. Shifting capital to the green economy
Challenges for institutional investors include access to bankable and comprehensively structured sustainability and climate projects aligned to their risk profile, and developing project finance mechanisms to deliver ESG impact.
Asset owners and project developers continue to wrestle with the approach to divest carbon intensive assets, methods to prepare sustainable and profitable projects, as well as limited access to potential financiers.
We recommend early engagement between financiers, asset owners, project developers and third-party verifiers to deepen the understanding of developer needs, climate finance requirements, and promote green finance products.
In turn, this can help to ensure early alignment of expectations, improve stakeholder collaboration in project preparation, design and deploy appropriate green finance products to ensure solid project structuring, achieve successful financial close, as well as deliver sustainable projects and carbon neutral assets.
This enables scalability and replicability in climate finance best practices aligned to emerging policies and regulations for greener economies; and provides a pathway from the pitfalls of stranded assets and greenwashing.
2. Use climate data to support financial decisions
Access to accurate, complete and timely climate data, as well as the analytical capabilities needed to support investment decisions pose significant challenges for financiers, project preparers, asset owners and verifiers.
Some of the key questions we continue to come across include, what climate data do I need, where do I get data from, how do I define my targets, what measures should I apply, what scenarios should I consider, how do I assess the financial impact associated with climate risk?
Defining your climate data needs, identifying key data sources and adopting a sophisticated climate analytics tool should be your first step. The Climate Change Scenario model originally developed by Baringa, recently acquired acquired by BlackRock to enhance their Aladdin Climate technology, enables integrated analysis of physical and transition risks, and assessment of the financial impact on assets at sector, portfolio and individual asset level. Modelling capabilities include scenario analysis of carbon emission pathways and temperature changes across different time periods. The model is being used to date by financial institutions with over $23 trillion of assets.
3. Understand reporting obligations
With no global standard framework around climate related financial disclosures, navigating regulatory requirements isn’t easy. On the regulatory side, there are various climate related disclosure frameworks and standards, but with some being sector focused and others regionally specific, this results in fragmentation. A positive development during COP26 was the IFRS Foundation announcement on the International Sustainability Standards Board (ISSB) consolidating with Climate Disclosure Standards Board (CDSB) and Value Reporting Foundation (VRF), and the publication of prototype disclosure requirements6. This should help drive global standardisation, and improve quality of climate and sustainability disclosures across organisations.
The challenges for market participants include knowing which framework to adopt and how to interpret requirements, compounded by a lack of clarity on performance monitoring, uncertainty on what and how to report, as well as to whom.
Developing a detailed understanding of your climate and sustainability reporting requirements and obligations, including those of your customers and supply chain is going to be key to success. It is essential to define and embed your climate strategy, governance and risk framework, metrics and targets in line with recognised industry standards on climate related disclosures (e.g. TCFD), and/or regional regulatory requirements (e.g. EU SFRD).
Ongoing performance monitoring and credible reporting requires clearly defined Climate / ESG metrics, targets, priorities, measures and KPIs to drive consistency in approach across functions, geographies, and enable comparability with peers.