COP commitments, Climate finance and Climate Risk – A Connected Continuum

The recently concluded COP 28 has, once again, flood lighted the need for focused and positive action to facilitate movement towards a low carbon ecosystem and therefore a sustainable future for all. A crucial decision made at COP 28, as relevant to this article, is the need to reduce Greenhouse Gases by 43% by 2030 and 60% by 2035 (relative to the 2019 levels) to achieve the net zero goal by 2050[1]. To enable this transition, as a sample, renewable energy alone requires tripling of capacity by 2030.

To actualize energy and similar “sustainability” objectives, both sizeable financial support and innovative technologies that help realize low emission capabilities, will be required. This leads to the next data point discussed at COP 28, continuing with the example of clean energy, finance requirement for this segment is estimated at about  $4.3 Trillion per year in global investments till 2030 and then $5 trillion till 2050 to meet the net zero targets by 2050, this against the current investments of about $1.8 trillion per year.

The climate finance gap and the related requirement for facilitating the net zero transition is staggering. All financial players and funds suppliers like governments, central banks, development banks, commercial banks, institutional investors, will need to gear up to provide the required financing to address climate change and accelerate green transition.

This directly leads to climate and sustainable financing, a relatively new area for banks. At the outset, banks require the skill set to identify the right kind of clients/ borrowers who qualify for “green loans or investments” and who are good lending or investment risk, as the purpose of financing is to recover the funds over a period on agreed terms. The next is the ability to ensure proper disbursement and tracking of end utilization of funds to ensure that they are being utilized for the purpose they were intended. The third is a good grasp of the potential climate-related financial risks that the funding could lead banks into and putting in place actionable risk mitigation measures. This takes us to the next part of the connected continuum - climate change risk.

An important detour here is to draw a significant distinction between the concepts and thereby conversations around climate change and climate risk. Climate risk, while innately connected to climate change, is a distinct subset of the broader themes of climate change and environment. Climate change discussions are shaped by global dialogue and intergovernmental summits like the COP meetings, the latest being the recently concluded COP 28 in Dubai which is to be followed by the proposed COP 29 in Baku, Azerbaijan.

The interpretation, way forward and narrative of climate risk is shaped largely by financial regulators, specialized global organizations and other related private sector institutions. There lies the distinction. Understanding the impact of physical and transition hazards/drivers, exposures and vulnerabilities, transmission channels and amplifiers, their collective impact on individuals, households, corporates, financial institutions that lend and invest in them, their spillover effect on different sectors, geographies, individuals in real economy and vice-versa, is the focus of the risk lens.

“Mitigating negative effects of climate change is an economic concern in addition to its being an environmental one as it exposes both the bank and its customers to the entire risk spectrum – both financial and non-financial[2]”,  To manage the scale of financing indicated earlier in the article, organizations will need to be geared to assess and manage  the complex inter-connected canvas of climate-related financial risks, understand the impact on traditional risks (credit, market, operational, liquidity), and more importantly the interplay of the real economy outcomes due to adverse climate changes which then influence and effect the financial system.

Climate change risk is an evolving and challenging discipline. What complicates the landscape is the staggering volumes of funds and responses required as well as the urgency of action that is expected of the fund providers. The complex but connected continuum of commitments/ decisions made at COP and similar meetings, the expectation of climate finance in the order of trillions of dollars, the resultant mandate of understanding and managing inter-connected climate risks, demands a lot from banks and other fund providers, who will need to come up the curve at breakneck pace. More so when “All that is Green is not Gold,” a theme I plan to discuss in my next blog.

[1] United Nations, Climate Action – Global stocktake reports

[2] Climate Change Risk Management in Banks – The Next Paradigm