By Partha Bose, Head of Capital Markets at Cervest.
Like all industries, the global finance sector is facing the need to deal with the pressing and escalating realities of climate change. This pressure has created a green finance boom, with investors channelling trillions of pounds into low-carbon and climate-resilient businesses.
The flourishing green finance space could play a decisive role in stimulating climate action, both in terms of mitigating future instability by encouraging decarbonization and safeguarding communities from climatic hazards by promoting climate resilience. In 2022, I am cautiously optimistic that a combination of market trends and external pressures will prompt green finance to fulfil this role, allocating funds towards impactful businesses and innovations, and coming to terms with the pressing issue of climate risk.
Looking beyond Net Zero
At present, conversations and investments in the green finance sector are very much centred on the transition to Net Zero. While reducing emissions is essential for long-term environmental stability, it won’t be enough to help us tackle extreme weather events and slow-onset risks locked in by decades of historic greenhouse gas emissions. The majority of businesses have already been impacted by climate volatility and recognise its bottom-line impacts. As climate change accelerates, the risks it poses to companies will grow.
This year, I believe green finance practitioners will come to appreciate that transitioning to Net Zero is only half of the Climate Action ‘equation’. Rather than looking solely at emission reduction, they will turn their attention to companies and technologies that facilitate adaptation; the process of adjusting strategies, models, and assets to compensate for climatic hazards. As the recent report from the Intergovernmental Panel on Climate Change (IPCC) made clear, adaptation is effective at reducing vulnerability to climate-related risk, but the window of opportunity to shift pathways towards a climate-resilient future is narrowing.
Growing regulation around climate and sustainability-related activity will move this forward. Countries around the world are beginning to adopt mandatory climate-related financial reporting, in line with the recommendations from the Task Force on Climate Related Financial Disclosures (TCFD). From 6 April, 1,300 UK-registered businesses will be required to submit information on climate-related risks and opportunities alongside their annual accounts. The US looks set to follow suit, with President Biden signing an executive order “to advance consistent, clear, intelligible, comparable, and accurate disclosure of climate-related financial risk.”
While the majority of businesses are already planning to publish information about the risks and opportunities associated with climate change, regulations based on a common framework are needed to equip green finance investors to discover, analyse and price climate-related vulnerabilities. These regulations should also go some way to solving the profound and growing lack of trust investors have in Environmental Social and Governance (ESG) reporting.
Scrutiny and standardisation
TCFD-aligned disclosure requirements are just the beginning of what I see as an international, cross-industry drive towards greater scrutiny of how carbon and climate risks are priced into financial transactions. This can’t come soon enough. Accurate, comparable information is essential to repricing risk, a key pain point for players in the finance industry.
Central to this scrutiny will be the emergence of independent ratings and verifiable data. There has been a lot of progress in this area already, not least by Cervest, through the upcoming introduction of EarthCap™, a financial markets product that helps banks, asset managers, and insurance companies integrate Climate Intelligence (CI) – asset-level intelligence for decision making – into transactions.
I believe we will also start to see the frameworks employed by different regulatory regimes begin to converge thanks to efforts in both the public and private sectors. The harmonisation, transparency, and materiality of ESG standards are essential to green finance. Without it, greenwashing will continue to distort financial decision making and apples-to-apples comparisons between companies and organisations will remain all but impossible.
That said, I am concerned that regulation and industry will not keep pace with each other. Businesses and countries are still adopting climate risk mitigation and adaptation strategies at different rates and levels. For the world to successfully combat and adapt to climate change, we need to be moving at the same pace — either we all win or we all lose. In 2022, we need to start making the first steps towards harmonisation and standardisation.
Supporting and embracing innovation
Climate-related technologies are key to helping businesses and governments adapt to climatic hazards. Over the next year, I expect to see green finance investors realising the importance of products like EarthCap and EarthScanTM, which provide an extremely comprehensive view of climate risk at the asset level.
CI-based financial insights will be a gamechanger for the financial world, enabling banks, asset managers and insurance providers to price climate risk for the first time. A recent report by analyst firm IDC corroborated this view, stating Climate Intelligence should be “a strategic priority for organisations worldwide” and “one primary solution” to the $23 trillion problem of climate change.
For the time being, I predict we will continue to see only a limited number of providers with the combined scientific and technology capabilities needed to produce decision-useful insights and create new instruments to price climate risk. Yet, by identifying and funnelling capital into deep research-based solutions, green finance investors can mature the market for non-carbon-related Climate Intelligence and insights, to the point where there are only a few key players equipped with the scientific rigour necessary to tackle climate risk in a meaningful way.
The time for being reactive to climate change is over. We cannot keep waiting for catastrophic events to happen in order to drive change. By moving beyond Net Zero, backing non-carbon-related innovations, and using Climate Intelligence insights and instruments to reprice risk, I believe that this year, green finance will begin to support the rapid changes needed to adapt with climate change.