Momentum around climate resilience in the financial system is building, from the Tragedy of the Horizon speech by Bank of England Governor Mark Carney in 2015 to the subsequent work of the Task Force on Climate-Related Financial Disclosures (TCFD). Recent Moody’s analysis estimates $69trn in damages by the end of the century if warming continues unabated and a report by the IFC identifies over $23trn of potential climate change related investments in just 21 emerging market economies by 2030.
Despite the growing awareness, much more is needed, in particular by the financial institutions that can drive financing towards low-carbon and climate-resilient investments, but also by the financial policymakers who can set the right market signals and create the enabling environment to facilitate such a transformation.
A recent UNEP-FI report, Driving Today’s Financial System for the Resilient Climate of Tomorrow, for the Global Commission on Adaptation, reviews the barriers faced by actors across the financial system and the opportunities in scaling up financing for resilience and adaptation. The report, authored by consulting firm Climate Finance Advisors (CFA), argues that efforts to bring about the changes in the financial system needed to integrate climate risks in decision-making have been initiated, but the necessary rules, regulations, standards, and best practices for doing so remain nascent and weakly defined.
Five broad categories of barriers which prevent the full integration of climate considerations – both risks and opportunities – into the financial system are identified in the paper, including:
1. Inadequate support for action on resilient investment
2. Lack of enabling policy and practice in the financial industry
3. Market barriers, perceived lack of pipeline
4. Nascent application of climate risk management practices
5. Low capacity in policy and finance for climate risk management
The paper offers six recommendations for measures which are specific to transforming the financial system through prudent policy and the mainstreaming of climate considerations into financial decision making. Key recommendations include:
1. Accelerate and promote climate-relevant financial policy, regulation: Financial policymakers and regulators can help ensure climate considerations are consistently disclosed and addressed in policies, regulations and enabling measures, such as metrics, standards and incentives.
2. Develop, adopt, and employ climate risk management practices: Promoting and incentivising the development and wide-scale application of climate risk management practices and tools, including robust scenario analysis, and quantification of climate-related financial exposure is essential, both for reducing climate risks to investments and identifying opportunities to invest in resilience.
3. Develop and adopt adaptation metrics and standards: Common definitions, metrics, and standards are vital for the financial sector to identify what constitutes an ‘adaptation investment’ or a ‘climate-resilient investment’, as well as more complex systems for hazard classification, ratings, and scoring. For example, the European Union’s Technical Expert Group on Sustainable Finance, where UNEP FI is an observer, are developing a taxonomy, including definitions of adaptation-related activities. Both financial institutions and policy makers should coalesce around such efforts quickly to ensure that these metrics and standards can form the basis of active adaptation and resilience investment.4. Build capacity among all financial actors: It will be absolutely fundamental to build the capacity among investors and policy makers on the practical and analytic approaches required to understand the effect of climate change on credit and risk. Developing the tools and analytics will be important, but equally important is to build the capacity within institutions for translating these risks to enable better risk management, and to enable institutions to better capture opportunities to invest in resilience.
5. Highlight and promote adaptation and resilient investment opportunities: There are an increasing number of examples of innovative investments that address adaptation, including blended finance approaches, resilience bonds, prizes for new products and services, and risk transfer products. For example, in Nepal, blended finance has played a key role in strengthening the resilience of hydropower facilities, as well as the development of the IFC Hydropower Environmental Impact Assessment Manual. This project allowed a $6.6m loan from the IFC to be leveraged with the support of a $2.1m grant from the Pilot Programme for Climate Resilience.
6. Use public institutions to accelerate adaptation investment: Through policy, blended finance and other mechanisms, governments and public financial institutions have the potential to play an outsized role in accelerating, catalysing and directing investments in the low-carbon, climate-resilient transition. By design and through their development mandates, green banks, development finance institutions and other public financing mechanisms can prioritise and accelerate climate-resilient investment, can promote the application of climate risk and resilience metrics, standards and analytical tools, and can play an important role in catalysing the low-carbon, climate resilient transformation.
The challenge of ensuring the financial system is able to weather the effects of a changing climate will require concerted efforts from both policy makers and financial actors alike. Transforming the financial sector into an engine for resilience will require adjusting our risk management practices to assess, quantify, and manage climate-related financial risks and thus highlight the vast potential for adaptation-related investment opportunities. It also requires establishing the definitions, metrics and standards around adaptation and resilience, as well as transparent disclosure of climate-related financial risks, which can enable the financial system to align investments with the goals of the Paris Agreement. Finally, it requires public policy, blended finance approaches, and other mechanisms to fuel the acceleration of climate-resilient investments.
UNEP FI is a partnership between UN Environment and the global financial sector to promote sustainable finance. The Global Commission on Adaptation was launched last year to encourage the development of measures to manage the effects of climate change through technology, planning and investment. It is headed by Bill Gates, UN Secretary General Ban Ki-Moon and World Bank CEO Kristalina Georgieva.
Stacy Swann is the CEO & Founding Partner of Climate Finance Advisors and Vice-Chair of the Board for the Montgomery County Green Bank. She was formerly Head of IFC’s Blended Finance Unit and a Senior Advisor for Climate Finance for the US Treasury.
Alan Miller is a climate finance and policy expert whose clients include UNDP, USAID and SE4All, and an adjunct professor at the University of Maryland and American University. He previously spent 10 years at IFC and 6 years at the Global Environment Facility.