The Climate Finance conference in Paris from 26-28 November 2018 was a three day effort to orchestrate, showcase and upscale action by the financial industry on climate and SDG finance. As a participant of this conference, I group the key takeaways from this conference in three strategies that economists use to address market failures and externalities: regulation, markets and collective action.
Strategy 1: Regulation
“Where the regulators are actively looking at this topic, and doing this transition and stress testing, now this moves the needle.” Maarten Biermans, Rabobank, stated in one of the panels
Let me start with regulation, or rather, regulators. There was a clear consensus at this conference that the issue of climate finance was taken a lot more seriously since the moment national financial regulators started to engage with this topic from a risk perspective, approximately four years ago. In particular the role of the Taskforce on Climate-related Financial Disclosures (TCFD) was stressed: a standard for climate-related disclosures to be integrated in mainstream reporting which will be embedded in financial regulation in Europe. It is no longer only the sustainability niche banks and NGO’s pushing climate finance. To motivate regulators to be able to play this role, the term ‘mutual signaling’ was coined: if the financial sector and markets are able to signal they want certain action, regulators can respond. At the same time, regulators are expected to provide a minimum standard, but not to push the market ‘all the way’. They will provide a back stop, but they will not push financial institutions to be forerunners and exploit the opportunities that arise due to climate change.
Strategy 2: Markets
“The business case of sustainability is challenging, particularly in the short term, but on the middle and long term, this is the way to go.” Thomas Buberl, CEO AXA, statement in his keynote speech
That brings us to the second approach to tackling climate change: using market-driven demand. The importance of building business models that support sustainable finance was widely shared, and identified as a challenge. Furthermore, it seemed that the ‘business model’ for sustainable investment was more or less apparent depending on the geographical context in which financial institutions are acting. Climate effects are already negatively affecting the underlying business of banks in some geographies: the CEO of the Land and Agricultural Bank stated that if banks would not push the agricultural sector in South Africa to become resilient to climate change, ‘there will be no sector left to finance and the bank will die a natural death’. In other geographical contexts it seemed to be client demand that provides the business case for sustainable finance: the CEO of Nordea noted that sustainable banking is the smart thing to do because it is driven by demand from clients.
At the heart of the discussion about the ‘business case’ for sustainable finance were two competing terms: risk and positive impact. Satya Tripathi, assistant secretary at UN Environment, argued that climate risk is being underestimated and that it will ‘wipe out long-term returns’. Erik Usher, chair of the UNEP Financing Initiative, and Andrew Parry, chair of the Positive Impact initiative, both stressed the importance of developing ‘positive impact’ business models as a driver of climate and SDG finance. A nice illustration of how both can be combined in a business case was given by Mark Tarcek of the Nature Conservancy, who worked with Swiss RE, Cancun hotel owners and Mexican authorities to structure an investment deal (including insurance) for coral reef restoration on the Mexican coastline. This nature-based intervention was calculated to reduce flood risk at a 15 times lower cost than man-made protection.
Strategy 3: Collective action
“The most important is collaboration in the sector. This is the one place where we don’t compete but we come together to work for the common good.” Julie Batch, chief customer officer IAG, statement in an insurance panel
During these three days, efforts to successfully create collective action for sustainable finance were abound. The Principles for Responsible Banking were launched by 28 forerunner banks from across the globe, with eight of their CEOs on stage publicly expressing their commitment to these principles and urging other banks to join this sector-driven initiative. The issue of accountability was explicitly addressed: bank activities will be monitored and banks can be asked to leave the group if they do not adhere to the principles (punishment). At the same time, the challenge of collective action ‘in action’ was expressed on stage by Minkhtsetseg Chultem, chairwomen of Golomt bank in Mongolia: “The banking principles are in line with beliefs but we need the help of other banks in Mongolia to realize this, since if we start putting green requirements we will go out of business if all our clients then move to other banks.”
It was not just about banking. A group of forerunner insurance players were presented onstage who were all signatories of the Principles of Responsible Insurance. Insurers can influence climate mitigation and adaptation activities on both sides of their balance sheet: they can use their asset management activities to pressure, for example by divesting from coal (which AXA did) and they can also adjust their insurance policies to incentivize home owners to undertake measures for climate adaptation (suggested by Dave Jones, California’s famous insurance regulator).
Metrics are crucial across strategies
A crucial topic that returned and seems to play a role for all three strategies (regulation, markets, collective action) is the issue of measurement. Metrics are needed to implement harmonized regulation and disclosure: to this end a taxonomy is currently being developed by the EU. Metrics are needed to build a business case for sustainability: hard evidence on the risk reduction potential and positive impact of natural capital can make financing available, as the case of coral reef investment in Mexico showed. Finally, metrics are also needed to monitor progress and accountability of financial players who commit to voluntary action, for example to Responsible Principles. The availability of metrics is one of the suggested reasons that climate action is more investible than biodiversity (and nature-based) action, also because the benefits of biodiversity are diffuse and indirect. A promising step in the right direction is the natural capital risk assessment tool that was launched at the conference, ENCORE. Another relevant development is the use of digital technologies ‘for good’, for example by using satellite data for natural capital monitoring and risk assessment. The UN taskforce for digital finance for the SDG’s was also launched the day after the conference.
Much is being done, much more is needed
Carving out part of a bond portfolio as ‘green bonds’ is the easy part but not enough. The CEO of Societe Generale, Frederic Oudea, shared his more difficult question: How do you deal with loans that are not sustainable but profitable? There are high expectations of the upcoming taxonomy and disclosure regulation to help financial institutions ‘deal’ with this perhaps in the future leading to more stringent regulation. I will keep following this space to monitor developments, in particular in relation to nature-based solutions.
Helen Toxopeus is a researcher working in the Sustainable Finance Lab at Utrecht University and for NATURVATION.