Addressing climate risks for climate finance takes centrestage

The Reserve Bank of India (RBI) has just joined the Network for Greening the Financial System. It is a voluntary group of central banks. The RBI has joined to share best practices and contribute to the development of environment and climate risk management in the financial sector to mobilise mainstream finance to support the transition towards a sustainable economy.

The group consists of 62 central banks and aims to help members design policies that incorporate environment and climate risk resilience in the financial sector.

Climate change poses risks to financial stability in the form of physical risks (extreme and slow onset weather events) and transition risks (caused by changes in policy, legal and regulatory frameworks, consumer preferences and technological development while transitioning to a low-carbon economy).

A lack of clarity about true exposures to specific climate risks for physical and financial assets, coupled with uncertainty about the size and timing of these risks, creates major vulnerabilities.

Earlier this month, New Zealand became the first country to announce a law that will require financial firms to disclose climate-related risks and opportunities.

The law seeks to bring climate risks and resilience into the heart of financial and business decision-making and is among latest in a series of government interventions requiring the private sector to assess and report systemic risks (multi-hazard risks with interdependencies between different systems) in the face of global climate change.

Climate risks in the future

The World Economic Forum’s (WEF) Global Risks Report 2021 noted climate action failure and infectious diseases as the highest risks (risks with greatest impact and likelihood).

In earlier editions of the report, infectious diseases remained lower on the scale until the novel coronavirus disease (COVID-19) pandemic changed perceptions significantly.

Risk perception of climate action failure however has remained unchanged. The report notes that “both the pandemic and climate change impacts are likely to play out disproportionately across countries, exacerbated by long-existing inequalities” — with a short window to redress these disparities by not delaying the shift towards a greener economy despite the pandemic.

Current climate finance system for developing countries is grossly inadequate

The WEF projected that by 2020, about $5 trillion will be needed to be invested annually in green infrastructure, far exceeding the current floor commitment of $100 billion annually. 

The $100 billion per year by 2020 commitment, to be provided as development assistance in the form of public funding from developed countries, is seen as the ‘bedrock’ of the entire international climate finance system.

The report of the Independent Expert Group on Climate Finance published in December 2020 underscores the urgency of fulfilling the $100 billion commitment from public contributors of climate finance including bi-lateral, multilateral climate funds, multilateral development banks and development finance institutions but also to leverage far greater private finance.

The report is critical of the lacunae in the current efforts to disburse finance from developed countries by highlighting four key deficiencies that include low levels and declining share of grant finance; underfunding of adaptation; lack of adequate finance for least developed countries and small island developing states; and obstacles to expeditious access by developing countries to climate finance.

The study states that the only way forward is to fully integrate climate-aligned structural change with economic recovery needing a fundamental shift in the entire finance system with a massive increase in private finance to get from “billions to trillions”.

It notes that every financial decision should take climate risk into account and climate finance is integral to the transformation process.

How to leverage private sector climate financing

To create climate positive actions, the starting point is to make private sector account for and mitigate systemic risks. Conventional economic models account only for linear risks (such a price volatility, business risks, legal risks, etc) which are critically insufficient while considering the imperative of low-carbon growth pathways.

Private sector across the world require to alter processes such that their investments do not (at the very least) exacerbate climate change.

Climate action in the private sector will need to focus on and developing three key areas progressively:

• Building reporting and disclosure frameworks that assess whether companies’ actions that cause negative externalities are mitigated.
• Increasing alignment of private sector with United Nations sustainable development goals to create positive impact.
• Increasing alignment with decarbonisation pathways according the 21st Conference of Parties agreement to recognise the pace of change required.

Substantial amount of finance will also be needed to mitigate transition risks of private companies, including in developing countries including India, that arise from the process of adjustment towards a greener economy.

In this scenario, valuations of companies with negative environmental externalities will be affected and jobs will need to shift towards a climate-neutral and clean technology dominated economy including renewable energy, energy efficiency, energy storage and decarbonising transport, industry.

India’s production-based incentive for solar and energy storage is a good example of creating industries that are eligible to receive climate-aligned finance and becoming a manufacturing hub.

What could India’s response be?

A World Bank report estimates that losses to India’s gross domestic product by 2050 due to climate change could be $1,178 billion.

The RBI has noted the importance of climate-related financial disclosures and private green finance as necessary to generate the enormous amounts of investments are required to combat climate change and bring about a transformation towards sustainable and low carbon development.

The most important international initiative to make private sector contribute to climate positive action and become resilient to climate risks are the recommendations of the Task Force on Climate-related Financial Disclosures (TFCD).

This is  which is now widely recognised as the gold standard for global business sustainability reporting frameworks, providing standardised and comprehensive guidelines for corporate climate disclosures.

About 32 Indian organisations have signed up for TFCD, including the Mahindra Group, Wipro, Confederation of Indian Industries, National Stock Exchange, DLF, Havells India, Hero MotoCorp, Piramal Enterprises among others.

A study by non-profit Shakti Foundation found that an assessment of BSE100 companies showcases that most of the Indian companies are lagging in the climate change disclosure space due to lack of relevant expertise; limited access to relevant tools and methodologies; and limited subject knowledge.

Therefore, the Indian government needs to introduce guidelines and regulations to standardise and mandate climate-related disclosures in all financial statements and push private companies and financial institutions to manage their exposure to climate risks in their portfolios and operations.

This would help not only in increasing resilience of Indian companies to face physical and transition risks of climate change but also in facilitating greater climate finance flows while minimising ‘greenwashing’.